Out of the ashes of the Enron scandal rose the Sarbanes-Oxley Act of 2002, which enacted protections for investors, including prohibiting the intermingling of audit and legal consulting services for the same client. The idea was to ensure that the critical “guardian of the capital markets” role of the auditor wasn’t unduly influenced by nonaudit services. That promise of independence is now at risk.
If someone were to ask you how many lawyers are employed in client service by the global Big 4 accounting firms, would your answer be: a) Zero, because the Sarbanes-Oxley Act prohibits audit firms from providing legal services to clients; b) Not many, because delivering legal services isn’t something accounting firms have the expertise to do and would create the appearance of a conflict of interest; or c) 2,200 lawyers working in 72 countries?
The correct answer is c, as recently reported by ALM Intelligence. According to ALM, this number of lawyers employed rivals even well-known law firms such as Jones Day and Clifford Chance.
More of us ought to be concerned about potential threats to audit quality and should be wondering how and why this has happened. It clearly represents a potential independence problem and puts pressure on the protections the act created.
The post-Enron world has been good for the Big 4 accounting giants who have gradually returned to providing nonaudit (consulting) services in a significant way. Those services now include legal assistance. But this legal assistance is provided almost entirely outside of the United States.
Deloitte Legal, EY Law, KPMG Law and PwC Law — these are names you probably haven’t heard. And the affiliated global firms are not talking too loudly about this advance into the field of law.
It is true that the Sarbanes-Oxley Act did not prohibit accounting firms from providing legal services. Rather, the law outlines restrictions or prohibitions on specified nonaudit services (including legal) that firms can provide to audit clients. Legal services may be provided to client companies that the accounting firm doesn’t audit.
Importantly, although tax structuring, advising and compliance services are closely related to legal work, these services are OK, even for audit clients.
The accounting giants are primarily focusing their legal services in long-standing areas of expertise — such as taxes, business structuring, mergers and acquisitions, and employment and immigration.
They have built their law practices in countries where the legal and regulatory environment is favorable to ownership by nonlawyers — e.g., the United Kingdom. They hire lawyers from competing law firms and aggressively pursue joint business relationships with smaller law firms in targeted practice areas.
PwC UK recently formed an alliance with Fragomen, a New York-based immigration specialist law firm, and Deloitte UK allied with another U.S. immigration law firm, Berry Appleman & Leiden. In 2018, EY Law acquired London-based Riverview Law. The American Lawyer reports that KPMG “is aiming to almost double headcount in its global legal services arm to more than 3,000 lawyers in the next few years.”
The geographic concentration of the global Big 4 legal practices today is primarily in Europe, but Asia is an area of growing focus. Challenges to further expansion include possible moves by global audit regulators to further restrict nonaudit services provided to audit clients. In the U.K., a serious debate has already started relating to potentially requiring “audit-only” firms.
In the U.S., restrictions on providing nonaudit services to audit clients and their foreign affiliates will continue to present a significant challenge to expansion plans. Keeping the firms in compliance with multiple jurisdictional rules is already a big challenge, and expansion of legal services makes it all the more difficult.
The U.S. auditor regulator, the Public Company Accounting Oversight Board, has said it is monitoring the firms’ compliance with independence requirements, including providing legal services. It is uncertain whether rules relating to law firm ownership and the audit regulatory environment will ever allow the provision of legal services by accounting firms or their affiliates in the U.S.
That is as it should be. Regulators and auditing firms must be committed to eliminating any possibility of inappropriate influence or bias in their critical oversight of the corporate world. That unbiased and fearless oversight is essential protection for investors large and small.
Jeff Johanns is a lecturer in the accounting department at the McCombs School of Business at The University of Texas at Austin and previously was a partner and U.S. assurance risk management leader at PricewaterhouseCoopers LLP.