EY’s Abandoned Split Exposes Obstacles to Big Tech Consulting – Bloomberg Law

Ernst & Young has a tech growth problem the size of Silicon Valley, and the firms failure to spin off its consulting business has eliminated what it envisioned as a way out.

Like all accounting firms, it is barred from forming lucrative consulting partnerships with its audit clients, but the restriction is especially onerous for EY, with its audit roster of tech heavyweights like Amazon, Alphabet, and Salesforce. Its inability to team up with such companies to build and sell tech solutions hamstrings its consulting practice, forcing it to leave millions of dollars on the table for in-demand services crucial to todays corporations.

EYs leaders had sought to split up the firm so its $19.7 billion consulting and strategy practices could pursue such partnerships, freeing those businesses from rules intended to ensure that auditors provide unvarnished views of their clients financial health. The collapse of the ambitious plan puts EY back where it started: Its restricted from promoting or jointly selling services offered by audit clients.

It really makes it impossible to enter into any kind of partnership or joint marketing, joint-service-provision type of an arrangement when youre auditing that company, Cathy Allen, who runs the ethics compliance firm Audit Conduct, said of US conflict-of-interest rules.

Those conflicts and restrictions will remain as the firm confronts its future with audit, tax and consulting tethered together.

EY didnt respond to requests for comment for this article.

EY leaders, however, have said that they still want to restructure at some point, committing to their argument that the practices would be stronger apart.

This was a way to disrupt our industry, Carmine Di Sibio, the firms global chairman, said about the firms restructuring in remarks to a Milken Institute event Monday. Its on pause, its really on pause for a while, but its something that well continue to look at over the next couple years.

In some ways EY is a victim of its own success. Its buildup of software and tech clientele over the years means its potential for conflicts of interest is bigger than for the other Big Four firms, said Doug Carmichael, former chief auditor of the Public Company Accounting Oversight Board and an accounting professor at Baruch College.

PwC, also known as PriceWaterhouseCoopers, KPMG and Deloitte are the other Big Four firms.

EY has acknowledged the restrictions under which its working.

The firm audits nine of the 10 biggest tech companies, DiSibio told CNBC in January while discussing the firms plans to carve out its consulting arm and much of its tax practice into a unit known provisionally as Newco.

Theyre also the companies we could have alliances with going forward on the Newco side, he said. So thats been an inhibitor in terms of our growth in consulting.

In addition to Amazon, Alphabet and Salesforce, EYs audit clients include Intuit, HP, Workday and Apple. It also audits small, nascent technology companies and has served as auditor to eight tech IPOs since 2018, according to PitchBook data.

EYs technology and digital transformation work contributed to a 25% spike in revenue for its global consulting practice last year. Tech consulting is among the most heavily promoted consulting services offered by the Big Four, and such work is much more profitable than auditing, said Elizabeth Cowle, assistant professor of accounting at Colorado State University.

Alphabet last year paid EY $41 million for auditing and related services, she noted.

If youre making $41 million off the audit, she said, how much could you be making off consulting?

Longstanding US securities rules prohibit accounting firms from entering into certain business relationships with their audit clients if they were to share whats known as a mutual interest. That means that profit sharing, jointly developing products or even advocating for a clients work is out of bounds.

Firms have learned the hard way to steer clear of arrangements that could threaten their independence from audit clients.

The Securities and Exchange Commission suspended EY in 2004 from accepting new public-company audit clients for six months over auditor-independence issues that dated back to the 1990s. EY had audited the software firm PeopleSoft at the same time the firms consulting arm profited from recommending PeopleSoft software to customers.

More recently, Marcum LLP, a top-15 US accounting firm, paid $525,000 in penalties and other sanctions in 2019 for promoting audit clients as good investment opportunities at conferences the firm hosted.

Although big partnerships with audit clients are off limits, firms may be able to help consulting clients adopt mainstream software or cloud platformsroutine implementation work considered a core consulting serviceeven if those platforms and apps are run by audit clients.

But accounting firms have to be careful how they market those services to avoid violating the independence rules, Allen said, referring to Securities and Exchange Commission regulations. Its a very tricky area to navigate.

Consultants, for example, cant tell a client to use a specific application or tool if it happens to be one provided by an audit client, but they could offer a menu of options which includes products of its audit clients, Carmichael said.

Sorting through those gray areas with regulators and audit committees takes time, however. Clients may be unwilling to wait to clear any possible conflicts and may choose instead a competitor who can start right away on the project.

Even there, EY could run into problems. Many major tech companies, including Netflix, Airbnb, and Pinterest, say Amazon Web Services is critical to running their businessand EY is Amazons auditor. Depending on the circumstances, that alone could be enough to preclude EY from pitching work to those companies, industry observers say.

The rules arent always very clear about this, said Fiona Czerniawska, CEO of Source Global Research, which tracks the professional-services industry.

EYs leaders contended that separating auditing from consulting would have better enabled EYs consulting operations to compete with consulting companies like Accenture, McKinsey, and Alvarez & Marsal that dont have to vet potential clients for audit conflicts.

They dont have to worry about calling us and us telling them, We cant serve you here because we have an audit conflict, Paul Aversano, managing director at Alvarez & Marsal and a former EY partner, said of advisory clients. They know when they call us, were largely going to be able to serve them.

Still, accounting firms, including their consulting arms, benefit from the stable revenue audits deliver, especially for decades-long client relationships. Sri Ramamoorti, an associate professor at the University of Dayton, compared that steady stream of revenue to a perpetual annuity.

And that stability obviously is very good in business, Ramamoorti said.

A split might resolve concerns about keeping auditors independent. But it would also deprive them of the market knowledge and technical skills that their consulting colleagues provide them under the current setup, in areas from cybersecurity to valuations to automation.

Theres no perfect solution here, Czerniawska said.

The future of auditing and consulting is going to be about technology, she said. Is there going to be an audit in the way we know it in 20 years time?

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EY's Abandoned Split Exposes Obstacles to Big Tech Consulting - Bloomberg Law