Period of Adjustment

EXECUTIVE SUMMARY

THE NONAUDIT SERVICES Sarbanes-Oxley prohibits CPAs from providing to their public company audit clients are bookkeeping or services related to the accounting records or financial statements of the client; financial information systems design and implementation; appraisal or valuation services, fairness opinions or contribution-in-kind reports; actuarial services; internal audit outsourcing services; management functions or human resources; broker/dealer, investment adviser or investment banking services; and legal and expert services unrelated to the audit. REGIONAL FIRMS CAN CONTINUE TO CROSS-SELL nonaudit services—just not to the public companies they audit. Midsize firms will have a better chance to sell their consulting services now that all firms are proscribed from offering specific nonaudit services to audited public clients, some say. SOME CPAs HAD BEEN EFFECTIVELY SHUT out from marketing nonaudit services to publicly traded companies because the larger national accounting firms charged significantly lower audit fees. Now that cross-selling is prohibited, small firms are in a position to credibly pitch nonaudit services. MANY FIRMS ARE PROVIDING CONSULTING services to clients on the consequences of Sarbanes-Oxley, adding more service specialties, increasing marketing budgets, dividing marketing between two staffs, adding marketing staff and hiring marketing directors to oversee their sales efforts. TO PURSUE AUDIT AND NONAUDIT MARKETING, a firm will need to analyze its client base, restructure the firm to effect the best provision of services and then market services according to each client’s primary needs balanced against what’s most profitable for the firm. CPAs should work out the decision together with their clients. BECAUSE AN INDIVIDUAL FIRM NO LONGER CAN serve as both the internal and outside auditor for a public company client, one CPA says it benefits his firm if a major competitor wins the work it loses. It effectively prevents that competitor from seeking a significant portion of work the firm wants and ensures that the internal auditor’s work is top quality.

Russ Banham is a Seattle-based author, journalist and playwright. His new book, The Ford Century, a history of Ford Motor Co., came out in November 2002.

he auditor independence rules mandated by passage of the Sarbanes-Oxley Act in August 2002 are a double-edged sword for regional CPA firms. No longer able to use audit engagements as an opportunity to spot client needs and sell remedial consulting services such as internal controls tune-ups, information technology, actuarial research or human resources management, many multiservice, midsize firms must change their marketing plans. To avoid sacrificing the considerable investment they made to become versatile business services providers, most still will sell nonattest services—just not to the public company clients they audit. What these firms aren’t doing is exiting one service market to focus on another—the strategy the largest firms have been forced to use. Here’s how some midsize firms are adapting to the law’s strict cleaving of audit and nonaudit services.

The act’s prohibition against CPAs’ performing any of eight nonaudit services for the public companies they audit is the biggest challenge to accounting firms. Those services are

Bookkeeping or other services related to the accounting records or financial statements of the audit client.
Financial information systems design and implementation consulting.
Appraisal or valuation services, fairness opinions or contribution-in-kind reports.
Actuarial services.
Internal audit outsourcing services.
Management functions or human resources consulting.
Broker/dealer, investment adviser or investment banking services.
Legal services and expert services unrelated to the audit.

Firms may provide other nonaudit services—including tax—if the public company’s audit committee preapproves the service and the entity discloses the fact to investors in periodic reports.

Providing consulting services to clients about the consequences of Sarbanes-Oxley.
Adding more service specialties.
Increasing marketing budgets and adding marketing staff.
Hiring a marketing director to oversee the firm’s sales efforts and suggest new services.

Paul Sepp, CPA and director at Elmore & Associates, a Missoula, Montana, accounting firm, provides consulting services to clients on the ramifications of the new law. “Our clients wanted clarification of the law’s specifics, and we wanted to set the stage for its potential impact on audit fees,” he says. “We also advised them to begin implementing some of the corporate responsibility aspects of the legislation whether or not they are public companies.”

Mendlowitz says the firm’s decision to offer corporate governance services is based on the observation that “boards of directors now feel greater pressure to perform their responsibilities to a higher standard. The firm teaches them how to read financial statements, understand what the reporting requirements are and what backup and additional information they should obtain from the company.” The firm’s marketing budget has been used for brochures, mailings to attorneys and personal contacts with clients who are directors.

To provide its virtual bookkeeping services, the firm set up a new department. It offers “accounting and bookkeeping services to companies that don’t want to hire their own people. We do it in our office and they have access to it on the Internet,” Mendlowitz says. “We have one ad alone costing us $25,000 a year and we’re spending $40,000 overall on software and other advertisements,” he says.

“We plan to go after large organizations that need to outsource their internal audit services—one of the prohibited services—and have started a new department to manage this,” says Mendlowitz. “From a marketing standpoint, the legislation gives us an advantage we didn’t have before: access to organizations that never would have talked to us because we weren’t doing their audit.”

Based on perceived advantages or disadvantages in the marketplace, other firms are adding items to or deleting them from their service menus. Scott Farb, CPA, a partner at the 60-person Beverly Hills, California, office of Rothstein, Kass and Co., says the impact of Sarbanes-Oxley has been mostly positive. The firm has hired 10 former senior executives from the Big Four in the past few months. “We’ve beefed up the business with people who are experts in areas that we want to market more fully, among them IT and tax consulting,” Farb says.

The firm will promote the new specialties, Farb says, “through writing articles and making speeches, getting more involved in the community and intensified public relations—the old roll-up-your-sleeves approach.”

SELLING AUDIT VS. NONAUDIT SERVICES
Reorganizing service niches within a firm is an ethical approach to selling under the new law. Ideas include separating a firm’s marketing into two teams, one for audits and the other for nonaudit services, and plying different marketing channels for each, some CPAs say. To do this would require a firm to analyze the client base to determine the primary needs of each client, restructure the firm to effect the best provision of services and then market those services, balancing the client’s needs against what’s most profitable for the firm.

“What CPAs can do to prepare depends on whether you’re looking at it from the audit or nonaudit side,” says Farb. “What we’re seeing because of Sarbanes-Oxley is a tremendous shortage of qualified audit professionals because a lot of them went into private industry or reevaluated their career options. Accountants must become more focused on auditing and the exposures related to it. I think continuing professional education is the key, as well as hands-on partner training and mentoring.”

The reasoning is this: “Under Sarbanes-Oxley that firm would be prevented from seeking most of the other work we want. In addition, as outside auditors, we may have to rely extensively on the work of internal auditors, so we want them to be among the best. This is self-serving, but it’s not entirely a financial issue. If our best competitors do this high-caliber internal audit work, we and the client both are likely to benefit,” Bunting says. “We hope our competition will take a similar view and reciprocate in areas where they face conflicts.” Recognizing that the marketplace will be divvied up in new patterns, some firms will pitch their services to competitors’ clients too (see “Respect the Spirit As Well As the Letter of the Law”). Services such as tax compliance might still be up for grabs, “but many larger clients have been splitting those off for some time anyway,” Bunting says.

Overall, the legislation has created a new playing field, providing opportunities for some firms and obstacles for others. “We’ve backed away from our traditional strategy of being all things to all people,” says Kretz. “We’re unbundling from a marketing standpoint—selling auditing, accounting and tax services as separate areas of expertise. It’s time to get back to basics now.”

REAPING AN UNEXPECTED HARVEST
For the most part, CPAs envision some good arising from the new federal securities legislation.

However, “there will be some initial, short-term shock—in our case it means that our go-to-market strategy and channels of distribution for prohibited services must change,” says Hildebrand. “Obviously, in situations where we do an external audit for an SEC client and are restricted from certain other services, we simply will market that capability elsewhere.”

Farb also reads the same tea leaves. “Frankly, the legislation has created a once-in-a-lifetime chance for us to obtain intellectual capital from the big firms—people who are reexamining their career paths,” says Farb, who heads a real estate niche. “We see the act as creating an opportunity for us in the middle market, too, now that big firms are less likely to focus on it. We’re marketing from an industry perspective—emphasizing our boutique services,” Farb says. “For example, we’re getting closer to professional organizations such as the National Association of Industrial and Office Properties and the Urban Land Institute, sponsoring events and speaking at conventions. We’re encouraged by the fact that we’ve acquired 15 new privately held clients in the past few months,” he says.

Mendlowitz says his firm will realize more audits and higher fees because of the legislation. “We were shut out of marketing nonaudit services to publicly traded companies because the national accounting firms would lowball the audit with the goal of selling their pricier nonaudit services. Now that cross-selling is prohibited, the playing field has leveled.”

Kretz also perceives more opportunities to market audit services. “We’re a regional firm and, like other firms this size, traditionally make most of our money doing audits,” he says. “But when we bid $50,000 on an audit and a national firm bid $30,000—using the audit as a loss leader—we had a pretty hard sell. Now that everybody is back to trying to make money on the audit, it’s a much fairer game.”

It’s also one that may have fewer participants in the future. “I expect the national firms will begin peeling off some of their smaller SEC clients and internal audit work to focus on higher margin business, which in the long run will be an opportunity for us,” Kretz says. “We’re building stronger relationships with national firms. Recently we met with the managing director of one to discuss our availability for local referrals in situations where it no longer could provide services to a client. As a regional firm we’re not necessarily in competition with them, whereas they’d be reluctant to refer work to another national firm because they don’t want them getting a foot in the door.”

TALK TO YOUR CLIENTS
As accounting firms and their clients shake up their relationships, new ones will emerge. “Clients will move away from monolithic relationships,” one source says. “They’ll shop for the best in class in each service category, no longer defaulting to their auditing firms for the services. Consequently, clients are likely to have multiple accounting firm relationships.”

Bunting says his firm now faces difficulty in determining which services it will continue to provide existing clients—audit work or nonaudit specialty services. “Sometimes we have to ask ourselves whether we want the audit,” he says. “That’s a very tough question to answer, so we have been asking our clients to participate in this decision making. We just had an audit client tell us we were number one for the audit, but the company was giving it to another firm because our nonaudit services to it were too important. We discussed this and reached a decision together.”

Rather than become a “victim” of the changes wrought by Sarbanes-Oxley, Bunting says, the firm will continue to be proactive—“choosing what we want to on a client-by-client basis, based on our analyses and theirs. In the long run, the more discussions—even difficult ones—you have with clients the stronger the relationship.”

One final word of caution: Firms must pay very close attention to regulatory pronouncements, which are ongoing. This is a good time to use the AICPA’s services to keep track of any potential movement by state societies, the SEC, FASB and Congress toward additional restrictions (go to http://cpcaf.aicpa.org/Resources/Sarbanes+Oxley/
The+Changing+Regulatory+Landscape.htm or call the Sarbanes-Oxley hot line at 866-265-1977).