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                                                                                BUSINESS, Page 48

ACCOUNTING

Who's Counting?


A once quiet profession suffers intense public scrutiny and
staggeringly expensive litigation over its role in financial
disasters

By THOMAS MCCARROLL


    On paper, Miniscribe certainly looked like a highflyer.
The Colorado-based company's financial statements in the
mid-1980s painted it as a vigorous, healthy computer-parts maker
with a bright future. But an internal investigation drew quite
a different picture. The probe uncovered massive fraud by
senior managers, who shipped boxes of bricks labeled as disk
drives and counted them as sales. Investigators blamed
executives for the company's cooked books, but bondholders also
sued Miniscribe's auditors, Coopers & Lybrand, for conducting
faulty audits. In February a jury stunned the accounting
profession by ordering C&L to pay damages of $200 million. It
was the largest judgment ever levied against an accounting firm.

    Coopers & Lybrand is not the only auditing firm being
dragged into court these days. From the Big Six firms, which
ring up a quarter of the industry's $46 billion in revenues, to
the bean-size outfits that operate in storefronts and home
offices, the accounting profession is facing the most serious
liability crisis in its history.

    All told, U.S. accountants now face 4,000 liability suits
-- double the number in 1985 -- and more than $15 billion in
damages. In the past year, the six largest firms alone have paid
more than $300 million to settle such suits. At the same time,
legal expenses and insurance rates are zooming. The financial
burden is so pressing that it is driving many firms out of the
riskiest lines of business and pushing others out of business
altogether. Says Mark Carr, editor of Public Accounting Report,
an industry newsletter: "The magnitude of the suits and the
potential risks pose a great danger for even the largest firms.
It's a crisis, and it's a big crisis."

    Roughly two-thirds of the litigation stems from the epic
savings and loan scandal. Accounting firms, along with lawyers
and others, face thousands of lawsuits by investors and
government regulators, including the Federal Deposit Insurance
Corporation. Accountants' financial liability in S&L cases could
exceed $9 billion, not counting compensatory damages. Last week
Ernst & Young agreed to pay $63 million to settle claims that
its negligence helped S&L honcho Charles Keating Jr. defraud
some 23,000 investors in Lincoln Savings & Loan. The settlement
came two weeks after the largest U.S. accounting firm, Arthur
Andersen, paid $22 million for fraud claims arising from the
same S&L collapse.

    Accounting firms can expect to be sued in connection with
many of the past decade's financial scandals. A notable
example: the collapse of the Bank of Credit & Commerce
International, which investigators shut down last July after it
was found to be a virtual supermarket of illegal services.
American firms Ernst & Young and Price Waterhouse are being
investigated for their part in managing B.C.C.I.'s books; both
could face suits. Coopers & Lybrand is coming under similar
scrutiny for its role as auditor for the media tycoon Robert
Maxwell, who apparently looted some of his companies in the
months before his mysterious death at sea. Deloitte & Touche
stands to be hit with hundreds of liability suits by
policyholders whose investments were put at risk by the failure
of Executive Life Insurance.

    The case against accountants revolves primarily around
their function as auditors, which accounts for 60% of the
profession's revenues. An additional 23% comes from tax planning
and the remainder from consulting work. After examining a
corporate client's books, auditors usually issue a letter
intended to adorn the company's financial statement and certify
that the statement is free of errors that could distort the
company's fiscal picture. The note often includes the auditor's
opinion of the company's business risks. But, cautions Dennis
Beresford, chairman of the Financial Accounting Standards Board,
the profession's chief rule-making body: "The auditor's
signature is not the Good Housekeeping Seal of Approval."

    The problem is that many investors think it is. If
something goes wrong, they tend to blame the auditor as well as
the company's top officers. The common assumption is that
auditors should be among the first to know whether a company is
failing or even defrauding investors. To be sure, accountants
can be found negligent and held liable if their own work is
sloppy. A 1989 report by the General Accounting Office on failed
thrifts, for instance, found many cases where auditors simply
failed to provide independent verification of management claims
that problem loans were collectible.

    Responsibility for spotting outright fraud, though, is
another matter. Says John Hill, assistant professor of
accounting at Indiana University: "No audit is going to uncover
cleverly disguised fraudulent schemes concocted by management."
In the strictest sense, auditors are not required to look for
fraud -- but controversy rages about what they should do when
they stumble upon it. Rather than inform on clients, auditors
usually prefer to drop the account quietly. When that happens,
the client must file form 8-K with the Securities and Exchange
Commission, explaining why the auditor resigned. But details of
the disagreement are typically fudged and played down.

    Many lawmakers want to change that practice. Democratic
Congressman Ron Wyden of Oregon wants to force accountants to
blow the whistle on lawbreaking clients. In 1990 Wyden
introduced legislation that would have required auditors to
report to the SEC any client found engaging in fraud. Though it
passed the House, the bill failed to clear the Senate. Says
Wyden, who plans to try again this year: "They're called
certified `public' accountants because they're accountable to
the public. But accountants are not living up to their public
duty. If they find wrongdoing, they have an obligation to come
forward."

    Wyden and others lay a large part of the blame for the S&L
crisis at the door of the accounting profession. "Accountants
didn't cause the S&L crisis," says Wyden. "But they could have
saved taxpayers a lot of money if they did their jobs properly
and set off enough warning alarms for regulators."

    The accounting profession sees itself as a scapegoat in
the S&L crisis. Says J. Michael Cook, chairman of Deloitte &
Touche: "The equation that an S&L failed, it had an audit, so
the audit failed -- that just doesn't add up." Industry leaders
complain that they are being targeted by government regulators
seeking to deflect blame from their own mistakes and by
investors looking for rich firms to make good their losses.
"People come after the auditors because they're usually the only
ones with money left standing," says Philip Chenok, president
of the American Institute of Certified Public Accountants
(A.I.C.P.A.).

    The industry's crisis has already toppled some stalwarts.
Laventhol & Horwath, the big Philadelphia-based firm, filed for
bankruptcy last year after it became the target of several
lawsuits stemming from its auditing and consulting work. L&H had
paid more than $50 million in claims before folding. Another
major failure could be imminent, some analysts believe. The
average Big Six firm has total capital of nearly $3 billion, but
in light of recent damage awards, even that amount could be
eroded. Of the Big Six, Ernst & Young may be the most exposed
because of its focus on the financial industry. The New York
City firm audited about one-fifth of all recently failed banks
and S&Ls.

    Firms are also paying the price in the form of higher
legal expenses and climbing insurance rates, which together can
eat up 25% of a firm's profits. The typical Big Six firm spends
an average of $30 million a year to defend itself against
lawsuits, twice as much as five years ago. Insurance premiums
are also rising, up at least 15% last year, to about $5,300 for
the average Big Six accountant. Increasingly, however, insurers
are refusing to offer any coverage at all to accounting firms
because the risks are too great and uncertain. Insurers have no
way to measure the risks of insuring some financial-services
audits because problems usually remain uncovered until several
years after the audit. Where 15 firms offered audit insurance
about five years ago, only three or four still do, including
Crum & Forster. In response, accounting firms are abandoning the
riskiest clients, most notably financial-services companies.
Goldstein Golub Kessler, a midsize New York City firm with more
than 1,500 clients, says it will no longer perform audit work
for banks, credit unions or insurance concerns. KPMG Peat
Marwick, the fourth largest accounting firm, is also turning
away high-risk cases, says Michael Conway, the partner in charge
of professional practices. "We're being very selective about
which clients we accept."

    Accountants won't be the only ones who will pay, say
analysts. As large firms retreat -- the Big Six currently handle
the audits of 90% of FORTUNE 500 companies -- industries that
require the most careful audits could be left without
accountants or with lower-quality auditors. "Financial markets
could grind to a halt if auditors stop certifying books," warns
Rick Telberg, editor of Accounting Today, a New York City
newspaper. "Investors are not going to invest unless they see
that stamp of approval."

    The profession is instituting a series of reforms designed
to prevent future legal shocks. In January 92% of A.I.C.P.A.
members voted to organize in forms other than partnerships,
which saddle individual partners with maximum liability risk;
most want to switch to general corporations. The plan needs
approval from all 50 states. The group's members also voted
overwhelmingly to maintain a long-standing policy that bars
members from volunteering confidential client information to
government agencies, making it even more unlikely that
accountants will squeal on clients unless subpoenaed.

    To some extent, the increased litigation has served to
make accountants more vigilant. But the reforms so far have
failed to slow the avalanche of lawsuits. More litigation is
bound to increase the cost of doing business for accountants,
which in turn will mean higher costs for the companies they
serve and for customers down the line. And if that drives the
best professionals away from the areas where they are needed
most, it would be a heavy price to pay for America's obsession
with lawsuits as the way to solve all problems.