The New Specialists

The torrent of new business that rained down on public accounting and auditing firms in the aftermath of the passage of the Sarbanes-Oxley Act has begun to subside somewhat. Receding waters reveal a landscape largely reshaped by regulation, increased litigation risk, the growth of capital markets, and globalization trends.

What hasn’t changed is the concentration of the Big Four—PricewaterhouseCoopers, Deloitte Touche Tohmatsu, Ernst & Young, and KPMG—who continue to hold a lock on the audit business of the top 1,000 global firms. That is not to say these prevailing giants emerged unchanged. The Big Four were forced to rethink their service offerings and client relationships, in part due to SOX requirements and its objective to assure independence, and, more specifically, to restrict audit clients from using the same firm for consulting services. Directors, newly mindful of their oversight responsibility, also began to seek advisers that had a specialty focus or could deliver service in ways that were more appropriate to their company’s accounting and financial consulting needs. Particularly in the aftermath of Arthur Andersen’s demise, says BDO Seidman CEO Jack Weisbaum, many boards were eager to find alternatives to the Big Four, and the investment community began to ease up on its bias toward top-tier audit firms. The result has been remarkable growth in next-tier accounting firms—enabled in part through consolidation—and the emergence of a new cottage industry of business services firms focused on forensics and risk.

While some audit committee members, particularly those at major global companies, will still feel limited in their choice of audit firms to the Big Four, there is now some variety of choice as the next-tier firms—BDO Seidman, Grant Thornton, and RSM McGladrey—offer sharpened capabilities and geographical reach, and specialty firms like FTI and Huron Consulting Group offer a broader portfolio of critical consulting services. Both large companies in need of these specialty services as well as smaller companies, which found that they could not get the attention they wanted from Big Four firms stretched thin by SOX, have welcomed the rise of these new specialists.

The Accounting Gap  
If size matters—and to some, it always will—the next-tier accounting firms continue to be dwarfed by the Big Four. Despite some consolidation, a huge gap remains between the smallest of the Big Four and the next largest accounting and audit firm. While next-tier firms have churned out year-over-year double-digit revenue growth, KPMG, the fourth largest of the majors, still has three times the revenue of its nearest competitor, RSM McGladrey. However, many audit committees are now seeking to align their needs with firms comparable in size, sector experience, and geography. Cono Fusco, who last month retired as a managing partner of strategic relationships at Grant Thornton after 40 years in public accounting, agrees. “You can’t put size 6 feet in a size 12 shoe,” he says. “Grant Thornton would not be the best fit for a small New York manufacturer, but it would be a good fit for a $1-billion manufacturer operating in 15 states and three countries,” Fusco says. Grant Thornton is expected to report in excess of $1 billion in revenues for its fiscal year ending July 2007, reflecting sizzling compounded annual growth of 22 percent for the past five years.

RSM McGladrey surpassed the billion-dollar mark in 2006 when it reported year-end revenue of $1.3 billion. The firm deliberately focuses on middle-market companies, those with revenues of $25 million to $1 billion. While the majority of its revenues are derived from accounting and audit services, increasingly, engagements from private-equity firms are creating new demand for business advisory services. As a result, Arthur Smith, RSM’s chief marketing officer, says his firm has begun to look at private equity as an industry unto itself, much like the manufacturing and nonprofit sectors it has traditionally served. “Three years ago, private equity was a nonexistent revenue stream,” Smith says.

The New Advisers
The second-tier accounting firms aren’t the only ones benefiting from the flood of new business that was once the domain of the Big Six. As the remaining Big Four were forced to stick to their knitting—audit, tax, and accounting—business advisory consultants in the areas of forensic accounting, finance, and litigation were experiencing rocket-like growth, prompting both a greater diversification of services and expansion, particularly overseas.