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Regulators Turn Wary as Accounting Firms Look to PE for Funding

By:
Karen Sibayan
Published Date:
Nov 1, 2024

Accounting firms are turning to private equity, seeking increased funds for technology and talent. While this might be an advantage to U.S. midsized accounting and consulting firms, resulting ownership shake-ups have increased concerns among accountants and regulators, according to The Wall Street Journal

There is much activity in selling large and small stakes to outside investors. Grant Thornton was the largest firm of its kind to sell its U.S. unit to a group led by New Mountain Capital in May. The sale was followed by an agreement last week to merge non-audit services in the U.S. and Ireland. Other examples include Armanino, a San Ramon, Calif.-based accounting firm, which also sold a stake to Further Global Capital Management in October, the Journal reported. 

By the end of next year, over half of the biggest 30 U.S. accounting firms will have sold an ownership stake or part of their business to private equity, increasing from zero in 2020, noted Allan Koltin, chief executive at advisory firm Koltin Consulting Group. 

The problem arises because an auditor’s objectivity is key to accounting firms' business, which usually also have consulting and tax operations. The Journal said that whether that independence can be preserved or not under these investors is now questionable, particularly since private equity managers have a hands-on approach to their portfolio companies. 

Although the relationships between private equity and audit might be part of the normal course of business, many accountants and regulators are closely monitoring the complicated dynamics, the Journal said. The AICPA is also looking at options to bolster requirements on undue influence on audit firms. 

At conferences and through public statements, the Journal said that Paul Munter, the Securities and Exchange Commission’s chief accountant, has called for accounting firms to be cautious when they obtain investments from private equity because of potential conflicts. “Firm leaders need to be sensitive to the message such arrangements could send and stand ready to correct any such misimpressions,” Munter noted in May. Meanwhile, a spokeswoman said the PCAOB is also closely monitoring the private equity activity. 

According to the Journal, there are existing guardrails. Audit firms with new investors are establishing structures to divide audit and non-audit practices. They do this to be compliant with rules that do not allow the impairment of the auditors’ objectivity and independence. For example, the private equity firm does not have direct ownership in the audit business and governance rights that could put pressure on auditors regarding financial metrics. 

Additionally, the Journal said that rules generally do not permit accounting firms to audit their private equity investors directly or funds that the private equity firm manages. However, the rules are less clear regarding portfolio companies that the private equity owner backs. 

Jenelle Conaway, an assistant accounting professor at Wake Forest University, noted that the mere perception that such investments influence auditor independence might cause auditors' financial statements to lose credibility. 

Many private equity funds consider accounting firms as low-risk investments that could net a reasonable return based partly on recurring revenue streams. They say they are investing heavily and are not just in it to cut costs, a strategy private equity is usually known for. the Journal said.

U.S. revenue at EisnerAmper, Citrin Cooperman and Cherry Bekaert, all of which sold stakes to private equity in 2021 and 2022, altogether increased 50% as of August 2024 versus the same 12-month period a year earlier, based on data from practice management and CPA firm resources provider Inside Public Accounting.  Faster-growing consulting revenue usually helps drive private equity firms' acquisitions, the Journal reported.

Several accounting firms have been reexamining their ownership structures given the strain from partners retiring, financing expansive technology and investing in staff recruitment and retention during a pipeline shortage. Aside from private equity, firms have chosen the route of an employee stock ownership plan, sale to a public company or a merger of equals, according to the Journal. 

Under CPA licensing laws in the U.S., certified public accountants need to represent the primary ownership of any audit business, ranging from 50% to wholly-owned, depending on the state, the Journal reported.

Private equity firms are adopting an alternative practice structure that audit firms began utilizing in the 1990s to comply with rules on outside investment. There is an administrative services agreement between the audit and non-audit units under this structure where the non-audit unit offers, for a fee, personnel and administrative services. Private equity funds invest in the firm's non-audit arm, and so they have oversight when it comes to budgeting and expenses on technology and talent, the Journal said. 

Nevertheless, accounting firms under new ownership must be cautious in applying the existing rules to their own circumstances since those rules mostly do not consider the new investments’ complexity, the Journal said.

 

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