In the weeks since this column of August 18, Seidman and BDO have been keeping a brave public front on the effects of the June verdict of $521 million. But even assuming eventual success on appeal, their business challenges to maintain clients, personnel and partners through an extended process remain formidable.
For Auditors, Is This the Way the World Ends?
Originally published in the International Herald Tribune on August 18, 2007
In his 1925 poem "The Hollow Men," T.S. Eliot bleakly chants that the world ends "not with a bang but a whimper."
For large-company auditors and the fragile world of privately provided financial statement assurance, an ominous whimper was just heard in a courthouse in Miami.
In June, a jury of six citizens of Dade County, Florida, found that the Seidman accounting firm had been grossly negligent in the audit of its client E.S. Bankest, a Miami financial institution whose owners included the plaintiff, Banco Espírito Santo, which is based in Portugal.
On Monday, after one additional hour of deliberation, the jury imposed damages of $170 million on Seidman in favor of Banco Espírito Santo, adding the crowning touch of an extra $351 million in punitive damages on Tuesday.
Those are numbers well beyond the capability of the partners of Seidman, which reported total revenue of $589 million for the 2007 financial year. And Seidman won't be helped by its membership in a global network, BDO International, which - with about 30,000 employees and a combined revenue in 2006 of $3.9 billion - ranks a distant fifth behind the Big Four global accounting networks: PricewaterhouseCoopers, Deloitte Touche Tohmatsu, Ernst & Young and KPMG, in order of size.
The Seidman firm has, perhaps quixotically, announced plans for appeal, but it faces a battle that's not so much uphill as up a cliff, and its future is, at best, mortgaged to that outcome.
Seidman could not possibly have wanted a trial over its Bankest audits. The plaintiffs claimed at trial that the audits failed to prevent or detect that Bankest, ostensibly a factoring company, was funneling funds diverted to its own principals - of whom the main players are either in or going to prison.
For Seidman, going to trial must have been an agonizing option of last resort, chosen only because it was unable to settle the case within bearable limits otherwise. Which is not surprising. Auditors have faced a formidable challenge defending themselves against claims they did not catch the bad guys, however pure their intent and skillful their efforts.
Juries have seldom been willing to look beyond the melodrama of seriously felonious executives. And in this America that increasingly elevates victim compensation to a social priority, Seidman's defense that it was competent but compromised by aggravated conditions was predictably unavailing.
Even more ominously, the Bankest verdict, which leaves Seidman and BDO teetering like a house of cards, casts doubt on the entire future of both the large global accounting networks and the one-page audit reports they deliver on consolidated corporate financial statements.
Since the disintegration of Arthur Andersen in 2002, the volume of commentary on the fragility of the audit reporting model has multiplied among the research groups and regulator-sponsored commissions.
But despite the noise levels, there have emerged neither strategies nor solutions for the threatened viability of the large firms in the face of death-threat litigation.
Topics in this dialog include the desirability of expanded competition for the Big Four, and increased auditor choice at the global company level. But the Seidman experience, which shows the smaller networks to be even more vulnerable than their larger counterparts, ends all expectation that a Big Fifth firm might emerge.
Never a realistic possibility in light of limits on the geographic and technical depth of the smaller networks, the idea is now as dead as Seidman's hopes for the trial.
Meanwhile, based on economic modeling done last autumn for the European Commission (here) , there is an estimated upper limit of $1.8 billion, or some €1.4 billion, that the partners' capital accounts of even the strongest of the Big Four firms might absorb without collapse. And the real survival risk threshold could be far lower, down in the range of $400 million.
But the impact can take the form of either judgments or settlements. While the Big Four firms have repeatedly shown that they could not or would not go to trial in cases at the level faced by Seidman, their payouts continue: Deloitte settled part of its Parmalat exposure this spring by agreeing with an administrator to pay $149 million, and in July, PricewaterhouseCoopers settled for $225 million with the shareholders of Tyco.
Yet nothing in the politicized debate on limiting auditor liability - whether in Brussels, London or Washington - suggests that lawmakers have any intention of providing the accountants with protection from litigation exposure at thresholds low enough to allow survival.
The Bankest verdict against Seidman was not the first shot across the bow of auditor survivability. That warning goes back to the disintegration of Laventhol & Horwath, a respected second-tier firm, under an adverse jury verdict in Texas in 1989. Ever since, the creaky vehicle of private audit assurance has been lurching along, always hostage to the next, and potentially fatal, blow.
As the number of firms still standing continues to shrink, the prospects for the survivors look increasingly grim.