It's always a pleasure to be a guest on Francine McKenna's Substack, The Dig. This from March 18 on a story where developments will be consequential:
The United States accounting firm of Grant Thornton, seventh largest of the global networks, announced on March 15 that it was selling a majority interest in itself to the investment firm New Mountain Capital.
Why the date was chosen will likely remain a mystery. Shakespeare’s invocation of the Ides of March to dramatize Julius Caesar’s bloody assassination in the Roman forum, however, suggests a comparison: Grant's forswearing its traditional partnership structure with the dazzling spin management of Marc Anthony’s funeral oration.
O judgment! thou art fled to brutish beasts,
And men have lost their reason.
As the partners/owners of Grant Thornton — the latest and largest of the mid-tier firms to embrace private equity — surrender their traditional status to become employees, it’s time to praise, not bury, the vexing challenges to maintaining professionalism when CPAs accept the golden chains of outside capital.
Where will Grant Thornton spend the money? What are its real ambitions?
The announcement itself is a word salad, the epitome of company-speak. “Quality” is referenced six times in seven paragraphs, “strategy” five, and “value” three. Grant's leadership provides no specifics regarding the expanded service offerings to be funded with its new wealth. Instead, it sticks to conspicuous vagueness, better to retain the flexibility to claim success whatever the future might bring.
A sound inference would be, however, that expansion of the Grant's audit practice is highly unlikely. There is a lengthening list of smaller firms withdrawing from the audits of publicly-listed companies in the US. Grant Thornton's United Kingdom firm has been winding down its presence in the large company sector (here and here). In 2018, it specifically said it was no longer interested in auditing large listed UK companies. The same should be assumed for the US, given that multinational companies require inter-connected global networks to deliver their audit services.
That leads even the casual observer to conclude that its growth ambitions – drawing on what the Financial Times says knowledgeable sources called an intended “war chest for investment” – are focused on the possible spectrum of non-audit consulting services.
Recall that the recent failed attempt to separate EY’s audit and consulting practices – the ill-fated Project Everest – was animated by the aggressive ambition of the EY consultants who dreamt of billions in return for launching an IPO of the consulting practice. (It would not have been the first time EY monetized its consulting practice in the last twenty years.) Feeding the downfall of the Everest mis-adventure was the absence of solutions to at least two parts of the necessary architecture. Answers to both challenges are reportedly included in the Grant Thornton project: provision for the partners’ pension rights, and separated “alternative practice structures” for the auditors and the consultants.
All this suggests at least the hint of a deeper agenda – that the outside capital for the Grant Thornton partners, which EY failed to secure, could be a down payment for a separation strategy. That possibility is not presently visible and even likely to be denied, but perhaps just over the horizon in the vision of at least some of the deal's advocates.
It’s not a crazy idea. Grant Thornton's modestly-scaled audit practice would be an appealing merger partner for another mid-tier firm bold enough to see a future in a traditionally-structured practice, while an independent consultancy underwritten by an angel investor could freely pursue its own path to possible growth and prosperity.
Concern would be legitimate, however, for a worm lurking in this Edenic apple. There is prior unhappy history with “alternative practice structures,” for example, notably the short-lived cohabitation of H&R Block with McGladrey. And the SEC has warned about alternative practice structures and private equity investments in public accounting firms, in general:
...as some accounting firms may be considering changes to their capital and firm structures, we expect accounting firms to keep as their top priority a focus on their vital gatekeeper function.
The usual metrics that drive the private equity model do not align comfortably with the auditors’ duty to the public and obligations to public company shareholders. It would be an ill fit for the auditors’ exercise of prudence, skepticism and independence alongside the motivations of their new owners to seek and exploit investment opportunities with value to be unlocked through cost-cutting, dispositions and head-count reductions.
It also sounds odd that the Grant Thornton press release describes the deal with New Mountain Capital as “subject to regulatory approval.” That's because neither the Securities and Exchange Commission nor the Public Company Accounting Review Board has a remit or any record of intruding into the structure, organization, or mergers and acquisitions activity of the audit firms operating under their oversight. Perhaps the comment was related to the role of state boards of accountancy?
Alternatively, it could reference the federal securities law and SEC/PCAOB rules on independence, particularly those involving bright-line prohibitions on financial interests in audit clients on the part of the firms themselves and their associated personnel and related and affiliated entities.
If so, it would be a warning shot across the bow of New Mountain Capital, because this new investment together with its April 2022 investment in the Citrin Cooperman firm would establish a three-way linkage for independence-impairment concerns.
It would surely make the regulators’ nerve ends quiver to think that the private equity sector, whose very business is the identification of otherwise underappreciated financial and economic advantage, would put itself in a role of dominant ownership of firms that benefit from the mandate in the securities laws that provides a protected franchise for those licensed to provide audits for public companies. Consider the temptations – an auditor knows a company’s strengths and more importantly its weaknesses – inherent in access to audit firms' access to all the skeletons and dirty laundry and, too, the existence of those financial cookie jars. The value to an investor of a peek behind the curtains of auditor confidentiality would be enormous, and amply concerning to attract regulatory attention. Appeals to good behavior would be followed by official after-the-fact wrath when the inevitable lapses are discovered.
Finally, however, this current version of Marc Anthony’s silver tongue may contain an irony worthy of his dissembling rhetoric. That is, it has been clear for years that neither the auditors’ traditional opinions nor their sprawling networks of inter-related country-level partnerships are robust in response to the current needs of the world’s capital markets.
The latter is displayed by the lack of interest of private capital itself in what the auditor does. The former lies with the clamoring public enthusiasm for different and extended forms of reporting and assurance, most dramatically in the crypto arena and now in the open-ended area of sustainability. The SEC’s wobbling on rules for climate risk disclosures, drawing lawsuits from both advocates and fierce critics of more disclosure, shows that neither the standards nor the approach to assurance are ready for prime time.
And yet, I have been urging for years that outside capital will be a necessary element for assurance to be fit for future purpose (on my blog, Re:Balance, back to August 7, 2011, and in my book, Count Down: The Past, Present and Uncertain Future of the Big Four Accounting Firms, Emerald Books, 2d ed. 2017). I did not predict private equity to be the source. But, at the same time that its emergence — to fund the accounting firms’ desires to further expand services — further de-legitimizes the traditional definitions that undergird the long-accepted professionalism of the audit function, the consequence is to enable new services actually responsive to the needs of the marketplace.
In other words, Grant Thornton may – like it or not - be showing us the shape of the future.
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