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Network News • 18-12-2022

Climbing project Everest: Toning down market dominance of major auditors

Author: Dr Lina Klesper - Legal Assistant PKF Malta
Published on The Malta Independent: 18th December 2022

Breakups happen every day, but this is one to look out for. The announcement of the proposed split of EY, known as Project Everest, does not come as a surprise since it has been on the table at EY internally for months. It is an ambitious undertaking with considerable risks that have been taken into due consideration.  The breakup is hoped to remove conflicts of interest and operational challenges and avoid future accounting scandals and business failures.  It is certain that the move, when approved, will change and shake up the industry.

There has been growing scrutiny of the Big Four, where auditor independence is questioned due to a lack of effective Chinese walls in cases where the accounting firm is also doing other consulting, advisory or lobbying work. EY is currently facing multibillion-dollar legal claims in Germany and the UK over its allegedly failed audits of two corporate implosions, fintech company Wirecard and hospital operator NMC Health. The split intends to benefit the business and keep global audit and compliance requirements to meet the international criticism regulators have had for years.  According to the firm's statement, EY is reacting to the changing landscape in that industry, trying to proactively define the future, hoping for new opportunities and long-term value for all.

The split is to be achieved by turning the consulting arm into a separate company fit to file for an initial public offering, also known as an IPO.  The auditing business will likely remain a private partnership.  Hopes are that after the split, the consulting operations will take off and increase profits due to fewer restrictions of conflict-of-interest rules.  EY's new consulting company is expected to generate an extra $10bn a year in advisory fees from big tech companies as EY is currently barred from selling advice to audit clients.  The new enterprise could raise $10bn by selling off 25% of shares.  The remainder of the shares would be distributed among the consulting partners, supposedly worth seven to nine times their annual salaries. Audit partners are anticipated to receive cash payouts of about $2m each.  The audit company plans on using the proceeds from the sale to improve quality and ease regulatory concerns and is expected to become an $18bn business with an annual growth rate of about 7 percent. The separate consulting company will begin as a $24bn industry and is expected to take up double-digit growth.

EY is still figuring out some of the split's key issues, such as allocating tax partners between the audit and the new advisory firm, client consent issues, equity and debt transactions to pay down its pension liabilities, payout of partners, and funding of the new business.  Besides the internal approval that partner votes will conduct in early 2023, EY is very likely to need regulatory approval at a national level from some of the countries it operates.  It is also still open who will be the leaders of the two companies.  Another issue is the explicit structuring of the possible equity ownership in the new business for both partners and staff.  Moreover, with the expected IPO securities, firms must meet requirements in various countries to ensure that the two companies are not working together or appear to do so.

In a three-page memo, more than 150 retired US EY partners expressed their concern about the radical split which they see as weakening both sides of the firm.  One of the retired partners' main concerns is that EY´s pension obligations, which could potentially strain the business and that more questions are raised than answered.  This shows that EY must keep efforts up to educate about and explain their case.

The biggest challenge is the partner vote and possible rejections.  More than 13,000 EY partners worldwide have to vote to approve the split.  EY seems confident even when the deal is turned down in the vote due to the timing, and in light of the current market situation, the deal could be voted on later. This shows that the key drivers of the fundamental remake of EY are committed and convinced of the success of their plans.

EY's move could prompt other firms, especially the Big Four, to follow suit.  So far, EY presents a compelling case for its third attempt to split, wanting to use the first mover advantage.  It guesses that the other Big Four companies and competitors will respond and eventually follow suit.  Currently, KMPG and PwC do not plan to split anytime soon and reiterated the value of their multidisciplinary businesses and Deloitte after restructuring rumours surfaced in June.

However, rival firms could hire away EY staff and poach clients.  PwC is prepared to poach senior executives and staff from its rival, taking advantage of an uncertain time for EY.  PwC has noted extensive growth in the last few years, like all the Big Four firms leading to a high demand in the workforce and can bring in up to 500 partners, according to PwC US. EY, however, commented that they are seeing no such activity and have themselves onboarded multiple partners from PwC in the US. 

The split will undoubtedly lead to challenges for the audit industry, and the question raises who the losers and winners will be.  EY may have to resign from specific engagements or realign its portfolio not just because of a conflict of interest but also because of profitability.  Criticism is loud that the timing and market are unsuitable for such an undertaking. However, EY, an established business with a strong revenue track record, is expected to overcome current market volatility and economic uncertainty. Consultancy work is in high demand for the following years in light of staffing shortages and diversified corporate goals, especially on the technology front.

Opportunities may arise for other companies in the industry.  Some new or smaller firms with global brand names, such as the BDIO and Grand Thornton, could now capture the market share, especially in auditing areas where EY may have to vacate specific spaces going ahead.  Niche areas like taxation or advisory may get a headroom to compete with the big firms.  Over the next decade, more breakups will provide space for medium-sized firms to pick up business and grow.

Project Everest is the breakup of the decade if it goes through.  It will stir up the industry, others may follow suit, and a new order will provide chances for other businesses.  The hope is that the split will bring a good and welcome change in the industry, benefitting employees, clients, and communities at large and be to the satisfaction of regulators globally.

Author: Dr Lina Klesper - Legal Assistant PKF Malta
Published on The Malta Independent: 18th December 2022
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