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The CPA's march towards law firms - the change of statuesque between law firms and accounting firms

14/5/2018

This article was published in Legal Business World eMagazine 4th edition. Click here to view the article in the eMagazine. 

 

The legal profession is going through dramatic changes. The global market, already filled with increasingly competitive multinational law firms, is witnessing the largest accounting firms (outside of the U.S.) “making their move” towards legal services.

 

These accounting giants, also known as the ‘Big Four’, include - Ernst & Young (“E&Y”), Deloitte, PricewaterhouseCoopers (“PwC”) and KPMG – are extending their reach by providing complementary legal services to a vast range of national and multinational corporate clients, as part of an extensive transformation from audit firms to “globally integrated business solution providers”[1].

 

Deloitte’s Legal Global Managing Director, Piet Hein Meeter, isn’t shy about the firm’s ambitions in the legal market:

 

“We at Deloitte Legal see a clear need for a new type of service that combines legal advice with strategic advice across other disciplines. This is not currently provided by other law firms. Our clients want us to bring new solutions to the table, and that’s exactly the gap we want to fill. Our ambition is to become the law firm of the future.”[2]

 

A moment in history

 

The Big Four’s current attempt at expanding into the legal market isn’t their first. Three decades ago, in the late 1980s, while they were still considered the Big Five, (notice one is missing today – you’ll find out why shortly) the firms began offering a wide variety of professional services in addition to the traditional audit, in an effort to halt decreasing profitability and deliver a more complete service experience.

 

Within 10 years, the Big Five firms became leading providers of legal services, and with an average of 2,000 lawyers per firm, four out of the five were ranked among the 10 largest legal service providers in the world[3]. This rapid progress was due to accounting firms focusing on lower value legal services having a natural overlap with finance, such as Tax, M&A, Insolvency and Forensic Accounting.

 

As the Big Five expansion continued, several regulatory bodies, including the American Bar Association (ABA) stepped into the ring. This happened firstly, due to the ABA Model Rules of Professional Conduct, which forbid non-lawyers from owning an interest in law firms, and second, due to the inherent conflict of interest that arose from providing legal and non-legal services to the same client.

 

Then Came Enron

 

For many, the regulatory concerns expressed by the ABA were the handwriting on the wall, and Enron – was the hammer that smashed the wall down.

With approximately 20,000 employees and claimed revenues of nearly US$ 101 billion during 2000[4], Enron was one of the world's major electricity and natural gas companies.

 

The Company went bankrupt in 2001, after it was discovered that its financial reports were systematically misleading and that it had implemented fraudulent accounting practices. Enron’s accounting auditor, Arthur Andersen, one of the Big Five and a leading legal services provider at that time, was convicted of criminal charges which voided its license to audit public companies and eventually – lead to the dissolution of the firm.

The firm’s dissolution was met with shock, and was to a great extent born from the conflict of interest between Arthur Anderson’s audit services and its’ advisory services.

 

Following the Enron (and later on - WorldCom) crises, the US congress passed Sarbanes-Oxley (SOX), which set a regulatory framework for providing audit and advisory services simultaneously – and in some cases prohibited it altogether - in an attempt to prevent similar conflicts of interest from re-occurring in the future.

 

Similar regulation was passed across the globe. In the mid-2000s, once the dust from Enron and Arthur Andersen had settled – low audit profit margins served as the catalyst for many accounting firms to focus on profitable non-audit services – including legal services.

 

 

The times, they are a changin’ – Bob Dylan

 

Corporate clients are becoming more sophisticated and expect law firms to provide added value and cost-efficient service that serves the client’s business challenges and strategy. According to David Wilkins from Harvard Law School “Clients don’t have legal problems; they have problem problems” – which lawyers are required to approach with a wider view and business-oriented insights. Law firms’ ability to adapt to the current winds of change will be a key factor in shaping the future of the legal market.

 

While accounting firms are often perceived as all-inclusive solution providers, a recent survey of Chief Legal Officers conducted by Altman Weil noted a concern from “the lack of innovation in service delivery by law firms”[5].

This confirms a growing dissatisfaction from services provided by law firms, and raises the question whether legislation (such as SOX) aimed to maintain the high level of legal proficiency and independency has in fact contributed to the lack of competition and inefficiency in the legal services industry.

 

Legislation which was previously advocated to be a gate-keeper - safeguarding the public interest, was now pointed to as a major reason for stagnation, and the results of the campaign to overturn the impact of the restrictive legislation (supported and opposed by interest fueled bodies) were immediately seen.

An increasingly liberal approach, permitting multidisciplinary practices (MDP’s) – meaning to permit lawyers to share fees and join with non-lawyers in a practice that delivers both legal and non-legal professional services[6], was adopted by the Law Council of Australia[7], the Canadian Bar Association and the Law Society of England.

 

The latter, has made the most aggressive regulatory transition in the history of legal services and enacted the Legal Services Act of 2007[8], authorizing “alternative business structures” (ABSs) and “multidisciplinary practices” (MDPs), and enabling the entrance of accounting firms to the legal market. In addition, the Legal Services Board was founded – an independent body responsible for overseeing various regulatory bodies of the legal profession in England and Wales.

 

In Israel, the status quo between accounting and law firms remain relatively unchanged. Current legislation and ethic’s guidelines made by various oversight bodies, including the Institute of Certified Public Accountants in Israel (‘AICPA’) and the Israeli Securities Authority (‘ISA’), dictate a framework in which proving audit and advisory services (including legal services) is prohibited in many cases.

 

 
 

Round Two

 

Accounting firms deal with numbers, and indeed a good way to demonstrate the
re-emergence of the Big Four in the legal services market as of 2016 is to take a look at the numbers:

 

  • The Big Four averaged 2,200[9] lawyers, with PWC ranking as the 6th largest legal service provider in the world in terms of total number of lawyers, similar number to well-known firms such as CMS Legal services and larger than Clifford Chance.

  • The Big Four boast a legal presence in 71 countries[10], on average. The 10 largest law firms in the world average only 31 country presence.

  • Europe holds the largest concentration of accounting firms’ legal arms with 35 offices on average – nearly 50%10.

  • Big Four firms own a combined market share of over 60% of the global accounting market. The largest 100 law firms in the world account for 15% of the market share.

 

As visible from the numbers above, the Big Four have made substantial progress in their effort to establish a legal presence. A combination of regulatory gaps of auditor independence, changes in the regulatory framework, globalization and a fragmented legal market, contributed to double-digit, year-on-year revenue growth. Although the firms’ revenue stream from the legal segment, as reflected from their financial reports, is still far from competing with law firms, the lacuna is gradually closing.

 

Big law firms are struggling to follow the Big Four’s expansion. This is mainly attributed to law firms being partnerships while accounting firms operate as multinational corporations, with shareholders or investors.

 

In most cases, partners decide how the partnership is run. Corporations are governed by shareholders, who conduct regular meetings to determine company management and policies. The goals of a partner and a shareholder are not always the same. Partners often find themselves walking a fine line between supervising and maintaining the partnership’s resources whilst shareholders many times focus on long term goals, productivity and profitability. Partners must be focused on short term and intermediate goals because these results effect their success in the present.

 

The firm’s financial results have immediate impact on the partner’s profit, while for shareholders, the correlation is less direct and is reflected in the share price.

Whilst the shareholder is not necessarily employed by the corporation, a partner is entitled to profit only as long as he is an active part of the partnership. This partnership and profit structure often works as a barrier, as it encourages partners to prioritize short term growth instead of long haul strategy.

 

Moreover, law firms usually finance their expansion using the partners’ profits which is significantly smaller than the Big Four’s profits. In 2017, the most profitable accounting firm – Deloitte, had revenues nearly 14 times higher ($38.8 billion) than the most profitable law firm - Latham & Watkins ($2.8 billion). This provides a solid financial base for expansion.

 

Accounting firms focus on areas of the law that complement their existing services, such as immigration, tax, employment, labor and human resources, compliance, due diligence and mergers & acquisitions. Based on the relatively low revenue per lawyer drawn from the Big 4 financial reports, it is noticeable that many of the services provided are lower value work, while major law firms continue dominating the lion’s share.

This comes as no surprise, as the Big Four are actively and openly focusing on repetitive legal tasks and services that can be easily performed by their legal teams or automated using technology. In Israel, for example, accounting firms offer full scale E-discovery services that include E-Discovery software use and technical support to law firms with cases requiring scanning throw hundreds and even millions of files(!).

 

 

Conclusion

 

Accounting firms are attempting to redraw the boundaries of professional services. The Big Four have demonstrated their ability to successfully enter new markets and consolidate their share, as seen in the consulting industry.

Now, with the legal services market in their sights, they will use their multidisciplinary business model and their global reach to lure in potential clients who require a multi-disciplinary, innovative and cost-effective approach.

Only time will tell whether these efforts succeed, but either way, we are likely to witness a deep professional and organizational change in the legal and accounting services fields.

 

 

The writer, Tzahi Sarousi (CPA) is the head of RobusCPA, an Israeli business development and marketing department dedicated for accounting firms – a department at the well-known Robus Group.

 

 

 

 

 

 

 

 

[1] Thomson Reuters “The re-emergence of the big 4 in law”

[2] Deloitte makes its case, CBA National Magazine, June 22, 2016

[3] ALM intelligence, Elephants in the room, Part I: the big four’s expansion in the legal services market

[4] Fortune 500: Enron, Fortune

[5] Altman Weil, 2016 Chief Legal Officer Survey

[6] American Bar Association, Commission on multidisciplinary practice

[7] Multidisciplinary Practices and Partnerships: Lawyers, Consultants, and Clients, Stephen J. McGarry‏

[8] Legal Services Act, 2007

[9] ALM intelligence, Elephants in the room, Part I: the big four’s expansion in the legal services market

[10] The Harvard Center on the Legal Profession

 

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