Auditors Draw Some Clients Closer

Some companies and their auditors might be getting a little too close for comfort.

Since the collapse of Enron and its auditor, Arthur Andersen, more than a decade ago, regulators on both sides of the Atlantic have been cautious about auditors receiving big fees for consulting and other services that could potentially cloud their judgment when reviewing a company's books. Now, they are taking a fresh look at the issue.

The U.S. government's audit watchdog says it has started quizzing accounting firms on whether their fast-growing consulting practices could hurt the quality of their audits. Overseas, the European Parliament is expected to vote in April on legislation that would cap nonaudit services provided by a company's auditor at 70% of the audit fee.

At least 300 companies in the U.S. and Europe paid their auditors as much for add-on services as they did for audit work, according to public filings from the past two years reviewed separately by data provider Audit Analytics and stock-research firm Exane BNP Paribas SA .

"You are talking about a huge amount of fees" at some companies, says Yohann Terry, an analyst who has studied the matter for Exane BNP. Auditors "are all pushing to develop consulting fees because the margins are higher," he says.

Auditing firms say they work to avoid conflicts of interest and that providing extra services can improve audits by enhancing their knowledge of an audit client's business.

HSBC Holdings PLC paid its auditor, KPMG LLP, $208 million for "other services" between 2010 and 2012. That's more than five times as much as the U.K. bank paid the firm for checking its books. The added work included "ad hoc accounting advice," consulting on information-technology security, and subsidiary audits, according to a regulatory filing.

The filing added that HSBC only uses KPMG for extra services when it can benefit from the firm's historical knowledge of the bank and when its independence won't be compromised.

HSBC declined to comment on the nonaudit fees, but the bank is set to change its auditor next year to PricewaterhouseCoopers LLP after 23 years with KPMG. "We thought it was the right thing to do," said HSBC spokeswoman Heidi Ashley.

"KPMG is fully committed to ensuring our independence with respect to all of our audit clients," said KPMG spokeswoman Deborah Primiano.

After Enron imploded, the U.S. barred auditors from performing many consulting services for audit clients, such as providing appraisals. The pending legislation and fee cap in Europe would mean even stricter regulations for businesses there. It isn't clear how new European rules would define, audit, nonaudit, and audit-related fees; companies vary widely in their own definitions.

The main concerns for regulators are "scope creep" and conflicts of interest that could distract auditors from their core responsibilities, says Paul Beswick, the SEC's chief accountant. "There are permissible services that are allowed, but over time if the nature of those services change, they can actually evolve into independence violations," he says.

In January, KPMG paid $8.2 million to settle allegations by the Securities and Exchange Commission that it violated independence rules with some clients where it provided additional services. The firm didn't admit or deny wrongdoing, and the SEC didn't identify the clients.

Companies going through mergers, initial public offerings or spinoffs frequently pay their auditors far more for additional services, such as meetings with deal underwriters and due diligence, company filings show.

From 2011 through 2012, German auto maker Porsche SE paid auditor Ernst & Young more than 20 times as much as its audit fee for work related to taxes and its integration with Volkswagen AG . Over the past two years, Manchester United PLC paid auditor PwC nearly eight times as much as its audit fees, largely for work on the British soccer club's ﻿ IPO. U.S. grocer Harris Teeter Supermarkets Inc., which Kroger Co. acquired in January, paid KPMG more than 1.5 times its audit fee for extra services in the two years ahead of the deal.

Manchester United and Kroger declined to comment. Porsche didn't reply to requests for comment.

"There are some cost efficiencies associated with it, but it's also easy to use your auditor—they're just one phone call away," says Ed Nusbaum, chief executive of auditor Grant Thornton International Ltd.

Last year, retailer Target Corp. paid Ernst & Young $3.7 million for an audit and the same sum for other work, including a "tax inventory accounting" project. Target declined to comment.

Some nonaudit services, such as providing quarterly reviews of internal controls or "comfort letters" to lenders, aren't considered controversial, but some companies may have to monitor such work more closely to ensure they don't exceed the potential fee caps in Europe, he said.

In general, high nonaudit fees are considered a governance issue. Proxy adviser Institutional Shareholder Services recommends against reappointing auditors if they provide nonaudit services exceeding their audit fees, except in the case of one-time events, such as an IPO.

Auditors, meanwhile, have financial incentives to offer more nonaudit services. At the Big 4 accounting firms—PwC, Ernst & Young, Deloitte & Touche LLP and KPMG—consulting revenue has climbed 33% over the past five years, while audit revenue has risen just 6%, according to the Public Company Accounting Oversight Board.

According to Audit Analytics, nonaudit fees at large companies in 2012 climbed to their highest average level since 2005—the year the Sarbanes-Oxley corporate-governance law took effect.

"Audit fees have remained pretty flat or even decreased some," says Cynthia Fornelli, executive director of the Center for Audit Quality, an accounting industry group. "There are two ways you can address that: one is to grow your audit business, and the other is to grow your nonaudit business so that it can support the audit business."

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