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Commitment Committees at investment banks exist to minimize the risks — capital, reputational and issuer-specific— to which the firm is exposed on any given transaction. Issuers typically need to clear more than one committee. For example, common practice in the equity new issue arena is to have one committee focused on risks to the firm (i.e., “Have we done everything we need to do to avoid getting sued?”), while another committee is focused largely  on marketing matters (i.e., “Can the deal get done, and on what terms?”).

In all cases, the issuer’s investment banker is called upon to present the transaction to these committees. In addition, the designated research analyst may be called upon separately to present to the committees and answer their questions.

All Commitment Committees have encountered issuers whose audit firm is not well known to committee members. In such cases, questions will arise about the suitability, and even acceptability, of the audit firm. The process for answering the “acceptability” question is typically ad hoc and, in the end, may do little to give comfort to the Committees.

This Reference Guide is based on objective information and is designed to assist investment bankers, venture capitalists, private equity investors, attorneys, CEOs, CFOs and Board Members with their evaluation of auditors, especially where acceptance in the capital markets (debt, equity, and mergers and acquisitions) is important. This information is useful in answering a range of questions about auditors, including:

• “Might we need to change auditors if we take the Company public?”
• “Which auditors should we consider when acceptance by Wall Street is critical?”
• “We believe that we will get better service from a non-Big Four auditor, but we are concerned about market reaction. Which firms should be on our list and why?”
• “What is the risk that another investment bank will execute this business if our Commitment Committee requires a change in auditors?”

Capital Markets Advisory Partners (CMAP) conducted four separate evaluations: IPO Bookrunner Acceptance, IPO Sector Representation, Audit Firm Categorization Under the Sarbanes-Oxley Act of 2002, and Development of a Global Organization. In each evaluation, CMAP assigned a color code of green for firms that demonstrated complete or near-complete satisfaction of the criteria (at least 90%), yellow for firms that showed partial satisfaction of the criteria (30% to 89%), and red for those firms that largely did not meet the criteria.
Introduction

“Unless commitment is made, there are only
promises and hopes.”
– Peter Drucker

1. IPO Bookrunner Acceptance

CMAP examined the top 20 auditors based on U.S. revenue and the top 20 underwriters based on their number of bookrun corporate IPOs (excluding SPACs and funds) for the five-year period from January 2004 through December 2008. The fact that an investment bank acted as bookrunning manager on an IPO is prima facie evidence that the bank’s Commitment Committee approved of the issuer’s auditor being engaged on the transaction.

CMAP considers IPOs to be the litmus test for auditor acceptability not only for institutional investors — because Wall Street markets deals to them — but also for lenders — because IPOs face the highest threshold of scrutiny, since they carry the highest litigation risk among transaction types, including bank borrowings, debt offerings and mergers and acquisitions.

Initial Public Offerings: Auditor-Bookrunner Matrix

January 2004–December 2008

• CMAP discovered that, in part due to the light IPO calendar (average of only 168 per year) in this period, two of the Big Four firms have not been the auditor of record on IPOs bookrun by all of the top 20 underwriters.
• Of the Big Four, Deloitte LLP and Ernst & Young LLP have been engaged on transactions led by all top 20 underwriters, while PricewaterhouseCoopers LLP and KPMG LLP have been engaged on transactions led by 19 and 18 firms, respectively, of the top 20.
• Only one firm outside the Big Four has made it through the Commitment Committees of all top 20 investment banks: Grant Thornton LLP.
  

2. IPO Sector Representation

Next CMAP examined the representation of the top 20 U.S. auditors on IPOs across nine industry sectors that typically are considered by investment banks: Consumer, Energy, Financials, Health Care, Industrials, Materials,
Real Estate, Technology & Telecommunications, and Utilities.

Initial Public Offerings: Auditor-Industry Matrix

January 2004–December 200

• Five audit firms were engaged on IPOs from all nine sectors: Deloitte LLP, Ernst & Young LLP, ■■Grant Thornton LLP, KPMG LLP and PricewaterhouseCoopers LLP.
  

3. Categorization Under the Sarbanes-Oxley Act of 2002

The Sarbanes-Oxley Act of 2002 (SOX), under Section 104(b) titled “Inspections of Registered Public Accounting Firms: Inspection Frequency,” established two categories for U.S. auditing firms: firms that audit more than 100 issuers (color coded green) are inspected by the Public Company Accounting Oversight Board (PCAOB) once per year, while firms that audit 100 or fewer issuers (color coded red) are inspected by the PCAOB only once every three years.

PCAOB Inspection Reports can be viewed at www.pcaobus.org/Inspections/Public_Reports/index.aspx.

4. Development of a Global Organization

Most countries prohibit external ownership of accounting firms; therefore, worldwide accounting firm partnerships do not exist. Each firm in each country is a separate and distinct legal entity, independently owned and managed by local partners. The larger audit firms — in order to access collective knowledge and experience from around the world — have, to varying degrees, created global organizations of independent member and/or correspondent firms.

CMAP visited the Web sites of each of the top 20 U.S. audit firms and sought to:

1. Identify the presence of an international organization with independent member or correspondent firms in 90 or more countries, and
2. Determine whether independent firms in that organization generally used a common brand as a market for the level of coordination among the firms.

Conclusion

Calling Officers at investment and commercial banks make money by consummating transactions. They may advise an issuer to change auditors if they believe there is any risk that a deal may not be approved by their Commitment Committees because of a lack of comfort with the issuer’s auditor. Many of these bankers may not be certain which audit firms will be accepted by their Commitment Committees, and they may push issuers to options they perceive to be safest (“Nobody was ever fired for hiring IBM.”) — in this context, an auditor with whom they have prior direct experience.

Some issuers lack the ammunition to push back on their bankers (e.g., “Check with your Commitment Committees; they — and your direct competitors — have accepted our auditor on past transactions.”). These issuers may change auditors unnecessarily, hiring an auditor for whom the issuer is the proverbial “small fish in a big pond.”

In the bankers’ eyes, the “safest options” often are limited to the four largest auditors – a limitation that may be problematic for many issuers. While these firms are qualified, they likely do not represent the best value for their fees, especially in terms of senior–level service and attention.

No bank wants to lose a deal because it is operating under an out-of-date and noncompetitive set of auditor acceptance standards. This Reference Guide contains current information that enables issuers to present auditor acceptance at the Committee level, giving comfort to and motivating investment and commercial bankers. CMAP’s analysis demonstrates that the notion of the Big Four may be inapplicable for companies looking to access capital markets. Clearly, issuers have real alternatives in firms that have successfully navigated the gauntlet of Commitment Committees and that have significant international footprints.

“Happiness can exist only in acceptance.”
– Denis de Rougamont

Contact information obtained from Web sites and press releases