There are two possible interpretations of the recent mud-slinging63;30bn-worth of due diligence, says Peter Williams. But maybe the Big Five should be doing a different kind of job for their clients. between bankers and accountants. The first is that the workings of the capital markets are at risk if accountants are unable or unwilling to perform the necessary due diligence without drastically limiting their liability. The second is that this is the latest round in an unseemly spat between two sets of overpaid City types amounting to no more than handbags at six paces.
If there is a serious dispute between the loose coalition that is the Big Five accountancy firms and the financiers – represented on this engagement by the London Investment Banking Association (LIBA) – the allocation of risk in mergers and acquisitions is just one, albeit important, piece of the jigsaw.
According to the City gossip, the present row was misconceived and never intended to enter the public domain. LIBA wrote a letter in a moment of temper and despatched it to the Office of Fair Trading, complaining about the accountants’ liability capping tactics. The story leaked out months later, by which time the bankers had apparently decided it would be better to try and reach an amicable settlement with the accountants rather than drawing up battle lines.
But there is more to the row than the LIBA complaint. It is tempting in some ways to see this as a rerun of the fallout last year between the accountants and the venture capital industry. However, a more subtle relationship exists between the merchant banks and the accountants. This is not just a simple case of the supplier becoming uppity with the client. For one thing, they are competitors. While the firms won’t take any lead advisory role with the big quoted companies, they are happy to compete for the private company and AIM-type of corporate finance jobs. The merchant banking fraternity has always had a sniffy attitude towards accountants going for the glamorous corporate finance work. But effortless superiority is, it seems, not quite enough. The accountants have had a consistent aim of competing with the bankers and the corporate finance boutiques in certain corners of the market. And with the dull persistence that is the hallmark of the successful accountancy firm they are gradually gaining market share.
But going for and winning the sexier stuff sits slightly uneasily with the duller audit-type due diligence work. For a start, such encroachment, however genteel, can hardly endear them to the merchant banks who are still handing them wads of cash for running the slide rule over the bigger deals. While the advisory work is the cream of the corporate finance work, the due diligence is meant to be the bread and butter. A report on financial integrity is clearly a key part of getting any deal off the ground. As the firms have been reassessing all aspects of their business in recent years, they have been asking how much due diligence they should be performing.
The answer is shaped by two considerations: the risk which they perceive and the fee which they have been able to negotiate. And the Big Five think due diligence is not the steady earner it is meant to be.
As the firms have traditionally done the work with unlimited liability, the risk there is significant. That may have just about been acceptable, but gone are the days of naming your price. The size of some deals have been reaching dizzy proportions – put your hand up if you would like to take on unlimited liability for the due diligence work associated with the £30.3bn merger between BP and Amoco – so you can start to realise why even our global-friendly Big Five are starting to suffer from vertigo.
The firms can’t do anything about the size of the deals, nor can they ramp up prices, so it seems reasonable to put a limit on how much work they do and how much they have to stump up if it all goes wrong. But no one likes cosy arrangements, which suit being disrupted. If matters go awry and legal action is threatened, the bankers are, unsurprisingly, quite happy with the present arrangement of hiding behind the deep pockets of the beancounters.
The final irritant for the Big Five is the enemy within. The corporate finance partners from the second tier, the so-called Group A firms, are always insisting that they have the manpower, skills, resources and expertise in equal measure to that of the Big Five. And for the moment at least they have one unique advantage over their larger brethren: professional indemnity cover. PI is as rare in the Big Five nowadays as quill pens.
They admit they just can’t buy it, whereas infinitely more modest firms are still sourcing PI providing cover somewhere between £30m and £50m a shout. As a result, the medium-sized firms may well find themselves picking up market share in the smaller end of the due diligence market.
Perhaps more importantly than nicking work, the medium-sized firms’ interference from the sideline makes it less likely that the Big Five will make much progress on their wider campaign for a limit on liability or proportionality.
When the row erupted last year with the British Venture Capital Association and the accountants, the 100 Group of Finance Directors were momentarily tempted to weigh in against the firms with charges of a cartel. They resisted then and they should resist now. For the FD trying to complete a deal, the last problem they want to address is who to sue when the whole deal comes unstuck. Beyond the question of whose name is on the writ, FDs should be bringing fresh thinking to the whole debate. FDs should be asking bankers and accountants about the nature of the work they are currently performing.
Perhaps the advisers – rather than attempting to surround themselves with get-out clauses and playing games of pass-the-buck – should be questioning the whole area of risk management and risk assessment procedures in M&A work. Then FDs and investors might have more confidence that the deal will succeed rather than clinging to the negative notion that one or other City adviser has their reputation – and wallet – on the line.
Peter Williams is a freelance journalist.
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