What Damages Can E&Y Afford and Survive?
posted by Lawrence Cunningham
Global banks are settling US government lawsuits for what looks like big money. Goldman Sachs earlier this year settled a securities fraud claim for $550 million. UBS recently settled tax fraud charges for $750 million. And Deutsche Bank will now fork over $553 million to settle a similar case.
These are large nominal amounts but they will not remotely break the banks. These firms are financial titans, each commanding some trillion in assets and boasting bountiful annual revenue: Goldman Sachs $52 billion; UBS $44 billion; and Deutsche Bank $37 billion. Payments such as those are significant but not crippling.
The same cannot be said of similar amounts if they had to be paid by the world’s global auditing firms. Those firms (Deloitte, Ernst & Young, KPMG, and PWC) command financial assets trivial compared to those of the global banks, with firm value residing primarily in personal and professional reputation (so-called “human capital”). Revenues are much less than at banks too, about $20 billion for E&Y and KMPG and $25 billion for Deloitte and PWC.
That revenue costs more than bank revenue too and is spread across a far larger employee base. E&Y and KMPG employ about 140,000 apiece and the others about 170,000 each. By contrast, Goldman has a mere 35,000 employees, with 65,000 at UBS and 82,000 at Deutsche Bank. In addition, those financial firms have access to insurance to cover at least certain kinds of losses arising from legal liability, whereas the auditing firms lack that resource and instead self-insure.
Even so, the auditing firms have absorbed considerable payments in legal liability claims in the past decade. Each firm incurs up to a dozen or so settlements in the modest range of a few to ten or so million dollars in any given year. Occasionally larger payouts occur, with nine to date exceeding $100 million: $110 million, $125 million, $200 million, $217 million, $229 million, $250 million, $335 million, and $456 million. All those but the last involved single-company frauds—the latter, the record to date, is KMPG’s settlement of tax fraud charges akin to those Deutsche Bank and UBS likewise settled.
No doubt, those figures sting, but are affordable. It’s easy to infer that E&Y, roughly of equivalent capacity to KMPG, could pay $500 million or more, perhaps twice that, if it had to settle the case involving Lehman Brothers. But amounts exceeding that could be crippling given the comparatively small asset base, fractional revenue, huge payroll, and reliance on self-insurance. The risk of a larger demand is realistic too, given the larger size of the Lehman fraud compared to the previous single-company cases the firms have settled.