Ernst & Young spin-off plan hampered by debt problems

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Ernst & Young’s efforts to spin off its audit and advisory businesses have been slowed by a management change in the United States, as well as complications over its multibillion-dollar debts, according to people familiar with the case.

A “go or no go” decision from senior executives at accounting firm Big Four, originally scheduled for June, is now expected by mid-August at the earliest, according to internal EY documents and people familiar with the matter.

Carmine Di Sibio, EY’s global president and chief executive, said in a webcast with the company’s 300,000 partners and employees on Thursday that the company had achieved record revenue of more than 45 billion for the year ended June 30. 13% of $40 billion the previous year, Mr. Di Sibio said.

EY management wants to convince the partners that the deal is being struck from a position of strength, rather than because of potential litigation or other financial issues, according to a person familiar with the matter.

The management is still trying to work out the final details of the proposals that will be put to the vote of the partners. Negotiations over the package have been slowed by the departure of Kelly Grier, the US chairman and managing partner who left the company in June, a person familiar with the matter said. Ms. Grier did not immediately respond to a request for comment.

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One of the thorniest issues still under negotiation concerns how much partners who will remain with EY’s audit business will be paid, the people said. Audit partners expect average payouts of millions of dollars for agreeing to let the most lucrative consulting business go it alone. But these payments will be affected by the amount of money used to reduce the company’s debt.

That debt represents about $10 billion in promised payments to retired partners, which is effectively an unfunded pension plan, according to people familiar with the matter. US audit partners fear the obligation – some $7 billion in the US – will fall mainly about their business, which will be much smaller after the split, the people familiar with the matter said.

Part of the auditors’ payments would come from the proceeds of an initial public offering of EY’s consulting business, which would then borrow to raise the remaining funds. The more money there is to pay pension obligations, the less money there is available for audit partners. EY executives are confident the pension problem can be solved, according to a senior official involved in the deal.

Other aspects of the deal still up in the air include the duration of the so-called non-compete agreement, which would prevent the audit firm primarily from continuing the same activities as the new consulting firm, according to people familiar with the matter. .

There is also no final decision on branding, although the assumption within the firm is that the primarily audit firm will retain the EY name.

The American firm has enormous bargaining power in the talks. It produces more than 40% of EY’s global revenue, so the proposed global deal is not viable without the agreement of its partners. Other major EY businesses include Australia, Canada, China, France, Germany, India, Italy, Japan, Netherlands, Singapore, Spain, Sweden and the UK.

Once the global executive committee has worked out the details of the agreement with the leaders of the largest member companies, it will have to convince partners in the approximately 140 countries that make up its global network. The votes in each member company are recorded in pencil for the fall and winter. In the United States, two-thirds of accounting partners must vote yes for the deal to be approved, people familiar with the matter said.

Payments processor Wirecard was the darling of the German fintech industry until auditors discovered a $2 billion hole in its books. The WSJ explains what we know about the missing money, as investigators are still trying to figure out what happened. Photo composition: George Downs

EY executives are trying to reassure the company’s roughly 13,000 partners that their windfall earnings forecasts would benefit from some protection against market volatility caused by an economic downturn. The company’s proposed sale of a roughly 15% stake in the consultancy, which is expected to fetch some $10 billion, is not expected to take place until late 2023, when the economy could rebound. If falling markets meant the IPO would rise significantly less than expected, the split would be postponed or cancelled.

The debt issue could also concern regulators, including the Securities and Exchange Commission, which could cancel the deal. Regulators don’t want the accounting industry to go from four big firms to three. So they don’t want EY’s auditors burdened with unsustainable debt, especially as the company faces legal action over a series of failed audits recently.

EY is currently facing multibillion-dollar lawsuits in Germany and the UK over its allegedly failed audits of two corporate blasts, fintech firm Wirecard AG and hospital operator NMC Health PLC. EY said it was sticking to its audit work.

EY US executives had preliminary discussions about the spinoff with SEC Chairman Gary Gensler a few weeks ago, according to an EY spokeswoman. The chief regulatory officer declined to be fired on his potential view on the proposed split before a formal proposal from the accountancy firm, people familiar with the matter said.

“Regulators will want to be assured that the audit-focused firm will have a strong enough capital base to withstand any risk it faces,” said Lynn Turner, former chief accountant of the SEC.

More WSJ coverage of structural change at Ernst & Young, Editors’ Picks

Write to Jean Eaglesham at [email protected]

Corrections & Amplifications
EY US executives met with SEC Chairman Gary Gensler a few weeks ago. An earlier version of this article incorrectly stated that it was EY chief Carmine Di Sibio who was at the meeting. (Corrected July 29)

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