Expert Commentary:

Audit Firms on Legal Market

17 May 2019

DAVID KHRIKADZE , Partner, BDO Legal |

See this article in Forbes May 2019 issue 

Recent expansion of audit firms into the legal market constitutes significant challenge for traditional law firms. This trend potentially might shake increasingly competitive and lucrative global legal market to its core and cause transformational changes. First successful efforts of audit firms to provide legal services took place in early nineties. However, the infamous Enron scandal and subsequent legislative reforms in various countries limited the ability of audit firms to provide non-audit advisory services (like legal services) to their audit clients.  

Legal markets of the US and the UK constitute more than 50% of the global legal market. Therefore, any legislative developments in those jurisdictions would have major global implications. The most significant reform of the legal profession so far took place in the UK when the UK Legal Services Act 2007 provided the opportunity for audit firms to render legal services under Alternative Business Structures (ABSs) in Wales and England. Situation is different in the US where audit firms are still subject to restrictions in respect to provision of legal services. Despite prevailing US restrictions today jurisdictions such as England and Wales, Australia, Germany, Spain, Italy, Mexico, etc., permit audit firms to practice law in certain forms. Result of such deregulatory reforms is apparent: BDO practices law in more than 20 jurisdictions, PWC in 85, KPMG in 69 and EY in 80 countries.

Situation in Georgia is similar to the global trend. International audit firms presented on Georgian market and local audit forms actively practice law. EY was the first international audit firm to render legal services on Georgian market through its legal arm EY Law and even before that predecessor GCG Law Office was the leading law firm in Georgia. BDO started offering legal services to its clients in 2005 and since 2008 BDO Legal as the separate law firm has been actively rendering legal services in Georgia. Deloitte has been presented on Georgian legal market for many years. In recent years KPMG, PWC, made significant moves to increase their legal practice in Georgia. Average number of lawyers in Georgian leading traditional law firms varies from ten to twenty lawyers. Judging by this headcount legal arms of audit firms could be regarded as average size law firms (BDO Legal -12 lawyers, PWC - 5 lawyers, , EY -14 lawyers).

Interesting conclusions can be made by comparing global legal and accountancy markets enabling conclusion that audit firms are well positioned to aggressively enter global legal market which is very fractured since no single law firm or group of law firms controls the major share of legal market. Gross income of ten largest audit firms is five times as much as of the same figure for ten largest law firms (data is generated from online sources as of 2018 and may include minor inaccuracies).  Furthermore, legal market is not dominated by several firms unlike audit market where several leading audit firms control major share of the market.  

Thus, it can be concluded that currently international audit firms constitute direct competitors to mid-tier traditional law firms. However, revenues generated by legal arms of audit firms keep increasing by double digits in recent years. According to the British consulting company Kerma Partners, international audit firms hold around 20% of German legal market. This figure is even higher in Spain where such firms own 30% of the legal market. These statistics must have caused the results of survey conducted by AML Intelligence - majority of traditional law firms surveyed consider international audit firms as the biggest competitive threat to their business.     

Gross income of legal arms of international audit firms for 2016 in Georgian equaled to GEL2.5 million. Unfortunately, official ratings per income of traditional law firms in Georgia is not published. Therefore, comparative analysis of income of traditional law firms and that of legal practices of international audit firms cannot be undertaken. However, we can assume that income of audit firms from legal services is still considerably low compared to income of the traditional law firms. But like in case of the global trend, income of audit firms from legal services in recent years has been increasing in Georgia as well.

The reality of Georgian legal market is respectively reflected in legal directories/rankings comprised by international organizations such as Legal500, IFLR1000, Chambers & Partners. Those rankings for Georgian market include audit brands alongside the traditional law firms. For instance, according to Legal 500, BDO Legal and PWC are ranked as the second-tier law firm in Commercial, Corporate and M & A together with such traditional law firms as Nodia, Urumashvili and Partners and BLC. The same directory ranked EY as the third-tier law firm. BDO Legal, Gvinadze & Partners, Begiashvili and Company are ranked as the third-tier law firms by IFLR1000.

AML Intelligence estimates the size of global legal market for 2016 at approximately USD600 billion while size of the market for audit/accountancy services at USD450 billion and advisory market – USD271 billion. At the same time average profit margin of audit firms equals to 22% and the same rate for law firms stands for 37% and in some case profit margin of law firms even reaches 66%. Therefore, from financial perspective global legal market is very lucrative and attractive for audit firms. Concertation rate of global legal market is very low meaning that international law firms cannot create additional barriers for audit firms to enter legal market and expand their practices into legal services. 

According to the survey of AML Intelligence, six largest audit firms control more than 60% of accountancy services market share. In contrast, global legal market is very fragmented and none of the law firms control more than 1% of global legal market. Therefore, international audit firms with all their financial, human and technological resources and brand strength have all necessary preconditions to use fragmentation of global legal market for their advantage and further improve their positions in the global legal market. For instance, if any international audit firm gets at least 1% of global legal market then based on such financial result the relevant audit firm would be one of the highest profitable law firms.

Brand strength, client base, financial and technological resources of audit firms and their ability to offer wide range of services to clients constitutes robust foundation for audit firms to further strengthen their legal practice.

As for the scope of legal services offered by audit firms, at early stage they had more focused approach to legal services and concentrated only on certain niche areas such as: immigration law, employment law, tax disputes and tax consulting and lower-value, process oriented, repetitive legal tasks that can be standardised by process or technology (registration services, outsourcing employment law tasks, etc.). However, as income from legal services grew, audit firms started expanding the scope of offered legal services and shifted emphasis to high value areas such as M & A, assistance in various corporate matters, regulatory compliance, etc.

Audit firms provide clients with the legal services as an integrated part of complex and comprehensive consulting services. Therefore, audit firms position themselves on the market as multidisciplinary, globally integrated business solutions advisors. Such approach is fully in line with needs of corporate clients which require from their consultants not just “purely legal” or “purely financial” solution. Rather businesses seek comprehensive approach to their problems and “multidisciplinary integrated business solutions”. Clients expect that any legal recommendation shall comply with their strategic business decisions and shall foresee technological implications of the relevant issues. Therefore, “multidisciplinary business solutions” cannot be based only on lawyers’ recommendations or even on tax consultants’ advice. Rather it requires much broader and comprehensive approach with the involvement of IT specialists. For instance, big multinational corporations or local medium size companies pay more and more attention to IT security and protections of personal data (under certain circumstances compliance with GDPR is obligatory for Georgian companies as well). Services portfolio of audit firms include IT audit, cyber security advice, etc. This gives audit firms comparative advantage over traditional law firms enabling them to offer clients advice on IT matters from purely legal perspective and also cover technological implications of the relevant solutions. Furthermore, technological innovations and effective methodology for process management enables audit firms to provide clients with cost effective business integrated legal solutions. 

And last but not least, nothing in this article suggest doomsday predictions for traditional law firms which hold and in the nearest future will continue to hold major share of legal market (whether global or local Georgian legal market). However, audit firms are no longer just accountancy firms. They have been transformed into international multidisciplinary consulting companies which offer wide range multidisciplinary business advice to their clients on global scale. AML Intelligence suggest that the following three scenarios are most likely in respect to further development of legal services by audit firms: (i) deepen focus on legal services with an accounting or consulting overlap; (ii) expand into a ‘Full Service’ offering; (iii) develop a managed legal service offering (similar to the current offering of alternative legal service providers).  It is unclear which of these scenarios will prevail.  But the fact is that the legal services play increasingly significant role in service portfolio of audit firms. If audit firms maintain their current growth rate and not least importantly manage to avoid another “conflict of interest” scandal (if something like new Enron scandal does not hit audit firms again), then we might witness much intensive expansion of audit firm into the global legal market and who knows maybe the second scenario is the future of legal services market.