Deloitte Touche Tohmatsu dropped out of the running for a possible merger with embattled auditor Arthur Andersen Wednesday, leaving only KPMG as a possible suitor.
Deloitte Touche said preliminary talks ended Wednesday and it was unable to move to the next stage of discussions "due to Andersen's unresolved litigation and legal issues."
"Our first preference for the capital market and for the profession is for Andersen to continue as a free-standing firm," Deloitte said. "We entered into preliminary discussions with Andersen when it appeared that insufficient progress was being made toward that goal."
A spokeswoman for Andersen could not immediately comment on Deloitte's statement.
Deloitte's decision is a blow for Andersen as industry observers considered Deloitte the most likely partner, especially after Ernst & Young opted out of negotiations with Andersen earlier Wednesday.
With Deloitte out of the picture, it leaves KPMG as the only likely candidate for a merger or deal. Andersen had hoped to settle on a deal for a merger or sale of parts of the company this week, a source with knowledge of the discussions told CNN/Money.
Andersen also is presently not in talks with PricewaterhouseCoopers, the largest U.S. accounting firm, the source said.
A merged Andersen-KPMG also would rank as the top accounting firm in the nation and would have revenue of $9.3 billion in the United States.
KPMG and Andersen declined to comment. PwC could not be reached for comment.
Chicago-based Andersen, the smallest of the Big Five accounting firms, has lost many large audit clients recently as the Enron scandal continues to cause companies to switch auditors and dump Andersen. So far, FedEx Corp. (FDX: Research, Estimates), Merck & Co. (MRK: Research, Estimates) and Freddie Mac (FRE: Research, Estimates) all have dropped Andersen.
Also on Wednesday, consumer finance firm Household International (HI: Research, Estimates) became the latest company to drop Andersen as its auditor. The company is appointing KPMG as its auditor for 2002.
In a statement Household International said, "Household has valued the quality of work and excellent service provided by Arthur Andersen during the course of the company's relationship with the firm. However, due to the current uncertainty about the future direction of Arthur Andersen, Household's Board of Directors felt that it was in the best interest of the company to make this change."
Andersen is currently trying to resolve possible criminal charges with the Department of Justice over its role in the collapse of Enron Corp. The firm has admitted that some of its staff shredded Enron documents. Andersen is also trying to settle shareholder lawsuits against the firm.
Even before Deloitte's statement, Art Bowman, of Bowman's Accounting Report, discounted the firm's chances of combining with any of its rivals. "No one will touch Andersen as long as the DOJ issue is out there and no one knows how to handle the liability issue," he said. "I don't think it will merge for now."
Andersen's actions this week represent a rapid about-face for the firm, which was once one the most powerful and ferocious in the accounting industry. Two years ago the firm lost its first place ranking when it split with Andersen Consulting (now known as Accenture) and now ranks as the smallest of the Big Five, with 85,000 employees and $9.3 billion in global revenue for the fiscal year ended Aug. 31.
"Andersen has gone into bunker mentality and is acting like a beaten dog," Bowman said.
Andersen is currently in talks with both the DOJ and the Securities and Exchange Commission to secure a settlement. The accounting firm is scrambling to meet a Thursday deadline to resolve possible criminal charges with the DOJ and could plead to lesser charges or face a criminal indictment.
However, the firm hopes to avoid any guilty pleas stemming from its role in Enron's collapse.
Andersen has admitted it shredded Enron documents but has tried to place the blame solely on dismissed partner David Duncan, who said he was advised by an in-house Andersen lawyer to destroy the documents.
On Monday, CNN/Money reported that the firm could reach a settlement with the DOJ this week.
Andersen also is trying to reach a resolution with the SEC, which likely will not come before Friday, the source said. The SEC talks are not directly related to the firm's negotiations with the DOJ, another source familiar with the negotiations told CNN/Money. Any deal with the SEC would seek to get some form of financial restitution for individual investors, the person said.
Press reports have said the SEC deal calls for Andersen to pay more than $100 million in fines and set up a fund to compensate Enron shareholders. The $100 million fine would represent the largest civil penalty levied against an accounting firm and greatly trumps Andersen's last pay out to the SEC.
Last summer, Andersen was fined $7 million to settle civil charges against it by the SEC. The agency said in June that Andersen's audits of Waste Management's financial statements were false and misleading but the accounting firm did not admit or deny any wrongdoing.
Andersen would be less eager to settle with the SEC if it is indicted by the DOJ. "Right now the Justice Department has a big, huge hammer," a source said.
The SEC faces a delicate enforcement issue if the Justice Dept. indicts Andersen on an obstruction of justice charge or if Andersen pleads guilty to such a felony.
SEC rule 102-E calls for the Commission to ban Andersen from signing off on public filings, including quarterly and annual financial reports.
"Any person who has been convicted of a felony or a misdemeanor involving moral turpitude shall be forthwith suspended from appearing or practicing before the commission," states the rule.
Experts in securities law say the SEC will have to be flexible since Andersen is auditor for more than 2,000 corporations.
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"The rules would quite possibly prevent their consent to an audit from qualifying if they have a criminal issue," said Richard Breeden, former SEC Commissioner.
"But the Commission itself would be able to waive that, and in this kind of a situation, might well provide some kind of a relief," Breeden added.
"The SEC would have to give them a waiver," said Ira Sorkin, former director of the Commission's New York office.
But a guilty plea from Andersen to either the DOJ or SEC doesn't necessarily mean the end of the 89-year old firm. The SEC can prevent Andersen from conducting any public audits of firms here in the United States but neither agency regulates the practice of accounting, which is governed on a state level.
"Each state would have to take action and either suspend or revoke Andersen's license," Bowman said.