Deloitte Touche Tomhatsu called off talks regarding a possible acquisition of Arthur Andersen LLP, the big five accounting firm that has drawn scrutiny because of its role in the collapse of Enron.
In a statement Wednesday, New York-based Deloitte said it didn't want to "pursue a business combination with Andersen Worldwide."
Deloitte spokesman Matthew Batters said talks between the two companies ended Wednesday.
The company said talks were "unable to continue to the next stage because of discussions due to Andersen's unresolved litigation and legal issues."
Negotiations began quietly last week between New York-based Deloitte and Chicago-based Andersen, said a source familiar with the talks.
Ernst & Young was the first of the "Big Five" accounting firms to say it definitely won't pursue Andersen as long as Andersen faces investor, and possibly criminal, litigation over its audit of the collapsed energy giant Enron Corp.
Andersen is seeking a merger to ensure its survival, but time is running out. A Department of Justice deadline to reach some sort of deal before Thursday looms large, and Andersen faces criminal charges related to its destruction of Enron documents that would almost certainly cripple the firm.
Andersen has been in merger talks with other big accounting firms PricewaterhouseCoopers, and KPMG, sources have said. But experts say any deal would be tough due to Andersen's legal problems.
"I'm not sure there's a deal to be had here, or that anybody will think, at the end of the day, there will be anything to buy," said Joe Basile, partner at the law firm Bingham Dana LLP in Boston. Basile's pessimistic assessment came even before the Ernst & Young announcement.
"We may see Andersen competitors simply going after the clients directly and then hiring the people necessary to support the clients," Basile added. "None of that has to happen through an acquisition of the entity with all of the worries about liabilities that would tag along."
Top-flight clients, including Merck & Co. and Delta Air Lines are bolting Andersen almost daily, and the 88 year-old firm has already been ordered to split its consulting and auditing practices by a special panel it established in response to the Enron scandal. Andersen, employs 85,000 people worldwide
Andersen has reportedly offered to settle lawsuits from shareholders, creditors and employees for $750 million, though leading shareholders have said they are looking for at least twice that figure, and do not expect a quick resolution.
Experts say possibilities include a Chapter 11 bankruptcy reorganization that would insulate any buyer from legal liabilities, overseas partners defecting to rivals, or a crushing blow from the Department of Justice leaving the once-prestigious firm useless.
"A lot of it hinges on what happens tomorrow with the Justice Department," said Jonathan Hamilton, managing editor of Public Accounting Report. "Maybe part of a settlement with the Justice Department will be that Andersen declares bankruptcy so that it can work out a strategy to sell off its pieces."
Justice Department prosecutors repeatedly have threatened Andersen with indictment for destroying documents in the Enron case, according to the sources' accounts of negotiations over the past week to 10 days.
The Securities and Exchange Commission and a dozen congressional committees are also investigating Enron, its accounting practices and Andersen's role.
Andersen is wary of pleading guilty in the Enron affair because that might bar the company from performing audits, the core of its business, say people familiar with Justice Department negotiations.
Despite Andersen's need to resolve any criminal legal problems swiftly, the firm wants assurances from the SEC that it would still be able to practice before the SEC, the sources said Tuesday, speaking on condition of anonymity.
In a terse statement recusing itself of any deal with Andersen, Ernst & Young specifically cited the Enron debacle.
"Ernst & Young has concluded that as long as Enron and other Andersen litigation matters are unresolved, it is not in the best interests of our people, clients, and our firm to pursue such a combination," the firm said.
It was not immediately clear how Ernst & Young's announcement might affect other potential buyers. A merger agreement where a remaining Big Five firm would absorb portions of Andersen's business or some overseas operations is certainly a possibility.
"We are in active discussions with Andersen," said a senior partner at a rival accounting firm in Europe Wednesday. "It isn't something we would necessarily want to do as a global deal, and it may not even be a deal we want to do as a European deal."
The firm has fought hard to restore its credibility, and last month hired former Federal Reserve Chairman Paul Volcker to lead a wide-ranging reform effort.
Andersen negotiators have been working on many fronts to salvage the firm but investigations ranging from Wall Street to Washington mean events are largely beyond their control.
"It's a very tough sell," said Basile.
Andersen regards SEC clearance in the event of a guilty plea as vital, the people familiar with the contacts said. Andersen spokesman Patrick Dorton declined comment.
"A felony conviction can have a draconian impact on the ability of licensed firms to practice in various states" and before the SEC, said Ira Lee Sorkin, a white-collar defense lawyer and former director of the SEC's New York City office.
"The SEC can bring a proceeding under its own rules barring or suspending or censuring a firm from practicing before the SEC," said Sorkin, also former deputy chief of the criminal division at the U.S. attorney's office in New York.
But another legal expert questioned the importance of the issue.
"I think it's a little farfetched," Duke University law professor James D. Cox said of Andersen's concern.
If the SEC prohibited Andersen from signing off on company reports filed with the agency, other accounting firms would have to absorb Andersen's business and hundreds of publicly traded companies would have to switch auditors, said Cox, a specialist in corporate and securities law.
Houston-based Enron was the world's largest trader of natural gas, growing into the nation's seventh-largest company and a Wall Street favorite as the country's leading electricity trader.
Enron entered the biggest corporate bankruptcy in U.S. history on Dec. 2, toppled by a complex web of partnerships - improperly buttressed by Enron stock - that were used to hide more than $1 billion in debt from investors and federal regulators.
Its financial reports, which overstated profits by nearly $600 million since 1997, were approved by the Andersen auditors. Some top Enron executives have said they believed the company's accounting was proper because Andersen had blessed it.