Whether flat retainers or hourly rates, as the federal billing cases play out, agencies will have to start doing a better job of backing up their fees.
The seemingly mundane issue of client billing has become a hot topic within the advertising and PR industries as the first of two recent high-profile fraud cases goes to trial.
Legal experts contend that the cases - which involve over-billing on lucrative government contracts - are isolated incidents and are unlikely to result in sweeping changes in how agencies bill clients.
But they acknowledge that agencies and clients alike will demand closer examination and more oversight of billing practices thanks to the exposure, especially on larger accounts.
Advertising agency Ogilvy & Mather (O&M) is currently presenting its defense for allegedly overbilling the Office of National Drug Control Policy (ONDCP) for $3 million in work that was never done.
The ONDCP has brought criminal charges against two O&M executives who oversaw the work on the account. Shona Seifert and Thomas Early are accused of fabricating time sheets to meet billing forecasts.
The total account was valued at $1 billion over five years.
The agency has already paid $1.8 million in a 2002 civil settlement.
Separately, a senior Fleishman-Hillard executive and two unnamed "co-schemers" have been indicted in Los Angeles for allegedly overbilling the city's Department of Water and Power by $4.2 million. A trial is tentatively set for this summer.
In the O&M case, the defense has argued that the time sheets were too complex for the advertising executives to manage.
"Evidence will show that Ogilvy was not organized to handle time sheets. Creative people do not want to be troubled with time sheets," Advertising Age quotes defense attorney Gregory Craig as saying.
Allan Weiner, an attorney in the business strategies and transaction practice at law firm Collier Shannon Scott, notes that government contracts are subject to more regulations than corporate contracts. And they might, therefore, require agencies to report additional details and file more paperwork.
But he disagrees that the level of complexity of the contracts is a legal excuse that is likely to set any precedent. Hourly billing might not be the most common way of billing clients, but it has been long established in not only advertising and PR, but also law and financial services.
"There are many service organizations that report time. An hour is an hour," says Weiner, who is not involved in the case.
He adds that the defendants have fallen back on "the defense that's used quite often, which is, 'I'm stupid.'"
Doug Wood, who leads the advertising and marketing unit at law firm Reed Smith, and is also not involved in the case, agrees. "Fraud is fraud," he says. "The underlying case is not all that exotic."
But some PR professionals point to a need to reform - or at least standardize - how agencies bill clients.
Harlan Loeb, director of the litigation practice at Hill & Knowlton, declined to discuss the O&M case because both agencies are owned by parent company WPP. But he did emphasize that the PR industry needs "common cause or consensus on standards" for billing.
Billing practices run the gamut from flat retainers to charging by the number of man-hours spent working on an account. Most agencies use a combination of the two models.
Bruce Marcus, a former PR executive who has counseled several large accounting firms, notes that changes in billing practices reflect shifts in attitude in how corporate executives view PR.
Pioneers in the industry billed clients according to a flat monthly fee, says Marcus. Agencies adopted hourly billing as the industry grew and became more established.
"Overbilling is not new - getting caught is," he says. "This is an era where business is suspicious. That's why we have Sarbanes-Oxley."
Marcus, who publishes an online newsletter, The Marcus Letter, is an advocate of "value billing," where agencies set a compensation fee based on what they can accomplish for a client.
"The only way you can justify a fee is by the value you can offer for a client and the value you can deliver," he says. "If you cannot explain what you're getting for your money, how do you decide how to charge for it?"
Philip Palazzo, MD at AdMedia Partners, a financial advisory firm that counsels marketing and media companies, also notes that the past two decades have seen a shift from commission-based compensation to a fee-based system.
But he disagrees that the trend is likely to change because the O&M case was a question of unscrupulous employees, not a reflection of its billing practices.
"You find these types of cases, and they're isolated," he says. "I don't think it's an indictment of the billing system involved."
Increase in audits
Industry audits, while not a new phenomenon, are likely to become more common because of the high-profile nature of the two cases, Wood notes.
"The public relations industry has been a very sloppy industry in terms of contracts. Audits are more frequent today than they were ever before," he says. "What this case has done has brought a significant focus on agency billing practices. This is a fascinating case only because it's a black eye on the industry."
He adds that the government is likely to try to make an example of billing fraud in these two cases "because it's in their own back yard."
"When you've got the government so angry about this that they're sending people to prison ... it's a real wake-up call," Wood points out.
Legal and financial experts note that there are several steps an agency can take ahead of a potential audit.
First of all, managers need to establish a set of rules and procedures for billing clients, Weiner notes. "What they should be doing is making sure that time billing is accurate and straightforward," he says.
Billing policies should be in writing, something that agency heads can point to and to which account supervisors can be held accountable, says Wood. Managers also should periodically do their own internal audits and strongly discipline wrongdoing, he adds.
Marcus notes that agencies need to meticulously describe what they are billing for.
"Transparency is the answer to any kind of corporate chicanery," he says.
But Palazzo notes that there is no billing procedure that will protect an agency against unscrupulous employees.
"You can have all the controls in the world, but it's going to be dependent on the internal checks and balances," he says.
Marcus notes that PR firms need to look introspectively to assess not just how they bill clients, but what exactly they're billing for.
"The problem with PR is that it's too hard to assess value," he says. "I'm not sure that the profession as a whole has done enough to educate its market about what it contributes."
From a legal standpoint, neither Wood nor Weiner believes that the advertising community is likely to get a pass by claiming that the industry was not set up to handle hourly billing.
"The laws are relatively simple: Don't lie," Wood says. "If these allegations are true, this is pretty indefensible."
O&M has also argued that the initial forecast for the account did not match the amount of work ultimately done.
But the question of whether firms can "adjust" hours to meet billing forecasts laid out in the contract also has a clear answer, Weiner says. "The basic rule is that if you're billing on an hourly basis, you should be billing on an hourly basis."
Weiner predicts that a guilty verdict will likely cause greater scrutiny of hourly billing - but not an overhaul. "If the defendants are found guilty, it will certainly establish fear in the industry," he says.