The U.S. operations of Andersen, on the verge of extinction over the failure of its auditors to warn of problems that led to the bankruptcy of energy trader Enron Corp., have a slim shot at survival as a smaller but better audit firm, experts say.

The odds are against it -- with the U.S. Department of Justice bringing criminal charges, angry Enron shareholders suing for billions of dollars and securities regulators threatening fines. Andersen has also been bleeding clients as the Enron scandal unfolds, but industry watchers say the partners remain commited to the firm, and may turn it around if it can solve its problems quickly.

"Andersen needs to get closure on these things," Joseph Carcello, professor of accounting at the University of Tennessee, told Reuters. "If they can resolve the criminal case, they have a chance. If they pull through, a lot of their clients will want to stay with them. "

Andersen, looking to take apart its worldwide network before it crumbles, is in talks to sell its non-U.S. operations to KPMG International. It is likely to spin off, or possibly sell, its tax and consulting units in the United States.

That would leave Andersen as a smaller, audit-only firm in the United States. Outside estimates say it would have about $2 billion in revenues, compared to $9 billion overall revenues last year.

Most important, Andersen could then sell itself as a squeaky clean, conflict-free firm specializing in audit work.

"They are making all the right steps," said Mark Cheffers, an accountancy consultant, who expects Andersen to settle its case with the U.S. Department of Justice in the next two months, before it goes to trial. "They could then place themselves as the premier audit firm."

MODEL AUDITOR

Although that is a dim prospect, some industry watchers say Andersen's survival could prove to be a good advertisement for the overhaul of the accounting business, seen by many as going soft on corporate audit clients in return for millions of dollars in consulting fees.

"A lot of people who care about financial reporting are rooting very hard for Andersen," said Carcello. "Andersen, if it survives, is going to make more drastic changes than any other auditing firm is willing to make. If it doesn't survive to put those changes into place, then we'll never be able to see if those lead to better outcomes."

Andersen is expected to split off its U.S. tax and consulting operations from its audit unit, following recommendations from former Federal Reserve chairman Paul Volcker, brought in last month to help Andersen revamp.

That recommendation and several others are designed to sever the cozy relationships that tempt accounting firms to go easy on the companies they audit. Regulators are weighing similar industry-wide rules.

Andersen did not return calls seeking comment on a report in the Wall Street Journal Tuesday that it was in talks to sell its U.S. tax and consulting operations to rival Deloitte Touche Tohmatsu, A source close to Deloitte dismissed talk of a merger, but said Deloitte was looking to explore opportunities.

SMALLER, BETTER

If it did sell, Andersen would likely look to medium and smaller firms for audit work.

"They (Andersen) could find their way back, and potentially place themselves as a premier audit firm," said Cheffers. "It's a dicey, landmine-filled proposition, but I would rather think positively. Five years from now we could be looking at a turnaround."

Others agreed that the way back would be tough.

"It's hard to say, but if Andersen beats the indictment, gets a not guilty verdict, they still have a chance of surviving," said Carcello at the University of Tennessee.

"I don't know if it can be a big five firm, but it can be a viable accounting firm as a U.S.-only auditor," he said. He suggested that Andersen would struggle to keep multinational clients, unless it builds alliances with overseas audit firms.

Other industry watchers doubted Andersen's U.S. audit operations would be strong enough to compete with major rivals.

"(A sale of non-U.S. operations) is going to weaken their domestic practice naturally, because many of their most prominent clients are multinational clients," Robert Willens, an analyst at Lehman Brothers, told Reuters.

But Andersen management and partners could also lose heart before the battle is over, as the Enron affair moves into its fifth month.

"There is a cost in emotional and reputation terms," said Cheffers. "There must be a temptation to throw up their hands, and say "We can't do it'."