Fyi...Why companies replace their external auditors Changing audit firms is a massive undertaking that requires careful considerationbut learning from the experiences of other audit committees that have gone through the process can simplify whats often a difficult decision. An analysis of public company regulatory filings shows the factors behind why companies change external auditors and the circumstances under which proxy advisory firms are more likely to demand it. Not surprisingly, a hike in audit fees is among the more mundane reasons for why companies decide to change audit firms. D.R. Horton and McDermott International are recent examples of companies whose audit committees decided to change audit firms following a competitive request for proposal process, according to their respective regulatory filings. PwC, which has served as D.R. Hortons auditor since 2008, and Deloitte, which has been McDermotts auditor since 2006, were each replaced by EY. The fact that public companies must rotate engagement partners every five years, as mandated by the Sarbanes-Oxley Act, sometimes plays a role in the decision-making process. If a company knows the five-year rotation period is coming up, theyll look to see what the other firms have to offer, says Trent Gazzaway, Grant Thorntons national managing partner of quality and innovation for audit services. Often, a company will change audit firms due to some sort of pain point, and its typically service related, says Jeff Burgess, Grant Thorntons national managing partner of audit services. Rarely do they change because of the fee only, but the fee will quickly become an issue if there are service hiccups. In recent months, there have been plenty of service hiccups. In one example, WageWorks audit committee in October 2018 fired KPMG as its auditor following an independent investigation of WageWorks accounting practices, financial statement reporting, and internal control over financial reporting for fiscal years 2016 and 2017. The investigation included a review of the accounting for a government contract during fiscal 2016 and associated issues with whether there was an open flow of information and appropriate tone-at-the-top for an effective control environment, WageWorks said in a regulatory filing. Although WageWorks said no illegal acts occurred, it concluded that its financial statements for 2016 should be restated and should no longer be relied upon. Following the audit committees investigation, KPMG raised concerns primarily relating to the audit committees lack of communication concerning allegations made by former managements counsel and that the audit committee knew that information was withheld from auditors. KPMG advised the company that these disagreements have not been resolved to their satisfaction as of the time the audit committee determined not to continue to engage KPMG, WageWorks regulatory filing stated. USA Technologies (USAT), a vending-machine payments provider, faced a similar issue with its independent auditor, RSM. In a Feb. 1 letter to USATs audit committee, RSM resigned as the companys independent auditor, saying it could no longer rely on management representations in connection with the audit of the companys 2017 internal control over financial reporting and consolidated financial statements. USAT disclosed the letter in a regulatory filing on Feb. 6. Furthermore, USATs board of directors, upon the recommendation of the audit committee and following discussions with management, determined that financial statements for the fiscal year ended June 30, 2017, as well as quarterly and year-to-date unaudited consolidated financial statements for Sept. 30, 2017, Dec. 31, 2017, and March 31, 2018 should no longer be relied upon, as well as any related press releases, earnings releases, and managements report on the effectiveness of internal control over financial reporting. USATs audit committee said it is currently seeking a new independent audit firm and intends to engage such firm as soon as practicable. Audit committees shouldnt necessarily terminate the relationship with their external auditor based on a restatement or negative inspection result alone, says Cindy Fornelli, executive director for the Center for Audit Quality. But it should certainly cause the audit committee to have a conversation with the auditor as to why it had those results and the circumstances around the restatements, she says. Auditor ratification Other times, amid rising tensions between a company and its audit firm, proxy advisory firms may be the ones to instigate a change in auditor, as opposed to the company. This is currently the situation faced by General Electric, in which 35 percent of GE shareholders voted in April 2018 against KPMG as GEs independent audit firm, after major proxy advisory firms Institutional Shareholder Services (ISS) and Glass Lewis urged shareholders to withhold support for KPMG, which has held the role for more than a century (since 1909), according to the firms 2017 audit report. GEs circumstances are notable because votes in any significant number against auditor ratification are quite rare. According to an analysis conducted by Audit Analytics of shareholder votes filed between Jan. 1, 2015, and Dec. 31, 2017, on average, 98.7 percent of votes were cast in favor of auditor ratification. Just 0.9 percent voted against auditor ratification, while abstained votes made up the remaining 0.4 percent. The against vote followed announcement of an investigation by the Securities and Exchange Commission into GEs revenue-recognition practices and internal controls over financial reporting related to long-term service agreements. Then, in January 2018, GE disclosed that it took a $6.2 billion charge in the fourth quarter of 2017 and plans to set aside an additional $15 billion over seven years to bolster insurance reserves. Following this update, the SEC expanded the scope of its investigation to encompass the process leading to the reserve increase. When you look at this list of factors and red flags, Glass Lewis made the determination, as well as many shareholders, that a rotation in auditor would be preferable, says Kern McPherson, senior director of North American research at Glass Lewis. ISS expressed similar concerns: While it is extremely rare for ISS to recommend an against vote, we felt there was a combination of factors that made it impossible for us to sign off on auditor ratification as if nothing were the matter, says Marc Goldstein, head of U.S. research at ISS. Specifically, ISS said in its proxy analysis report of GE, In light of concerns about GEs previously undisclosed liabilities and accounting practices at GE that have prompted an SEC investigation, accompanied by unqualified reports by GEs long-time auditor KPMG, support for the ratification of KPMG as auditor is not considered warranted. If a company knows the five-year rotation period is coming up, theyll look to see what the other firms have to offer. Trent Gazzaway, National Managing Partner of Quality and Innovation for Audit Services, Grant Thornton