Fewer Companies Changing Auditors

Fewer companies changed their auditor last year, according to a Compliance Week analysis, and while smaller firms made some inroads, the pecking order among major audit firms remained relatively stable in 2011.

Among the Big 4 firms, KPMG won more new public company audit clients in 2011 and Deloitte & Touche lost the largest number, but the smaller firms outshone the Big 4 overall in winning new business.

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KPMG and its affiliates lost 27 audit engagements in 2011 but picked up 43 new ones, for a net gain of 16 audits, according to a Compliance Week review of Form 8-K filings announcing auditor changes in 2011. Deloitte, however, lost 30 clients and replaced them with only 8 new engagements for a net slide of 22. That was the largest swing among any of the first- and second-tier firms, but still a small move overall considering that 938 public companies changed auditors last year.

The turnover was flatter at PwC, where 23 departures and 25 hirings produced a net gain of two clients for the year. Ernst & Young suffered a net loss of five clients, on 26 departures replaced by 21 engagements.

Second-tier firms made small gains on the Big 4. Overall, the Big 4 firms lost more clients than they gained, but the opposite is true for the next tier of audit firms—that is, those audit shops large enough to be inspected annually by the Public Company Accounting Oversight Board, but who aren't among the Big 4. Those firms—BDO, Crowe Horwath, Grant Thornton, McGladrey & Pullen, MaloneBailey, and ParenteBeard—lost a total of 65 clients but scooped up 93 more, for a net gain of 28. In contrast, the Big 4 collectively suffered a net loss of eight clients.

Still, second tier firms remain miles behind the Big 4 in terms of net client billings, according to data compiled by Bowman's Accounting Report based on 2010 fiscal year billings. The smallest Big 4 firm, KPMG, is nearly four times larger than the next firm, RSM McGladrey & Pullen, with $5.02 billion in net billings compared to $1.38 billion for McGladrey.

Across the entire audit market, churn dropped 22 percent, from 1,205 in 2010 to only 938 last year.

Reasons for auditor turnover vary widely, and “losing a client” is not always a bad thing. For example, a company may indeed decide to switch to another auditing firm because it was offered better service or a lower price—but an audit firm might also decide to resign an account because the client was too risky to keep. Of the total 938 auditor changes executed last year, 646 were cases where the company dismissed the auditor; in 244 cases the audit firm resigned (although it's not always clear whether the auditor walked away from the client or the client asked the firm to resign); in 35 cases, the auditor was terminated. In 14 cases the filings did not include a specific reason for the change.

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The data is not surprising to Erick Burchfield, senior director and financial consulting lead at the Kennedy Consulting Research & Advisory firm. He describes 2011's data as fairly typical for audit engagements, with changes concentrated among middle-market or smaller companies and audit firms. Larger companies tend to change auditors infrequently, he says, because of the complexity of the engagements and the cost and difficulty associated with a transition to a new firm.

The differences among Big 4 firms are perhaps more noteworthy, although not easy to explain. None of the Big 4 firms were willing to discuss the data, except KPMG to provide some updates and corrections to Compliance Week's auditor-change database. Burchfield says Deloitte's drop in engagements could stem from any number of issues. As the Big 4 pursue growth strategies, they focus more on advisory and tax services than audit, he says. “Nowhere is that more true than at Deloitte,” he says.

The Big 4 firms are taking careful note of the regulatory tone these days too— particularly in Europe, where the European Commission is considering measures to force the creation of audit-only firms and mandatory rotation, and in the United States where the PCAOB is flirting with mandatory rotation as well. Profit margins are already stronger in non-audit areas for the major accounting firms, so their growth strategies revolve around investing in those areas, Burchfield says. And Deloitte's recent unflattering reviews from the PCAOB probably haven't helped it win new business.

“Companies are starting to realize they don't get a bump in stock price because they paid extra for another audit firm's name.”

—Trent Gazzaway,

National Managing Partner,

Grant Thornton

While all four firms have had their share of shareholder litigation and fraud entanglements, Deloitte is still the only Big 4 firm to suffer a public disciplinary action from the PCAOB, and the only firm to have its audit quality control methods openly criticized by the PCAOB. It also remains in a standoff with the Securities and Exchange Commission over audit documentation at a Chinese affiliate in connection with accounting fraud allegations at Longtop Financial.

Still, the rest of the Big 4 are in the same uncomfortable spotlight as Deloitte. The PCAOB has issued blistering reports to the entire group lately based on audit inspections that found all the firms had a higher frequency of poor audits. While all Big 4 firms experienced nearly a doubling of failed audit inspections, Deloitte fared the worst, with failed inspections jumping from 22 percent in 2009 to 45 percent in 2010.

Independent accounting analyst Art Bowman says litigation and regulatory enforcements are not likely to cause a Big 4 firm like Deloitte to lose business. “I'm not thinking Deloitte has a quality-control problem with its clients,” he says. “When they were the Big 8 or Big 6 and they would get beaten up occasionally and fined, it meant something. In these days, it's just a cost of doing business. A $1 million fine is not even an erasure mark on a spreadsheet.”

According to Bowman, perhaps the biggest factor that might lead to auditor turnover, especially away from Big 4 firms and toward middle market or smaller firms, is cost. “The economy is a big factor,” he says. “Every company out there is looking for ways to save money.”

Small Proposition

Not surprisingly, the smaller firms make the same argument. Trent Gazzaway, national managing partner for audit services at Grant Thornton, says smaller firms have had a great value proposition to compete against larger firms over the past few years. Following the swinging pendulum in the 2000s—when the Sarbanes-Oxley Act compelled the Big 4 to shed audit clients early on, then woo them back as internal control auditing matured—tough economic times have forced companies to scrutinize what they spend on audit services.

WIN SOME, LOSE SOME

The following chart reflects audit client net gains and losses in 2011 by firm.*

*Includes affiliated firms.

Source: Based on CW analysis of data provided by Morningstar Inc.

“We're in an environment where companies don't need to spend money on a name,” he says. “They need value. Companies are starting to realize they don't get a bump in stock price because they paid extra for another audit firm's name.”

Peter Bible, partner-in-charge of the public companies practice at audit firm EisnerAmper, says his firm lost one client but picked up six in the past year. “It could be any number of things,” he says. “It could be cost or service motivated. Or it could be that people are becoming more comfortable with the non-standard household names.”

The data also suggest plenty of change has been happening among China-based firms listed on U.S. exchanges. The BDO network, for example, saw a number of China-based audits change hands within its own network. “There was some restructuring going on in our BDO China member firm,” says Wendy Hambleton, an audit partner and director of the national SEC practice at BDO USA. “Some of the changes were between our China member firm and our Hong Kong member firm.”

Many of the changes also involve Marcum Bernstein & Pinchuk, a firm created in early 2011 from the merger of Bernstein & Pinchuk with Marcum. Many of the firm's clients filed 8-Ks to drop the former firm name and adopt the new firm name, said Drew Bernstein, co-managing partner. The new firm also is picking up new clients, he says, with its size now giving it the ability to target more substantial, established companies, he says.