Auditing your Auditor

When telecommunications provider IDT decided to switch
auditors from Ernst & Young to Grant Thornton in early 2008, the “driving force
was to save money,” says CFO Bill Pereira. It worked. Part of a companywide
effort to reduce corporate overhead, the move cut IDT’s $ 4.3 million audit bill
almost in half. Although initially “we were fearful of leaving the Big Four,”
says Pereira, “in retrospect, we are really happy with the decision.”

In fact, the switch went so smoothly that IDT declined to
announce the renewal of Grant Thornton’s contract in its most recent proxy —
because IDT was open to switching again. “We knew there had been changes in the
market and we wanted to evaluate where fees stood,” says Pereira. “We didn’t
just make the automatic assumption that we’d stick with Grant Thornton. We felt
it was our responsibility to do our homework.” (IDT eventually did renew with
Grant Thornton — and cut its bill by nearly another million dollars, to $ 1.42
million last year.)

Welcome to the new auditor-client relationship. In the wake
of the Sarbanes-Oxley Act of 2002, audit fees soared, auditors dumped risky
clients by the hundreds, and ‘value-added’ services all but vanished under the
weight of new independence rules. Today, the reverse is true. Audit fees have
been dropping across the board since 2007. In 2004, more than a third of auditor
changes were the result of audit firms walking away from clients. Last year, 82%
of auditor changes were because companies fired their auditors (among the Big
Four, the number was 90%). And companies aren’t just negotiating lower fees;
they are also demanding more value — read ‘services’ — covering everything from
corporate-board education to competitive intelligence.

Publicly traded companies alone spent $16 billion on audit
and audit-related fees in 2008, with nearly 7,000 companies paying more than $
100,000 each year, and 2,585 paying more than $ 1 million, according to CFO’s
analysis of data from Audit Analytics. Little surprise, then, that half of all
CFOs now say they regularly (at least every two years) benchmark what their
company pays its external auditor against what their peers pay, according to the
latest Duke University/CFO Magazine Global Business Outlook Survey.

Unusually low or high fees both can signal trouble: weak
audits for the former and potential conflicts of interest for the latter.
“Companies paying the highest fees (may do so to gain) more flexibility and
aggression in accounting,” says Whisenant. He has done studies that suggest that
fees that are unexpectedly high or low “can both lead to conditions where the
shareholders do not benefit.”

Take, as an extreme case, Fannie Mae, which in 2003 paid a
surprisingly low $ 2.7 million for its audit by KPMG. An accounting scandal the
following year subsequently caused the company’s audit bill to soar to $ 203
million (paid to Deloitte & Touche after KPMG was dismissed).

More recently, in building its case against David Friehling,
auditor of Bernie Madoff’s Ponzi scheme, the SEC charged him with raking in
“substantial fees.” But, in fact, the opposite is true : that Madoff’s
multi-billion-dollar fund paid the tiny audit firm of Friehling & Horowitz a
mere $ 186,000 per year should have been a glaring red flag.