December 1, 2006

Parsing the Reasons for Auditor Resignations

A while back, Floyd Norris of the NY Times wrote this article urging the SEC to tweak its rules to require companies to provide reasons why an audit firm resigned in all cases, rather than the limited circumstances currently triggered under Item 4.01 of Form 8-K. Here is an excerpt from the article:

“A new study by Glass Lewis & Co., a consulting firm, finds that 1,430 public companies in the United States changed auditors in 2005, a turnover rate of 11.3 percent. The turnover is biggest at small companies, and about 60 percent of the departures are characterized by the companies as firings, with the rest resignations.

Why the changes? In 72 percent of the cases, the companies chose not to give any reason when they notified the Securities and Exchange Commission of the departure. That was up from 58 percent in 2004, when 1,451 companies changed auditors. Companies audited by the Big Four accounting firms, generally the larger companies, are even less likely to give reasons, with 82 percent choosing to remain quiet.”

Director Resignations Intersecting with Auditor Resignations

Some companies have changed auditors after (1) in their 302 certifications, CEOs and CFOs said their company’s internal controls were effective, (2) the auditors came in, conducted their audit and said “no, they weren’t” and (3) restatements were made. Obviously, this type of situation can call management’s certifications into question.

Even worse are situations like Take Two’s, where this Form 8-K was filed in January 2006 to reflect the resignation of the audit committee chair – and then there is this Form 8-K filed in April where the auditor resigns and states they had no disagreements. The letter from the resigning audit committee chair’s lawyer below is fascinating – and certainly raises eyebrows about the auditor who claimed there were no disagreements.

“As you know, we have just been retained to represent Barbara Kaczynski. I write in response to your email of Friday, January 20, 2006, to Ms. Kaczynski, regarding her resignation from the board of directors of Take-Two Interactive Software, Inc. (“Take-Two”).

Your email seeks confirmation from Ms. Kaczynski that her resignation from Take-Two’s board was not due to a disagreement with management of the type requiring disclosure under Item 5.02(a) of S.E.C. Form 8-K. Your email further asks Ms. Kaczynski to approve draft language describing the circumstances surrounding her resignation, which language the company intends to include in its upcoming Form 8-K disclosure.

Ms. Kaczynski does not know whether her resignation is of a type requiring disclosure under SEC rules and she does not feel able to express a view with respect to the language the Company intends to include in its Form 8-K disclosure about the resignation.

However, she is able to express to you directly the reasons why she resigned. During Ms. Kaczynski’s tenure as a board member and chair of the audit committee, several matters requiring the board’s attention caused Ms. Kaczynski concern. These matters included Take Two’s discovery of illicit images depicted in its “Grand Theft Auto” videogame, the Federal Trade Commission’s investigation of Take-Two following that discovery, and various SEC inquiries directed at Take-Two and its employees.

More recently, in connection with preparation of the 10-K and its late filing, Ms. Kaczynski’s concerns have risen significantly because of what she views as an increasingly unhealthy relationship between senior management and the board of directors. In her experience, management’s interactions with the board were characterized by a lack of cooperation and respect. Moreover, Ms. Kaczynski felt that management failed to keep the board informed of important issues facing the company or failed to do so in a timely fashion. In these circumstances, Ms. Kaczynski decided to resign her position as a member of the board.”

Cell Phones Could Betray Former Users

Recently, Fox News ran this article about how sensitive information accumulated in your cell phone could be accessed by new users, even though you thought you had deleted the data. Resetting the phone may make it appear that confidential information was erased, but it actually can be recovered using inexpensive software that is readily available online.

The article made me wonder what kind of confidential information would be left on a Blackberry – or a computer hard drive for that matter – when it gets replaced on an upgrade. Lawyers have an ethical duty to protect client confidentiality, so lawyers disposing of smart phones, computers, PDAs, etc. should ensure that the data really gets deleted so that it cannot be recovered. That would also be a good practice for anyone seeking to protect their own personal data or to guard other confidential information.