When Auditors Walk: Red Flags and What They Signal
When Auditors Walk: Red Flags and What They Signal
Understanding the Subtle but Telling Signs of Auditor Resignations
Red flags in auditor departures – update # 1
Audit firm’s departures do not always spell troubles. Companies may change auditors because they seek a larger firm with expertise that better aligns with a company’s growth or because they delist from an exchange following a going-private transaction. Audit firms may drop clients because the firm scales down its public audit practice or strategically reshuffles its clients' portfolios.
But you know what is a glaring red flag? When an auditor quits with public criticism of the company or due to disagreements with management, it often signals severe underlying accounting issues. My friend and frequent co-author, Francine McKenna of The Dig, discussed how auditors publicly criticized Molex in 2004. For readers unfamiliar with the case, The Dig provides an excellent summary.
Public disagreements between auditors and their clients are rare. Using the Audit Analytics Auditor Changes database, I identified two 2024 cases where an audit firm resigned because the auditors could not trust the company’s management:
On June 27, 2024, Ernst & Young LLP (“EY”) resigned as an independent auditor of SunPower Corporation. The 8-K Item 4.01 filing noted that “…information has come to EY’s attention that, if further investigated, may materially impact the fairness or reliability of the Company’s financial statements, or cause EY to be unwilling to rely on management’s representations or be associated with the Company’s financial statements”. The 8-K filing was subsequently amended on July 12, 2024, to note that EY disagrees with certain statements in the original 8-K Item 4.01 provided by the management. On April 23, 2024, SunPower disclosed that the Company will have to restate its financial statements for fiscal annual 2022 and quarterly 2023 periods. SunPower filed for Chapter 11 bankruptcy protection on August 5, 2024, without engaging a new auditor.
Tingo Group, Inc. [Ticker: TIOG] disclosed on January 22, 2024, that the Company’s auditor, Brightman Almagor Zohar & Co. Certified Public Accountant, a firm in the Deloitte Global Network (“Deloitte Israel”), resigned effective immediately. The resignation followed a Department of Justice inditement, which was unsealed on January 2, 2024. The new information led Deloitte Israel to conclude that the firm can no longer “rely on management's representations” and is “unwilling to be associated with the financial statements prepared by management”. The SEC suspended trading of Tingo’s shares following allegations that the financial statements were fabricated.
Loud resignations, like Ernst & Young's departure from SunPower Corporation and Deloitte Israel’s resignation from Tingo Group, signal an inability to trust the management's representations. In both cases, the companies were delisted from exchanges. These high-profile exits underscore that when an auditor explicitly questions the integrity of a company’s financials, it likely points to deeper, systemic problems. Yet, in both cases, the resignations followed the negative news that - at least partially - were already known to the market.
However, not all auditor resignations are this noisy. Some departures may seem routine on the surface, yet subtle nuances of the disclosure may still spell troubles. In these quieter cases, context matters.
Let's look at several patterns that, in my opinion, point to subtle red flags in auditor resignations.
Unexpected immediate resignations initiated by the auditor. SEC rules require that companies disclose on 8-K Item 4.01 whether the auditor resigned or was dismissed. Sudden auditor-initiated resignations —rather than dismissals by the company—suggest that the audit firm is unwilling to continue auditing a client. Why? For instance, the resignation may follow perceived higher audit risk, concerns about accounting quality, or governance issues.
Departures related to disagreements over accounting treatment. While departures concerning disagreements over accounting may not be as severe as issues involving unreliable management, they suggest that the auditor and management may have diverging views on how certain financial information should be reported. The disagreement may lead to a restatement of past results or a prospective change in accounting practices.
Auditor resignations with a delay in engaging a replacement firm. SEC rules mandate that companies alert investors in an 8-K filing about changes in independent accountants. While SEC rules treat an audit firm’s departure and engagement as two distinct events, based on data from Audit Analytics, almost 60% of the auditor changes reported in 8-K filings in 2024 announced the departure and the engagement on the same day, and more than 80% of the companies engaged a new auditor within two weeks of the departure. A short lag between departure and engagement is expected – a rational company would not dismiss an existing auditor without lining up a new engagement. A long delay in hiring a replacement firm – even if a delay was related to a tight audit market - poses a risk to investors because the company may become delinquent with SEC filings or face steeper audit fees.
Behind the cut, I discuss several recent examples of companies with auditor resignations that warrant more attention.
Importantly, early indicators may provide food for thought but do not always predict bad outcomes. These indicators should be evaluated in context and as part of a broader information set, including the company’s overall financial health, governance practices, and relevant disclosures. Therefore, while these red flags can signal areas for closer scrutiny, they should be assessed alongside other factors.