Turmoil in small audit firms market : who is affected and what does it mean for companies and investors

Borgers was not the only audit firm banned from doing public auditing work. The PCAOB revoked the registration of at least six audit firms in 2023 and the first half of 2024.

When regulators ban an audit firm from doing public accounting work, its clients face a challenging and prolonged process of finding a new auditor and securing a clean bill of health for the financial reports initially signed by the sanctioned firm.

Financial statements filed with the SEC must be audited by a firm registered with the PCAOB. The revocation of registration means that the financial statements must be re-audited, incurring additional costs for the companies and raising concerns that the re-audit may uncover previously unreported errors.

While the Borgers fiasco garnered extensive media attention, the revocation of registration for several smaller audit firms did not receive similar coverage. According to the PCAOB website, the Board revoked registrations of at least six US-based small audit firms since January 2023.

• Halperin Ilanit CPA. Disciplinary action on March 19, 2024; no audit opinions in 2022 or 2023;

• Gries & Associates, LLC. Disciplinary action on March 5, 2024; 23 audit opinions for fiscal 2022;

• Jack Shama. Disciplinary action on January 23, 2024; 7 audit opinions for fiscal 2022;

• K. R. Margetson LTD. Disciplinary action on September 12, 2023; 5 audit opinions for fiscal 2022;

• Ciro E. Adams, CPA, LLC. Disciplinary action on August 8, 2023; 1 audit opinion for fiscal 2022;

• RAM Associates & Company LLC. Disciplinary action on August 8, 2023; 1 audit opinion in 2022.

The count of audit opinions is based on publicly available Form AP data on the PCAOB website. Some clients of these firms had to re-audit their financial statements; for instance, see the discussion of Healthcare Triangle, Inc. (Ticker: HCTI) audit opinions in my April 10, 2024, amended filings alert.

Others didn’t and received comments from the SEC, reminding them of the obligation. From SEC comment letter to YUMMIES INC (Ticker: YUMM), emphasis added:

“We note your auditor’s report for the fiscal years ended September 30, 2022 and 2021 refers to Brisset Beer International, Inc. and not the company. Further, the going concern conclusion by the auditor does not explicitly state “substantial doubt” about the company’s ability to continue as a going concern, as required by PCAOB AS 2415, paragraph 12. Please amend your filing to include an audit report for the company which is compliant with Public Company Accounting Oversight Board (“PCAOB”) standards for the year ended September 30, 2022. As part of this, please note that the PCAOB revoked the registration of your auditor, Gries & Associates, LLC. You can find a copy of the order on the PCAOB’s website at https://assets.pcaobus.org/pcaob-dev/docs/defaultsource/enforcement/decisions/documents/105-2024-011-gries.pdf?sfvrsn=b9b25830_4. As this auditor is no longer registered with the PCAOB, you may not include their audit reports or consents in your filings with the Commission on or after the date of deregistration. Given that Gries & Associates, LLC is not currently registered with PCAOB, you should have a firm that is currently registered with the PCAOB re-audit the impacted year(s) that are required to be included in your filings with the Commission.”

Form AP is a good starting point for identifying companies that may need to find a new auditor and re-audit previously filed financial statements. Note, however, that the list might be incomplete because some audit firms may continue signing audit opinions without filing a Form AP.

For instance, Ahmed & Associates did not file a Form AP for its 2023 audit opinion issued to CYAP. As far as I understand, the Form AP requirements did not apply to Ahmed & Associates when CYAPs opinion was issued because the firm was already sanctioned by the PCAOB and deregistered. (See additional discussion in my July 17, 2024, alert.)

Let's consider another scenario where audit-related issues prompted re-audits. Item 4.02 is a form companies typically file to warn investors that their financial statements contain material errors. However, last week, three companies - Clean Vision Corp. (Ticker: CLNV), Zeuus Inc. (ZUUS), and Hammer Fiber Optics Holding Corp. (HMMR) – announced that their previously filed reports could not be trusted because their audit firm, Fruci & Associates II, PLLC, issued audit opinions without completing all the required audit procedures. (The 8-K announcements are available here, here, and here.)

From the Clean Vision 8-K Item 4.02 disclosure:

“On July 20, 2024, Clean Vision Corporation (the “Company”) received a written notification from its independent registered public accounting firm, Fruci & Associates II, PLLC (“Fruci”), advising the Company that, through no fault of the Company and solely due to Fruci’s failure to follow sufficient audit procedures, the financial statements (the “2023 Financials”) and audit opinion (the “2023 Fruci Opinion”) issued by Fruci in connection with the Company’s Annual Report on Form 10-K for the year ended December 31, 2023 (the “2023 Annual Report”) can no longer be relied upon and that Fruci was withdrawing the 2023 Fruci Opinion.”

A withdrawal of an audit opinion means that the financial statements will need to be re-audited. Once the audit is complete, the companies will need to file amended 10-Ks with the new audit opinion.

According to Form AP, Fruci & Associates II, PLLC had four engagement partners that audited 54 clients in the past year. Bloomberg recently reported that the audit firm picked more than a dozen former Borgers clients, expanding its public audit practice by about 20%. While only a fraction of Fruci’s clients have filed non-reliance reports so far, the important question is – are other clients affected? Is it possible that the incomplete audits were associated with excessive busyness – a metric defined as the number of audits per engagement partner?

Clean Vision Corp, Zeuus, and Fiber Optics Holdings Corp did not disclose how Fruci identified the audit deficiencies – namely, whether the discovery was prompted by the audit firms’ internal review or a PCAOB inspection.

The most recent inspection report available on the PCAOB website was publicly released on June 7, 2023, and was based on the 2022 inspection of fiscal years ending in 2021. While the inspection found an audit deficiency in two of the three audits inspected – a deficiency rate of 67% - the inspections did not trigger a revision of past results or change an ICFR conclusion for any of the issuers whose audits were inspected. The inspection report released on May 26, 2022, found that three out of four audits inspected had at least one audit deficiency – a 75% deficiency rate.

PCAOB annually inspects registered audit firms that regularly audit more than 100 issuers, while smaller audit firms are inspected at least once every three years. Suppose Fruci’s change of mind related to incomplete audits of Clean Vision Corp, Zeuus, and Fiber Optics Holdings Corp were induced by the PCAOB inspection of 2023 audits. In that case, the 2023 report will likely mark another year with a high deficiency rate.

In my opinion, two simple metrics—namely, the history of audit deficiencies discovered during the inspections and busyness—should be considered by issuers when engaging an audit firm and by investors when gauging the accounting quality of the companies they invest in.

Losing an auditor due to disciplinary action could be costly. How costly can it get? According to Bloomberg, dozens of Borgers clients were still struggling to hire a replacement audit firm as of mid-June. Bloomberg provided possible explanations: costs and the lack of motivation of the audit firms to start “financial checks from scratch.”

The lack of motivation to accept Borger clients is hardly surprising given the diminishing supply of firms providing public audits. Stephen Foley of the Financial Times reported in December that mid-size audit firms – including CliftonLarsonAllen and Armanino – exited the public companies audit market. Those continuing providing public auditing services may elect to become more selective in accepting new clients.

Consolidation in the auditing industry added to the small issuers’ woes. For instance, Mazars USA LLP shed several clients following its merger with FORVIS, LLP. From a regulatory filing of Reliance Global Group, Inc (Ticker: RELI):

“On April 4, 2024, Mazars USA LLP (“Mazars”) advised Reliance Global Group, Inc. (the “Company”) that Mazars will cease to act as the Company’s independent registered public accounting firm, effective with the filing of the Company’s Annual Report on Form 10-K for the year ended December 31, 2023. Mazars is entering into a transaction with FORVIS, LLP such that by June 2024, Mazars will no longer be providing accounting and auditing services, and effective June 1, 2024, FORVIS, LLP will rebrand as Forvis Mazars, LLP. The Company is in discussions with several national audit firms and intends to engage a new independent registered public accounting firm in the near future."

An acquisition of Marcum LLP by CBIZ poses a similar risk. Currently, there is no indication that Marcum is planning to drop its audit clients, but if that happens – finding an audit firm will become even harder.

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