The Break-up: Auditor Resignation or Dismissal

Gary Grobowski, GC of a publicly traded studio in Hollywood, is on the line. The company is breaking up with its auditors, Brooke Meyers LLP, and wants to know what they have to disclose.
Background: 8-K Item 4.01; Regulation S-K Item 3.04

An auditor’s resignation or dismissal triggers Item 4.01 of Form 8-K, which requires disclosure of detailed information enumerated in Item 304(a) of Regulation S-K. The most salient substantive issue is whether the auditor and the company have had “disagreements” (which we discuss in more detail below). In addition, procedurally the company also must provide the disclosure to the auditor and receive written confirmation from the auditor expressly confirming the auditor’s agreement or disagreement with the company’s disclosure.
Public company’s disclosure obligations

In summary, Regulation S-K Item 304(a) requires the company to disclose whether:

  • the auditor resigned or was dismissed and the date of that event [Item 304(a)(1)(i)];
  • the auditor provided an adverse opinion or qualifications within the two most recent fiscal years and any subsequent interim period [Item 304(a)(1)(ii)];
  • the company’ audit committee recommended or approved the change in accountants [Item 304(a)(1)(iii)]; and
    there was a disagreement between the company and the auditors within the two most recent fiscal years and any subsequent interim period [Item 304(a)(1)(iv)].

What is a “disagreement"?

Regulation S-K Item 304(a)(iv) states that a relevant “disagreement” is one occurring “at the decision-making level, i.e., between personnel of the registrant responsible for presentation of its financial statements and personnel of the accounting firm responsible for rendering its report.”

Instruction 4 to Item 304 explains that a “disagreement” is “interpreted broadly” and includes “any difference of opinion concerning any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedure which (if not resolved to the satisfaction of the former accountant) would have caused it to make reference to the subject matter of the disagreement in connection with its report.” A disagreement requires a “difference of opinion,” not an actual argument. The Instruction does acknowledge that a “disagreement” does not include “initial differences of opinion based on incomplete facts or preliminary information that were later resolved to the former accountant’s satisfaction” based on additional relevant facts or information that dispel any difference of opinion.

Instruction 5 to Item 304 also clarifies that “an oral communication from the engagement partner or another person responsible for rendering the accounting firm’s opinion (or their designee) will generally suffice as the accountant advising the registrant of a reportable event or as a statement of a disagreement” such that Item 304(a) would require disclosure of the disagreement.
Additional disclosure regarding a disagreement

Where a disagreement exists, there are additional disclosure requirements regarding the nature of any disagreements with respect to issues that arise in specifically enumerated areas:

  • internal control over financial reporting [Item 304(a)(1)(v)(A)];
    management representations [Item 304(a)(1)(v)(B)];
  • the need to expand the scope of the audit based on information suggesting issues with prior audit reports [Item 304(a)(1)(v)(C)]; and
  • questions regarding reliability of previous audit reports [Item 304(a)(1)(v)(D)].

Notice to the auditor and the auditor’s response

Form 8-K Item 4.01 specifically references Regulation S-K Item 304(a)(3), which requires the company to:

  • provide to the auditor a copy of the disclosure no later than the date that the registrant files the Form 8-K;
  • request the auditor’s written response in a letter from the auditor addressed to the SEC and indicating whether the auditor agrees with the company’s disclosure and, if not, how not; and
  • file the auditor’s letter as an exhibit to the 8-K, either with the initial filing or as an amendment to the initial filing no later than 10 business days thereafter (but, in any event, within two business days of receipt).

Regulation S-K Item 304(a)(3) contemplates that the auditor may elect to provide an interim issue-spotting letter and follow up with a more detailed response at a later date. Where an auditor follows that approach but does not provide a detailed response within the period of 10 business days, the company must file the auditor’s interim letter.