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Despite Entering a ‘War Zone’, the Next Auditor of Herbalife Should Find Solace in All the Fees They’ll Earn

Part of the reason this KPMG resignation is such a conundrum for both Herbalife and Skechers is that the firm withdrew its audits back to 2010. The clean-up crew for each company will have its work cut out, and according to Georgetown professor James Angel, Herbalife's new auditor, especially, will "be walking into a war zone":

They know the previous auditor was compromised and has partially disavowed their results. They said there’s nothing wrong them, but they took their name off of them anyways. That in and of itself is a very curious thing and I’m not aware of any cases of that ever happening in the past. So the new auditor knows there’s a lot of land mines here and everything Herbalife does will be scrutinized very closely. 

Yes, that is quite a curious thing. But the answer is quite a simple, really. Matt Levine explained it in a footnote to his post yesterday:

Because KPMG explicitly provides an opinion, as of February 2013, that HLF’s financials for the three-year period ending December 31, 2012, are accurate. People who care about auditor independence would thus say that, if the guy insider traded at any point before February 2013, you can’t trust his opinion on those three years of financials – even the past ones, he might have reopened if he hadn’t been profiting by trading the stock, I guess. Even if he insider traded after that February 2013 opinion you could probably find a reason to disclaim the financials, which I leave as an exercise for the reader because I don’t care. People are pretty anal about this stuff.

Yes, people are anal about this stuff. Especially people like risk managers and the office of general counsel at accounting firms. There were really no good options here, but they chose wisely to pull the opinions. I mean, they're getting sued anyway.   

Anyway, back to the future auditor of Herbalife. KPMG charged Herbalife $3.9 million for its 2012 audit. The firm charged the company $3.8 million for 2011. Those aren't wet dream fees but they're nothing to sneeze at. But because this is not your typical auditor musical chairs situation, there's going to be a lot more money going into the new firm's pocket. Back to the professor: 

If I were one of the companies involved, I would be extraordinary [sic] angry. Not only do I have to find new auditors, I have to get re-audited for the last few years. That’s going to cost a boat-load of money. This is not a good time for Herbalife to shop for a new auditor. There are only three of the big four accounting firms left that they can choose from at this point. Because of the battles going around the company, any auditor going in there is going to demand more money. They’re going to scrutinize everything twice as hard as they normally would because they know that everything they do is going to be examined with a  fine tooth comb.

All true. Herbalife is undoubtedly pissed. They have to find new auditors to audit three years of financial statements and they need it done pronto. And yes, Herbalife has been in the news recently because a rich guy used "pyramid scheme" and "fraud" to describe their business and another rich guy didn't like that. Oh, and rich guy #2 really doesn't like rich guy #1 and the feeling is reciprocated. This gets lots of people interested, including people at the SEC. And that's always fun. 

The next auditor of Herbalife will be very careful during its engagement but if one of the firms was smart (and they are when it comes to winning new business), they would give Herbalife a bit of a break on the re-audits in order to win Herbalife's heart and then charge them a big premium if they find problems. After things quiet down, they'll settle on something that's amicable to both parties. Herbalife will be very grateful to their new audit firm for helping them out in a jam and the new audit firm will be VERY grateful for the millions in new fees.

See? All it took was some positive thinking and some loose talk at the clubThings will turn out just great!

For Herbalife, New Auditor Will Be ‘Walking Into a War Zone’ [WSJ]