(UPDATE) In Becoming Herbalife's Auditor, PwC Does a Dicey Independence Dance

~ See update below

It seems fitting that PwC would replace KPMG as Herbalife's auditor, doesn't it? 

On May 21, 2013, the Audit Committee of the Company’s Board of Directors engaged PricewaterhouseCoopers LLP (“PwC”) to serve as its new independent registered public accounting firm to audit the Company’s financial statements for its fiscal year ending December 31, 2013 and to re-audit the Company’s financial statements for the fiscal years ended December 31, 2010, 2011 and 2012.

Now that the question of "Who?"1 has been answered, there is the question of what services PwC provided to Herbalife prior to becoming auditor and therefore could potentially violate independence rules. The filing has all the details and we bolded some of it for you:

As part of the engagement process, the Company and PwC identified certain non-audit services that PwC or another firm in the global network of firms had performed for the Company that are not permitted under the SEC’s auditor independence rules. The Audit Committee and PwC discussed these non-audit services and concluded that the provision of these non-audit services will not affect PwC’s objectivity or its impartiality and will not impair its ability to serve as the Company’s independent registered public accounting firm. In reaching this conclusion, the Audit Committee and PwC noted that all of these services, with one exception described below with respect to the Company’s U.S. payroll department, were provided to entities that were immaterial to the Company’s consolidated financial statements in each of the prior years. PwC also noted that none of the professionals who provided such services will serve on the re-audit or future audits.

Ahh, yes. Immaterial. Pass further review. Music to an auditor's ears.

What are all these services that aren't worth calling home about? Mostly "corporate and administrative legal advisory services" provided in Eastern Europe, but also:

  • Financial reporting, secondment and bookkeeping services in Israel
  • Secondment services and "tax services pursuant to a contingent fee arrangement" in India 
  • Payroll and executive recruitment in Ghana
  • Payroll and administrative services in Colombia
  • "Seconded two PwC staff members who served in the U.S. payroll department for the Company for a few months in 2010." 

Okay, but what about the numbers? Well, the filing states that "[t]he assets and revenues of the non-U.S. subsidiaries in the countries noted above represented in the aggregate less than 5% and 8.5% of the Company’s total consolidated assets and revenues, respectively, in each year from 2010 through 2013." Individually, none of the countries "represented more than 2.5% or 3.6% of the Company’s total consolidated assets or revenues."

And PwC's fees for these services were minimal, too. Altogether they were $55k in 2013; $250k in 2012; $192k in 2011 and $330k in 2010. And, naturally, there's this:

PwC and the other firms in the global network of firms ceased providing these services to the Company’s subsidiaries upon being engaged as the Company’s auditor.

So independence sticklers don't have anything to complain about, right? Well, there is the matter of those re-audits of Herbalife's financial statements for 2010 and 2011. For starters, there's this classicly opaque disclosure:

During the fiscal years ended December 31, 2011 and 2012, and the subsequent interim period through May 21, 2013, neither the Company, nor anyone on its behalf, consulted PwC regarding either (i) the application of accounting principles to a specified transaction, either completed or proposed, or the type of audit opinion that might be rendered with respect to the Company’s consolidated financial statements, in connection with which either a written report or oral advice was provided to the Company that PwC concluded was an important factor considered by the Company in reaching a decision as to the accounting, auditing or financial reporting issue; or (ii) any matter that was either the subject of a “disagreement” as such term is defined in Item 304(a)(1)(iv) of Regulation S-K and the related instructions or a “reportable event” as such term is defined in Item 304(a)(1)(v) of Regulation S-K.

What's missing? 2010 of course! Our friend Francine McKenna says it seems that "[Herbalife] consulted PwC on GAAP/SEC reporting issues in 2010," and that it could be an issue. 

Furthermore, there's this question from the Office of the Chief Accountant's "Application of the January 2003 Rules on Auditor Independence" under Nonaudit Services: 

Nonaudit Services
 
Question 16
 
Q: A firm was not independent with respect to Company A for Year 1 because the firm performed bookkeeping or other prohibited services for Company A during the audit and professional engagement period of Year 1. For Year 2, however, the firm is independent with respect to Company A. The firm is auditing the Year 2 financial statements. In the course of conducting the audit for Year 2, the firm becomes aware that there will be restatements of prior year's financial statements. Can the accounting firm re-audit the prior period financial statements?
 
A: Rule 2-01 does contain a specific "cure" if the independence issue related to the prior period is a financial interest. However, if the independence problem is caused by something else (e.g., having provided prohibited non-audit services in that prior period), there is no cure and the firm's independence would continue to be impaired. Since the accounting firm would need to be independent with respect to that prior period in order to issue an opinion on that period, the accounting firm would be precluded from re-auditing the prior period financial statements.
This "no cure" seems problematic doesn't it? Francine thinks so, writing us, "[It's] incurable like a case of herpes. Can take some valtrex to inoculate you for the future exposures but never quite the same again." 
 
So is PwC independent in fact and appearance? Going forward, yeah, it doesn't seem like a problem. The re-audits are where things get tricky. They can't really take those services back, can they? And while I'm guessing the firm did their homework, they probably didn't run anything by the SEC before making their pitch to Herbalife.
 
PwC spokeswoman Caroline Nolan could not comment beyond the firm's statement: "Herbalife announced Tuesday that PwC has been appointed as the company's independent auditor. PwC believes it is well-positioned to perform an objective and quality audit for a company of Herbalife's global reach and scale."
 
Perhaps what the firm is banking on is that up until this point, the enforcement of independence by the PCAOB and SEC has been lax. There's that and the real money doesn't care about independence anyway. The stock is up.
 
Run along, auditing purists. 
 
UPDATE: Good news, everyone! Herbalife got the SEC's blessing! From a Dow Jones Newswires (if you have a Factiva account you can read it) article written by Michael Rapoport we learn this:
Ultimately, Herbalife's auditor search became knotty enough that the company said it had to seek guidance from the Securities and Exchange Commission, to resolve concerns that any potential new auditors had conflicts of interest that would prevent them from taking on Herbalife as a client. 
It goes on to say that Herbalife CFO John DeSimone "secured a determination from the commission that it wouldn't object to the move, after Herbalife's audit committee concluded that PwC's past work for the company wouldn't interfere with its ability to be impartial as an auditor."
 
And to alleviate anyone's concerns about the payroll work that PwC "seconded" a couple of staff people for, the company said it would engage another firm to do the re-audit. The SEC only commented for the article to say that in "exceptional circumstances" will companies ask for guidance from the Commission when situations arise like this. DeSimone sorta explained:
"What we provided (to the SEC) is reasons why the audit committee thinks PwC can still be impartial and objective despite the technical independence violations," Mr. DeSimone said.
Of course if the business world had more than four and two (three?) half-firms to choose from, this might not be such a problem, and the SEC wouldn't have to make exceptions to its rules.  I suppose we'll all live.
 
1 Sam Antar would like the record to reflect that he predicted this.

Herbalife 8-K [SEC]
Application of the January 2003 Rules on Auditor Independence FAQ [OCA]

 

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