Auditor Changes at Daily Journal Corporation Charlie Munger is vice chairman of Berkshire Hathaway Inc. and is informally known as War- rem Buffett's "right am." Munger also serves as chairman of Daily Journal Corporation, which publishes 10 newspapers and offers specialized information services and tech ology-based prod- ucis. While often mentioned in the media because of his association with Buffett and long tenure and leadership at Berkshire Hathaway. Munger was recently in the news for another reason: his penchant to change auditors at Daily Joumal. REPORTING DELAYS On December 16, 2013. Daily Journal informed the Securities and Exchange Commission (SEC) that it would not meet the filing deadline for its 2013 Form 10-K. (Daily Journal has a September 30 "fiscal year end.) The reason stated in its For 120-25 filing was that Daily Joumal's auditor (EY) had not completed its audit of the financial statements or intemal control over financial reporting Subsequently. Daily Journal informed the SBC that it would also miss the filing dead- line for its December 31, 2013 and March 31. 2014 Forsex 10-0.' Once again, the reason sipo- lated in the fillings was additional time required by BY to complete its andit and assessment of internal control over financial reporting (While BY had audited Daily Journal's financial state- ments since 2000, 2013 was the first year EY reported on Daily Journal's internal control over financial reporting ) DISMISSAL OF EY On June 24. 2014. Daily Joumal filed its 2013 Form /0.K (almost seven months after the filing deadline), in which BY issued an unqualified opinion on the financial statements but an adverse opinion on Daily Journal's internal control over financial reporting. Two days later, Daily Jour nal reported that its audit committee approved the dismixal of BY. effective June 24, 2014. Am excerpt from Daily Journal's Form 8-& filing is shown here:" The Audit Committee of the Board of Directors of Daily Journal Corporation (the "Company"} approved the dismissal of Ernet & Young LLP ("BY") as the Company's independent ree- istered public accounting firm, effective June 24, 2014 . . . The reports of BY on the Company's financial statements for the past two fowl years can- tained no adverse op man of disclaimer of opinion and were not qualified or modified as to uncertainty, audit scope or soooo ting principles. During the Company's two most recent fiscal years and the subsequent interim period, there have been no disagreements with BY on any matter of accounting principles or pre- tices, financial statement disclosure, or auditing scope or procedure, which disagreement() if not resolved to the satisfaction of BY would have caused BY to make reference to the subject matter of such disagreements) in its report on the Company's financial statements.During the Company's two most recent fiscal years and the subsequent interim period, there have been no reportable events of the kinds described in Item 304(a)(1)(v) of Regula- tion S-K under the Securities Exchange Act of 1934, except the EV expressed an adverse opinion in its report on the Company's internal control over financial reporting as of Beprember Jo, 2013 (emphasis added) . .. The Audit Committee of the Company's Board of Directors has discussed this matter with BY and has authorized BY to respond fully to the Inquiries of the Company's successor independent registered public accounting firm. The Company requested and has received a letter from BY addressed to the Securities and Exchange Commission stating whether or not BY agrees with the statements in this Item 101. A copy of the letter, dated June 26, 2014, Is filled na Exhibit 16.] to this Form 8-K. Those Form 13b-25 Tinga wona dated February 10, 2014 and May 12. 20H for Daly Journal's fleet and second muster 2014 Fans 10-2. respectcty Doly Jonno' For 8 K Quad with the SEC Jum 36 2014 Auditor Changes at Daily Joumal Corporation C31 APPOINTMENT OF BDO USA, LLP On July 3, 2014, Daily Journal announced the appointment of BDO USA, L.I.P as auditor to replace EY, Shortly following BDO's appointment, Daily Journal filled its Forme /(@ for the first filed on August 13. 2014). second (filed on August 15, 2014), and third (filed on August 18, 2014) quarters of 2014. bringing Daily Journal current with respect to its SEC filings. SEC COMMENT LETTER Almost on cue, the Division of Finance at the SEC sent a letter of comment to Gerald Salman (CEO of Daily Journal) that mised concerns with the 2013 For 70-K. This letter (dated September 25, 2014) referenced Daily Joumal's disclosure of intangible assets from an acquisition, the effective-SEC COMMENT LETTER Almost on cue, the Division of Finance at the SBC sent a letter of comment to Gerald Salzman (CEO of Daily Journal) that raised concerns with the 2013 Form 10-K. This letter (dated September 25, 2014) referenced Daily Journal's disclosure of intangible assets from an acquisition, the effective- ness of Daily Journal's internal controls, and discrepancies between preliminary financial filings on Form 8-K and subsequent filings on Form 10-Q. With respect to the intangible assets, Salz- man's response to the SEC noted the following: At the time of the New Dawn acquisition, the Company discussed the purchase price allocation with EY. Accordingly, the Company was surprised when BY first raised the [accounting] issue after the original filing deadline. As further discussed below, the Com- pany does not believe that the adjustments were necessary under GAAP, but BY required them as a condition to the delivery of its audit report. The Company did not view this as a disagreement with EY, but rather a matter of the parties making different judgment calls about the requirements in these specific circumstances regarding a matter the Company believed was not material to investors, Accepting BY's position was a practical decision on the part of the Company, and not the result of deficiencies in the Company's close process or in the areas where the adjustments were made." In the midst of these distractions, Daily Journal notified the SEC that it would not meet the fil- ing deadline for its 2014 Form 10-K (which was ultimately filed 28 days after the December 31, 2014 deadline). BDO issued an unqualified opinion on Daily Journal's financial statements and an adverse opinion on its internal control, citing in part issues noted in the SEC's letter of comment in this latter opinion: The Company does not have sufficient technical expertise in assessing and applying accounting standards to non-routine transactions, reviewing the quarterly and annual tax analysis and provision, and assessing the adequacy of disclosures in the quarterly and annual consolidated financial statements. The Company amended its Form 10-Q for the third quarter of fiscal 2014 to restate amounts to correct a misstatement in the accounting for income taxes in connection with one of its acquisitions. This resulted in material audit adjustments the Company recorded to primarily offset the previously recorded income tax benefit as well as additional disclosures in the consolidated financial statements.* ANOTHER AUDITOR CHANGE BDO's opinion on Daily Journal's 2015 financial statements and internal control over financial reporting was issued on December 14, 2015 (ahead of the December 31, 2015 deadline). As in the previous two years, Daily Journal received an unqualified opinion on its financial statements and an adverse opinion on internal control over financial reporting: in this latter report, BDO cited a material audit adjustment that was required in the fourth quarter of fiscal 2015. In February 2016, Daily Journal announced the dismissal of BDO and the appointment of Squar Milner LLP, a regional accounting firm with offices in California that provides audit or taxmaterial audit adjustment that was required in the fourth quarter of fiscal 2015. In February 2016. Daily Journal announced the dismissal of BDO and the appointment of Squar Milner LLP, a regional accounting firm with offices in California that provides audit or tax services to 30 public companies." Ironically, less than one week carlier, Daily Journal sharehold- ers ratified the appointment of BDO as its auditor with a positive vote of 95 percent of all shares voted.* "Letter from Gerald Salzman to Securities and Exchange Commission, January 26, 2015. "Dally Journal 2014 Form 10-K filled with the SEC on January 28, 2015). "http//squanmilner.com/services/audit-and-other.attest-services/public-companies/. "Dolly Journal Form B K filled with the SEC on February 11, 2016) CONCLUSION U OG8 TO THEMTNIORRA Over a three-year period, Daily Journal engaged the following auditors:? Inside Public Accounting Perlod Auditor No. Offices Revenue Revenue Rank 2000-2014 EY $9.9 billion 3 2014-2016 BDO 63 $1.1 billion 7 2016-current Squar Milner 5 $47.4 million 71 Academic research" examining auditor changes has concluded that clients receiving adverse internal control opinions are more likely to dismiss their incumbent auditors and choose a higher- quality replacement (represented by the size and level of firm, with Big Four being highest qual- ity): this decision may reflect a desire of clients to improve their financial reporting quality. A more recent study" found that clients engage in "opinion-shopping" by dismissing auditors prior to potentially receiving an adverse opinion on internal control and often do so later in the fiscal year, in response to anticipating a negative report on their internal control.Period Auditor No. Offices Revenue Revenue Rank 2000-2014 EY 80 $9.9 billion 3 2014-2016 BDO 63 $1.1 billion 7 2016-current Squar Milner 5 $47.4 million 71 Academic research" examining auditor changes has concluded that clients receiving adverse internal control opinions are more likely to dismiss their incumbent auditors and choose a higher- quality replacement (represented by the size and level of firm, with Big Four being highest qual- ity): this decision may reflect a desire of clients to improve their financial reporting quality. A more recent study" found that clients engage in "opinion-shopping" by dismissing auditors prior to potentially receiving an adverse opinion on internal control and often do so later in the fiscal year, in response to anticipating a negative report on their internal control. DISCUSSION QUESTIONS 1. From the SEC website or other sources, locate Daily Journal's 2013 Form /0-K and review BY's report on Daily Journal's internal control over financial reporting, What were some of the weaknesses noted in this report? 2. Review the excerpt (presented in the case) of Daily Journal's Form 8-K (filed with the SEC June 26, 2014) related to the dismissal of BY. What type of disclosures are provided in this excerpt? What are some reasons that Daily Journal would provide these disclosures? 3. Review the excerpt (presented in the case) from Gerald Salzman's response to the SEC. Do you believe this response is consistent with the Form 8-K filing related to the dismissal of EY? What implications might this response have with respect to Daily Journal's internal control over financial reporting? 4. From the SEC website or other sources, locate Daily Journal's Form 8-K (filed July 3, 2014) related to the appointment of BDO. What type of disclosures are provided in this filing? What are some reasons that Daily Journal would provide these disclosures? (Wore: Daily Journal filed two different Form 8-Ks on July 3, 2014.) 5. Referring to the professional standards (AU-C 210), what is BDO's responsibility with respect to communicating with EY? 6. From the SEC website or other sources, locate Daily Journal's Form 8-K (filed February 17, 2016) that announced the dismissal of BDO and engagement of Squar Milner, Compare the disclosures in this filing to those in questions (2) and (4) related to the dismissal of BY and engagement of BDO. 7. Why might adverse opinions on internal control over financial reporting prompt Daily Journal to change auditors? Are Daily Journal's auditor change activities consistent with the results of the academic studies summarized in this case? Why or why not