GE: How Much Are Auditors Paid? The financial report accompanying this letter is historic in that it is our first one covered by Section 404 of The SarbanesOxley Act of 2002 (SOX). . . . But what does it mean to you? Is it a check-the-box bureaucracy based on an overreaction to the market scandals of yesterday? None of us likes more regulation, but I actually think SOX 404 is helpful. It takes the process control discipline we use in our factories and applies it to our financial statements. Implementing SOX 404 cost GE $33 million in 2004. But we think it is a good investment. Jeffrey R. Immelt, Chairman of the Board and Chief Executive Officer, General Electric, in his Letter to Shareholders from the 2004 annual report BACKGROUND Since its required implementation in 2004, section 404 of SarbanesOxley has generated a great deal of controversy. Its requirement that auditors assess the operating effectiveness of their clients internal controls over financial reporting and express opinions on the effectiveness of their clients internal controls over financial reporting and on managements assessment of its internal control over financial reporting (this latter responsibility has since been rescinded) has imposed significant costs on accelerated filers.1 (Subsequent modifications to this initial guidance, now recodified as AS 2201, have reduced these costs somewhat.) In addition to the provisions of section 404 related to internal control over financial reporting, SarbanesOxley reduced auditors ability to provide nonaudit services to their clients. Section 201 prohibits two major types of services that had become significant revenue sources for accounting firms: (1) financial information systems design and implementation and (2) internal audit outsourcing. Not coincidentally, these were two areas in which Arthur Andersen provided extensive services to Enron prior to its failure. Furthermore, section 202 requires that the entitys audit committee approve all nonaudit services (with the exception of those less than 5 percent of the total revenues paid to the accounting firm). HOW DID SARBANESOXLEY AFFECT ACCOUNTING FIRM REVENUES? The preceding suggests that SarbanesOxley has a significant (yet indeterminable) effect on accounting firm revenues. On one hand, the internal control requirements of section 404 would presumably increase total revenues; however, the prohibition against providing financial information systems design and implementation and internal audit outsourcing services would likely reduce revenues. In addition, the requirement that the entitys audit committee approve all nonaudit services would presumably heighten these individuals awareness of potential conflicts related to these services and reduce the likelihood that such services will be approved (or reduce the dollar level at which they are approved). GE Exhibit 1 summarizes fees paid by General Electric to its auditors (KPMG, LLP) for various years both preceding and following the issuance of SarbanesOxley; GE Exhibit 2 provides similar information for the average of Fortune 100 companies during these same years.2 In 2018, GE had the highest fees in the Fortune 100, followed by Citigroup ($98.8 million), J.P.Morgan Chase ($97.0 million), IBM ($86.8 million), and Metlife ($85.9 million). Audit fees are identified based on SEC rules and include fees paid for the (1) audit of the annual financial statements, (2) review of quarterly financial statements, (3) audit of the effectiveness of internal control over financial reporting, (4) attestation of managements report on the effectiveness 1 Accelerated filers are those public entities filing financial statements with the SEC that have market capitalizations of more than $75 million. Initially, public entities with market capitalizations of less than $75 million were to be subject to the provisions of section 404 in 2005 (one year following the effective date for accelerated filers). In 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act permanently exempted smaller entities from these requirements. 2 The fees shown in Exhibits GE 1 and GE 2 reflect only those amounts paid to the entitys financial statement auditors. It is likely that other accounting firms that are not involved with the financial statement audit also provide services to these entities. However, these latter data are not publicly available. C24 Cases of internal control over financial reporting, and (5) other services provided in connection with statutory and regulatory filings and engagements. Audit-related fees include other fees that can be reasonably related to the preceding services as well as fees paid for due diligence and audit services on mergers and acquisitions and fees paid for audit services on employee benefit plans. SEC-REQUIRED FEE DISCLOSURES One additional phenomenon that may influence the fees reported by General Electric and the Fortune 100 companies in Exhibits GE 1 and GE 2 is the disclosure requirements implemented by the SEC. In November 2000, the SEC adopted requirements that registrants disclose the various types of fees paid to its financial statement auditors; under this initial guidance, audit fees included fees paid for the annual financial statement audit and those paid for the reviews of quarterly financial statements. Beginning in 2003, the SEC expanded the definition of audit fees to include services that generally only the independent accountant can reasonably provide, such as comfort letters, statutory audits, attest services, consents and assistance with and review of documents filed with the [SEC].3 Some argued that broadening the definition of audit fees would be misleading in terms of user perceptions of auditors independence. Barbara Roper, director of investor protection for the Consumer Federation of America, noted that its absolutely industrys water thats being carried here. It makes it look like their audit fees are bigger, their nonaudit fees are smaller, and it masks the conflict of interest.4 Clearly, any comparison of fee breakdowns prior to and following SarbanesOxley must consider the SECs revised definition of audit fees. GENERAL ELECTRIC AND KPMG KPMG (or its predecessor firms) have served as General Electrics auditor since 1909. In 2018, two proxy advisory firms (Glass Lewis & Co. and Institutional Shareholder Services) recommended against the reappointment of KPMG, citing numerous accounting issues as well as the high level of audit fees. In response, KPMG received a mild endorsement from General Electrics shareholders, with only 64.9 percent voting to reappoint KPMG (this is only the fifth time since 2015 that an auditor received less than 90 percent shareholder support)5 . While KPMG received 88.7 percent support from shareholders in the 2019 shareholder vote, General Electric has indicated that a formal 3 Securities and Exchange Commission, Strengthening the Commissions Requirements Regarding Auditor Independence, Release No. 33-8183, March 26, 2003. 4 Redefined by the SEC, Audit Fees Get Murky, The Wall Street Journal, January 22, 2003, p. C1. 5 KPMG Gets Cold Shoulder from GE Shareholders, The Wall Street Journal Online, April 25, 2018. 2000 2004 2011 2018 Audit fees $23.9 $78.2 $87.1 $92.2 Audit-related fees 15.5 15.5 15.1 40.3 Tax fees 13.8 8.9 11.0 0.8 Financial information systems fees 50.4 0.0 0.0 0.0 Other fees 0.0 0.0 0.0 0.0 Total fees $103.6 $102.6 $113.2 $133.3 GE EXHIBIT 1 Fees Paid by General Electric to KPMG (in millions) Source: Various General Electric proxy statements. 2000 2004 2011 2018 Audit fees $7.1 $16.3 $20.9 $24.5 Audit-related fees 0.9 2.8 3.5 4.9 Tax fees 1.1 4.0 2.5 2.2 Financial information systems fees 3.9 0.0 0.0 0.0 Other fees 16.2 0.5 0.4 0.2 Total fees $29.2 $23.6 $27.3 $31.8 GE EXHIBIT 2 Average Fees Paid by Fortune 100 Companies to Auditors (in millions) Source: Data extracted from Wharton Research Data Services. GE: How Much Are Auditors Paid?C25 auditor search process will begin following its 2019 audit.6 In June 2020, GE announced that it was switching auditors from KPMG to Deloitte. DISCUSSION QUESTIONS 1. From a conceptual standpoint, how do the requirements of SarbanesOxley related to nonaudit services affect perceptions of the auditors independence? 2. Assume that your firm was auditing General Electric in 2000 and was recommending an adjustment to its financial statements that reduced net income. Based on the fees paid to your firm in 2000, what incentive(s) might your firm consider in insisting upon this adjustment? How would your firms incentive(s) differ after 2004? 3. Compare General Electrics fees prior to (2000) and following (2004, 2011, and 2018) the implementation of SarbanesOxley. Based on the trends in these fees and various components of these fees, comment on the effect of SarbanesOxley on General Electrics fees. 4. Repeat question 3 for the Fortune 100 companies. Are the trends for these companies similar to those for General Electric? 5. For General Electric and the Fortune 100 companies, can you identify the increased costs of section 404 compliance cited in the press? 6. Comparing the fees in 2004 versus those in 2011 and 2018 for General Electric and Fortune 100 companies, does it appear modifications to the provisions of SarbanesOxley have reduced the cost of compliance? 7. Refer to GEs 2019 Proxy Statement (filed March 18, 2019). What is the explanation for the high level of audited-related fees in 2017 (not shown in this case) and 2018 compared to historical levels?