Wells Fargo execs, directors got the boot. Will its auditor be next?

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A year ago, the biggest issue at Wells Fargo’s annual meeting was the makeup of the scandal-plagued bank’s board of directors.

Twelve months later, seven out of 15 board members are either gone or on their way out, and the question for shareholders now is whether the San Francisco bank should hire a new auditor.

KPMG has been Wells Fargo’s auditor since 1931, or three years prior to the establishment of federal deposit insurance. The accounting giant was also the auditor for Wachovia, which Wells Fargo acquired in 2008.

KPMG has not been accused of wrongdoing in connection with the phony-accounts saga at Wells, but critics such as Democratic Sen. Elizabeth Warren of Massachusetts are skeptical of its repeated contention during the run-up to the scandal that the bank was maintaining effective internal control over its financial reporting.

In February, the Federal Reserve Board took the unprecedented step of capping Wells Fargo’s assets after concluding that the bank needs to improve its risk management and control framework.

Then on Tuesday, the proxy advisory firm Glass Lewis recommended that Wells Fargo shareholders vote against the reappointment of KPMG. Wells Fargo’s annual meeting is scheduled for April 24 in Des Moines, Iowa.

The proxy advisory firm stated that it generally supports the choice of auditor made by a company’s management, except in cases where the auditor’s independence or audit integrity has been compromised. Its report suggested that the situation at Wells Fargo is one such exception to its general rule.

“Given the severity of the fraudulent account activity and KPMG’s prior knowledge of the incident, we believe shareholders may question whether KPMG is adequately ensuring the integrity and transparency of financial information,” Glass Lewis wrote in its report.

“Our concerns are heightened by the fact that KPMG has served as the company’s auditor since 1931.”

A Wells Fargo spokesman declined to comment on the advisory firm’s recommendation. A KPMG spokesman also declined to comment.

In late 2016, KPMG acknowledged that it had known about illegal and unethical conduct by certain Wells Fargo employees, but said that it was not aware of any facts that implicated the effectiveness of the bank’s internal controls over financial reporting.

The auditing firm, which collected $54.9 million in fees from Wells Fargo in 2017, reiterated that conclusion last month.

It is unclear how much weight the Glass Lewis recommendation will carry. Another influential proxy advisory firm, Institutional Shareholder Services, has yet to make its views known. Last year, even amid the scandal at Wells, KPMG was reappointed with 97% of the vote.

One question facing Wells Fargo’s shareholders is whether KPMG’s long tenure has led to excessive coziness. Another question is whether any negative effects from the 87-year relationship are outweighed by the accounting giant’s intimate understanding of the bank.

“I think the relationship now is one where there’s a loss of independence,” said Gerald Armstrong, a Wells Fargo shareholder who has long been critical of the bank’s corporate governance.

In the European Union, publicly traded companies are required to put their audits out for bid every 10 years, and to change auditors within no more than 24 years. No such requirement exists in the United States, though auditing firms have been required since the passage of the Sarbanes-Oxley Act in 2002 to rotate the lead audit partner every five years.

The academic literature on the value of rotating auditors is inconclusive, said Jeff Johanns, an accounting professor at the University of Texas business school.

Still, he favors rotating auditors every 25 years or so. “I just think, at some point fresh eyes in any organization is a good thing,” he said.

Brandon Rees, deputy director of corporations and capital markets at the AFL-CIO, said that there is a gap between what investors expect of auditors when they encounter illegal conduct and what the existing accounting standards require of them.

Rees serves as a member of an advisory group to the Public Company Accounting Oversight Board, which has been studying whether its standards in this realm should be updated.

One reason that KPMG’s work for Wells Fargo has come under close scrutiny is that the bank deemed its financial exposure regarding unauthorized customer accounts to be immaterial, an assertion that may look dubious in retrospect.

After it was revealed that thousands of Wells Fargo employees created millions of accounts without permission, the bank agreed to pay $190 million in order to resolve the issues. That sum amounted to less than 1% of the company’s net income that year.

But the subsequent fallout from the scandal has been much more costly, doing substantial damage to Wells Fargo’s reputation and triggering scrutiny by regulators and the press that has uncovered additional misconduct.

In the latest development, Bloomberg reported Thursday that some of the bank’s wealth management clients were steered into investments that were not already in their best interests, but which maximized revenue for the bank and compensation for employees.

“The resulting brand damage to Wells Fargo has been catastrophically material,” Rees said.

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