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Does This Auditor Change Raise Red Flags?

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Netflix (Nasdaq: NFLX  ) has replaced its auditing firm. A long-standing relationship with accounting giant KPMG has come to an end as the movie maven brings Ernst & Young aboard instead. The switch was described as the product of "a competitive process," with plenty of language to reassure us that KPMG wasn't booted for saying mean things about Netflix.

That being said, it's easy to panic when a company you're invested in switches auditors. We don't really know what goes on in the back rooms and financial archives. Did KPMG stumble over some unsavory secret? Is Netflix trying to avoid a bad audit? Will the balance sheet blow up in 2012? Is the sky about to fall?

If you imagine skeletons in Netflix's closets, I'd ask you to chill out. For one thing, kicking KPMG would do very little to hide anything -- Netflix is replacing one well-respected Big 4 accounting firm with another, which would very likely follow the same purported evidence to the same uncomfortable conclusions. So the switch wouldn't hide anything.

For another, major companies change auditors more often than you might think. Here's a handful of examples from the last 12 months:

  • Irish drug developer Jazz Pharmaceuticals (Nasdaq: JAZZ  ) replaced Ernst & Young with KPMG at the end of February, ending a nearly two-decade relationship. That's the exact mirror-image of the Netflix move. Jazz bought smaller rival Azur Pharmaand adopted the new addition's auditors rather than sticking with Ernst & Young. Tough cookies.
  • Kodiak Oil & Gas (NYSE: KOG  ) picked up Ernst to replace smaller firm Hein & Associates about a year ago. This one makes perfect sense: Kodiak is growing up and wanted to work with a more established auditor.
  • Chimera Investment (NYSE: CIM  ) gave Ernst a call a couple of weeks ago as the firm muscled out another major, Deloitte & Touche. That switch caused Chimera to delay its 2011 annual report, and Deloitte did find errors in the company's accounting history. But even that slightly saucier situation falls far short of a scandal -- at least until further notice.

That's just the tip of the iceberg: My search on S&P Capital IQ found 87 auditor changes among large, publicly traded companies in the past year. The vast majority of these changes had nothing to do with corporate scandals.

Maybe Ernst & Young simply outbid KPMG. Perhaps the former auditor's staff simply didn't get along all that well with their Netflix contacts. Or the KPMG manager in charge of the Netflix account might have moved on. These are just some of the many reasons companies change auditors.

Long story short: Don't panic. Auditor changes happen.

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Fool contributor Anders Bylund owns shares of Netflix but holds no other position in any of the companies mentioned. Check out Anders' holdings and bio, or follow him on Twitter and Google+. Motley Fool newsletter services have recommended buying shares of Netflix. The Motley Fool has a disclosure policy.

We Fools don't all hold the same opinion, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.

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