KPMG caught up in scandals
Published On : 2018-09-04 08:45:44
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The firm has lost clients in South Africa. The fallout elsewhere is limited

AUDITORS are often accused of being too lenient on the companies they scrutinise. After all, those companies pay the bills. The four that dominate the market—Deloitte, EY, KPMG and PwC—also offer lucrative services like consulting and tax advice. Concerns have long swirled that conflicts of interest risk deterring auditors from challenging dodgy accounting.

 

Recent controversies have centred on KPMG, the smallest of the Big Four. In Britain lawmakers have criticised it for signing off the accounts of Carillion, a public-sector contractor that later went bust. A regulatory investigation is under way. Last week regulators fined it for misconduct in its audits of Ted Baker, a clothing retailer.

 

 
In America three former partners face criminal charges for alleged involvement in the theft of confidential information about the regulator’s plans to inspect KPMG audits. In South Africa KPMG is under investigation for its work for companies owned by the Gupta family, which has been accused of corruption. Among the auditor’s alleged misdeeds are allowing the costs of a wedding as business expenses. On top of all this, in the United Arab Emirates it has been under scrutiny for its audits of Abraaj, a private-equity firm that filed for liquidation in June. Investors in Abraaj claim that money from some funds was used to plug holes in others, and that KPMG failed to notice.

 

The scandals have raised questions about KPMG’s culture. The partners charged with data theft in America were high-ranking. Eight executives in South Africa stepped down after an internal investigation concluded that they should have severed ties with the Guptas earlier. In Britain the regulator has lamented an “unacceptable deterioration” in the quality of audits. For its part, KPMG says it has made clear to stakeholders that “conduct that violates its code of ethics will be strongly dealt with”. Partners found to have fallen short of standards in America and South Africa have been sacked. The firm has acknowledged some failings in South Africa and says it looks forward to co-operating with a regulatory review. It is also taking steps to improve audit quality in Britain.

 

KPMG’s troubles tarnish its main asset—its reputation. A big enough blow could knock it over, disrupting capital markets in turn. According to Audit Analytics, a research firm, KPMG audited 19% of the S&P 500 in 2017 and a quarter of companies in the FTSE 350. If clients fled, other firms would have to absorb that work.

 

More nasty news is quite possible. The inquiry into KPMG’s audit of Carillion is still under way, and the trial against its former partners in America is due to begin only in 2019. But it is in South Africa that KPMG’s reputation has been hit hardest. Its links to the Guptas have tapped into public anger at state corruption, says Iraj Abedian of Pan-African Investment & Research Services, a consultancy. The firm has laid off more than 400 staff; some senior partners have jumped ship. It has been banned from auditing public-sector entities; some private-sector clients, including Barclays Africa, a bank, have switched auditor. Mr Abedian reckons that national regulators might even revoke its licence.

 

But according to Jim Peterson, who was once an in-house lawyer for Arthur Andersen, an accounting firm that went bust in 2002, each of the Big Four has weathered storms similar to those now buffeting KPMG. Critics attribute this resilience to a broken market for auditing services. Large companies may employ several of the Big Four as consultants or advisers. That limits a company’s choice if it wants to switch auditor, because regulators generally prevent a single firm from providing many consulting and auditing services simultaneously. Some wonder if the concentrated market, and the potential disruption if a large audit firm were to fail, also leads regulators to go easy. (Regulators maintain that their priority is to ensure that quality stays high.)

 

At least as important a reason for the auditing trade’s resilience is a feature that stops scandals in one market having much impact in others. Rather than being standard multinationals, all the Big Four are networks of local firms that share a brand but are managed separately. That creates firewalls between jurisdictions. Auditing firms can plausibly tell regulators and clients that problems elsewhere are nothing to do with them.

 

Moreover, clients tend to form relationships with their individual audit partner; news about the firm matters less. Investors generally wave through the selection of auditors (though a significant minority of shareholders of General Electric voted against reappointing KPMG this year).

 

Accounting networks have survived the closure of local offices before. PwC’s affiliate in Japan shut down in 2007. Its Indian affiliate has been banned from auditing clients for two years, starting in March. That has passed largely unremarked elsewhere. Still, Arthur Andersen’s fate is salutary. The collapse of Enron and WorldCom, two big clients, led to a series of legal cases against the firm. Clients fled. So did member firms—for fear of exposure to legal damages, says Mr Peterson. Audit firms are resilient, but they are not immortal.

 

This article appeared in the Finance and economics section of the print edition under the headline "In the eye of the storm" 

 

Source: The Economist 

 
 
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