The revelation that a partner at KPMG leaked privileged information to a “golfing buddy” for a few silver coins is not just another accounting scandal. A 29-year veteran of the accounting firm provided advance notices of client earnings releases and merger plans in exchange for more than $50,000 in cash and gifts, including a $12,000 Rolex watch. It would be easy to dismiss this event, given its minor monetary consequences relative to some of the auditing blunders of the past decade. But this event just may be a watershed.
Investors can view today’s global capital markets as secure only if they trust the financial statements issued by publicly traded companies. Fundamental to this is the belief that information provided by market participants is accurate, complete, and reliable. Accountants have been given the task of certifying this. Investors must, therefore, trust that public company auditors are not only knowledgeable and experienced, but also independent and possess the highest levels of integrity.
There is already mistrust of the profession. The auditors who allowed Enron to flatter their balance sheets have not been forgotten. Nor those who signed off on the infamous Lehman Brothers “Repo 105” accounting wheeze, which magically transformed loans into sales. Such cases cause one to wonder if our current levels of trust in the auditing profession may be too high.
What makes the KPMG case so important is that it involves a senior partner with authority over 50 other partners and more than 500 staff in one of the firm’s largest offices. He placed his own self-interest before that of his clients, much less the investing public. As a result, KPMG has withdrawn several years of audit reports for some clients.
This is quite a moment: it is the first significant withdrawal of an audit report since 2007, when PwC did the same for Yukos, the bankrupt oil company, over concerns about the accuracy of information provided to the auditor by the management.
Auditors rarely withdraw from an engagement. Audit Analytics, a service that tracks reports on publicly traded US companies, reports 12 resignations during 2013 thus far, but only 26 during 2012 and 33 in 2011. Of these resignations, with the exception of the recent KPMG debacle, not one was related to so-called “independence” issues – conflicts of interest – in 2013. There was only one independence-related resignation in 2012 and six in 2011. So, actually, to have a major accounting firm admit not only to discovering a breach of auditing standards but then to withdraw its previously issued audit reports, is indeed rare.
Given the extraordinary nature of KPMG’s recent breach, how it came to pass and its consequences, we should be scrutinising this event carefully. Some parties are using this recent partner’s inappropriate behaviour to push for regulations requiring the naming of auditors, or the periodic rotation of audit firms. It should however be noted that neither of these “fixes” would have detected or prevented this partner’s disregard of basic auditing standards.
Clearly, internal controls in the audit process are not working at KPMG and other large accounting firms. With increasingly constrained resources, increased governmental oversight is not likely to solve the audit quality problem either. We simply need more transparency from these firms upon whom we rely to protect our interests.
Just as investors require reports to make informed decisions, so do we need information to better assess auditor competence, integrity and quality. I would suggest that any accounting firm that audits a traded company be required to provide an annual report, which would include certifications for financial statements and internal control systems.
For those who may argue that I am overreacting to this “outlier” event, I would remind them that the audit itself is based on trust. As William O. Douglas said: “Sunlight is the best disinfectant.” Sunlight may be exactly what we need to restore our trust.
The writer is an accounting professor at Villanova University and Maguire fellow at the American College
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