This week Big Four accounting firm KPMG fired six US employees over a scandal that calls into question efforts to ensure that public company accounts are being properly scrutinised.
Here’s what happened: KPMG recruited an employee from the Public Company Accounting Oversight Board, which is charged with overseeing the nearly 2,000 accounting firms that audit US companies. The watchdog inspects the Big Four and other firms annually by taking a random sample of audits and checking them for deficiencies and conflicts of interest.
KPMG says that its new employee received a heads up from someone who still worked at the PCAOB about which audits would be inspected. The new employee then shared the information around. Eventually, five partners, including the head of the US audit practice, “either had improper advance warnings” or were aware that others had received this information and “failed to properly report the situation in a timely manner”, the firm said. All six people have been fired.
Tampering with a random sampling process strikes at the heart of how auditors do their jobs. It is physically impossible for an accounting firm to examine and verify everything a big company does in time to provide investors with meaningful quarterly results. The auditors have to select a relatively small group of transactions, investigate them thoroughly, and hope that they are representative of the larger company.
The process can easily break down, as it did in the 2003 Royal Ahold accounting scandal, where employees at its US Foodservice subsidiary conspired with suppliers to lie to the auditors about whether specific transactions took place as described.
That reality makes it all the more staggering that five KPMG partners failed to act on the danger posed by their secret tipster. Even schoolchildren know that it is cheating to get an advance copy of the test.
On the upside, when someone at KPMG eventually did the right thing and reported the shenanigans, upper level management reacted immediately and appropriately. That should send the message to the global firm’s 189,000 professionals in 152 countries that KPMG’s 51-page code of conduct really means it when it says “Your voice counts. So speak up if something doesn’t seem right.”
The PCAOB also investigated and an employee has left as a result. “The improper disclosure here was clearly a violation of [our ethics] code and does not reflect the integrity and honour that the majority of PCAOB employees bring to their jobs every day,” says chairman James Doty. “I want to take a hard look at what additional safeguards may be necessary to reinforce the integrity of our regulatory processes.”
Both reactions contrast pleasantly with the behaviour of Barclays chief Jes Staley, who this week was reprimanded for trying to unmask the author of a letter that his compliance department had classed as whistleblowing.
But the episode highlights the troubling side of Washington’s revolving door. While the US has long been comfortable with watchdogs and industry lawyers changing places, the auditing profession has a particular problem.
The Big Four are so dominant that today’s regulator is not just a potential future industry peer, but literally tomorrow’s co-worker or boss. Stricter conflict of interest rules and longer cooling off periods should be required.
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