KPMG’s annual report—vague about ethics

In Blog by Ian Fraser0 Comments

25 March 2016

By  Atul Shah

Screen-Shot-2016-03-08-at-07.24.18-550x328The growing size and influence of “big four” accountancy firms as they further transform themselves into global business services supermarkets is generating alarm among many who are concerned about ethics, independence and truth.

Our research at Suffolk Business School has raised a number of questions about the firms’ ethics, conflicts of interest and culture.

There is confusion as to whether the “big four” – made up of Deloitte, Ernst & Young, KPMG and PwC – are a regulator of business, or exist to help businesses escape regulatory control through skilled professional services, with the primary driver being the maximisation of profit. There is also evidence of high-level corporate and political networks and influence on government and regulatory processes.

Given that they are supposed to be the world’s leading “experts” in accounting, one might have thought their own annual reports would be clear, legally compliant and transparent. I tell my MBA students to read annual reports very carefully – producing an annual report bit like asking students to write their own evaluations, so objectivity is bound to be compromised.

The latest annual report from KPMG UK (headlined “Investing to become the Clear Choice”), sadly falls short where objectivity and transparency are concerned. Here are some specific areas of concern:

  • KPMG claims to have paid £786 million to Her Majesty’s Revenue and Customs from pre-tax profits of £383 million. This seems very generous, until one discovers the figure is remarkably disingenuous, in that the tax paid includes £673 million (e.g. PAYE and VAT) where KPMG are merely acting as a tax intermediary (for further analysis of how KPMG is misrepresenting the amount of tax it paid in 2015 see Insurance Tides).
  • KPMG’s return on equity was 133% in 2015 – a huge return given that, on average, companies return about 10%-15% in a good year. This shows that the real capital is the “skill set and experience of most of their employees” for which they do not get a share in the profits but simply a wage – a kind of rental fee, with a huge return going to the firm’s equity partners. Grant Thornton has decided to turn their firm into something resembling a co-operative – with employees in future getting a share of the profits. There is no sign of this model being adopted at KPMG.
  • The governance of the firm is still primarily a closed affair – all its executives and non-executives are partners of the firm, and there is no cultural/national diversity in spite of it being a global firm with stated aspirations about inclusiveness.
  • KPMG’s “independent” public interest committee (whose legal status is unclear, and whose members are appointed by KPMG) was previously chaired by Sir Steve Robson. Our research raised a number of questions about the conflicts of interest from this appointment. He has now been replaced by a new chair, Professor Laura Empson, who admits in the annual report that “public interest is notoriously difficult to define.” Well here’s a suggestion. How about ensuring that the firm’s audits are genuinely independent and that clients are robustly challenged over their use of aggressive accounting techniques?
  • There is, however, an acknowledgement of the ‘debate on tax’ and the need for companies to change their ethics and practices, with KPMG trying to be at the forefront of this new era.
  • The most critical audit area would be contingency provision for fines and losses relating to the major multi-billion pound business failures where KPMG were auditors and which are currently under investigation – e.g. The Co-operative Bank and HBOS. There is near total silence about these threats, including in the public interest report. The declarations here are vague and wooly, citing insurance cover and commercial confidentiality, and there is a cop-out clause used by both KPMG and their own auditors Grant Thornton – there is a “significant degree of inherent uncertainty in the assumptions and estimates”. Does this mean the audit is qualified because of this uncertainty? Word play is used not to give an audit opinion in risky areas – even though these are precisely the areas where people need a good audit. Should we be surprised given the audit industry’s mastery in regulatory arbitrage?
  • Our research raised a number of questions about KPMG’s ethics policies and practices. In particular, we were concerned that there were no rules or explicit pro-active monitoring and enforcement processes; e.g. there were no rules or limits on client entertainment, a direct conflict of interest. The latest report explains that policies are being developed in this area – so no rules in sight again then (for more on KPMG’s ethical lapses see Ian Fraser and Richard Murphy’s blogs from  11 April 2013)
  • KPMG UK’s annual report 2015 makes clear that the provision of legal services has become a major growth area for the “big four” firm.  The report states that KPMG’s revenues from providing legal services jumped by 53% in 12 months, and that further growth is expected. KPMG claim that clients really like their “multi-disciplinary services”. However, adding the law to the other services already provided by KPMG will only give rise to further conflicts of interest –  in addition to being a auditor, the firm is now also a lawyer, a tax advisor, a strategic consultant, an IT consultant, an insolvency practitioner, etc…. The risks generated by such conflicts in the areas of audit quality and elsewhere are clearly growing.
  • Our research raises major questions about the systemic role that the “big four” accountancy firms have in fuelling “regulatory arbitrage” – using their knowledge of rules and regulations, and how these vary between jurisdictions to help their clients game the system and often avoid rules altogether – something that is all too familiar in the area of tax avoidance. The latest KPMG report sadly reinforces this view. Regulatory management is one of their core business activities.
  • Reserves and retained profits are generally very low every year, so if the firm is sued, for example through a heavy lawsuit from HBOS shareholders costing hundreds of millions of pounds, it can close down easily without much financial loss to partners or staff.

Dr Atul Shah is senior lecturer at Suffolk Business School. His research is focused on the areas of business ethics, governance, and financial regulation. A version of this article was published on Richard Murphy’s Tax Research UK.

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