8 January 2009
The House of Commons Treasury Select Committee is to cross-examine representatives of the audit profession later this month as part of its investigation into the banking crisis — and it is not before time.
At the January 28 session, senior accountants will be grilled over their role in the crisis and whether reform of their industry is needed.
The “Big Four” firms – Deloitte & Touche, Ernst & Young, KPMG and PricewaterhouseCoopers – have a stranglehold over auditing large companies in the UK and together earned £6.72 billion in fees for providing audit and other advisory services to British clients in 2007.
Liberal Democrat MP John Thurso said: “Auditors obviously play a crucial role in the corporate governance of financial institutions. The clear lesson of the last 18 months is that the ability to create new financial instruments outpaced our ability to understand and regulate them. Auditors are best placed to help us understand the problems and potential solutions.”
The MPs ought to have a close look at KPMG, whose future may be at risk because it audited so many of the banks and financial institutions that collapsed during the crisis.
In the UK, KPMG signed off the 2007 accounts of disastrous failed banks such as HBOS and Bradford & Bingley. The firm also audited Countrywide (US), Hypo Real Estate (Germany), Independent Insurance (UK), Fannie Mae (US), Fortis (Belgium), New Century Financial (US) and Wachovia (US). The string of failures makes one wonder about the rigour of its audits.
Peter Elwin, head of accounting and valuation at investment bank JP Morgan Cazenove, has warned that, if one particular firm of accountants were found to have been negligent in signing off the accounts of failed or financially unviable institutions, investors could take fright and create a “run” on the audit firm question.
“We’re in Andersen territory here,” Elwin told a round-table event hosted by KPMG. “We’re in that kind of market right now.”
He believes that there is a danger that one of the “Big Four” firms could see its international network implode like so many dominoes, as short-sellers would target the shares of the audit firm’s clients, and clients would seek to distance themselves from the fall-out by sacking it as their auditor.
If I had the (mis)fortune to be a KPMG partner, I would be kind of worried right now.
A history of questionable practise
- In August 2008, the US Public Company Accounting Oversight Board said KMPG had failed to conduct proper evaluations and testing procedures to back up its audits of ten clients. The PCAOB cited instances where the firm should have performed additional tests to confirm its clients’ valuations and assertions, as well as to notice instances where a client had strayed from generally agreed accounting principles (GAAP).
- In June 2008, KPMG was ordered to pay a £495,000 fine and costs of £1.15m by self-regulatory accountancy body, the Joint Disciplinary Scheme for failing to complete a professional audit of the collapsed insurer Independent Insurance. The JDS found that KPMG had failed to take steps to check suspicious information provided by Independent’s management during the company’s audit for the year ending December 2000.
- In December 2006, Fannie Mae, the biggest US mortgage finance company, started legal proceedings against KPMG’s US arm in the hope of retrieving $2 billion. The government sponsored enterprise alleges that KPMG failed to serve its role as an independent watchdog and prevent accounting errors that led to $6.3 billion in overstated earnings. That is over and above the $400 million KPMG agreed to pay the SEC to settle the regulator’s fraud allegations.
- In a counter-action, KPMG is suing ex-client Fannie Mae for “fraudulent deception” which it says prevented it from uncovering $6.3 billion in overstated earnings. KPMG alleges that from 1998 to 2004 Fannie Mae withheld and distorted its accounting, engaging in “breach of contract, fraudulent misrepresentation, fraudulent inducement”. KPMG says Fannie’s misrepresentation caused it to suffer “injury to its reputation, legal costs, exposure to legal liability, costs and expenses of responding to investigations” of Fannie Mae, and other losses.
- In August 2005, KPMG admitted to criminal wrongdoing over a multi-billion dollar tax fraud in the US and agreed to pay $456 million in fines and settlements as part of an major agreement with the US Justice Department and the Internal Revenue Service. Six former KPMG partners and its former deputy chairman were criminally prosecuted in relation to the tax fraud conspiracy, relating to the design, marketing, and implementation of fraudulent tax shelters. Attorney General Alberto R. Gonzales said: “The agreement requires KPMG to accept responsibility and make amends for its criminal conduct while protecting innocent workers and others from the consequences of a conviction.” The agreement imposed permanent restrictions on KPMG’s tax practice and banned KPMG from becoming involved with pre-packaged tax products. IRS Commissioner Mark Everson said: “At some point such conduct passes from clever accounting and lawyering to theft from the people.”