The KPMG em­bar­rass­ment proves au­dit­ing needs a shakeup

The Globe and Mail (Prairie Edition) - - REPORT ON BUSINESS - ERIC REGULY EURO­PEAN BUREAU CHIEF ereg­uly@globe­and­mail.com

The­often cozy – some­times way too cozy – re­la­tion­ship be­tween au­di­tors and their clients was put on hu­mil­i­at­ing pub­lic dis­play Fri­day, when the fall­out from the Bell Pot­tinger PR scan­dal in South Africa hit the lo­cal arm of KPMG, one of the world’s Big Four au­dit­ing firms.

Eight top man­agers of KPMG’s South African di­vi­sion, in­clud­ing chief ex­ec­u­tive Trevor Hoole, re­signed, pre­sum­ably un­der pres­sure, af­ter an in­ter­nal in­ves­ti­ga­tion by KPMG In­ter­na­tional de­ter­mined that the firm should have ended its re­la­tion­ship a long time ago with the Gupta brothers, the wealthy, In­dian-born South Africans em­broiled in a scan­dal over their al­legedly cor­rupt ties to Pres­i­dent Ja­cob Zuma.

The au­di­tor said “there were cer­tain red flags that came to KPMG South Africa’s at­ten­tion re­gard­ing the in­tegrity and ethics of the Gup­tas,” which were ap­par­ently ig­nored. KMPG had been the Gup­tas’s au­di­tors for 15 years, but only ditched them as clients in 2016 as civil-so­ci­ety groups ac­cused the Zuma gov­ern­ment of award­ing the Gup­tas un­usu­ally sweet gov­ern­ment con­tracts – “state cap­ture,” to use the so­ci­eties’ term (the Gup­tas in­sist they are not guilty of wrong­do­ing).

The first vic­tim of the scan­dal was Bell Pot­tinger, the once hugely suc­cess­ful Bri­tish PR firm that was launched 30 years ago by Lord Tim Bell.

Mr. Bell had been Mag­gie Thatcher’s cher­ished spin doc­tor (he re­signed as the firm’s chair­man last year).

Bell Pot­tinger col­lapsed this week, shortly af­ter it was ejected from Bri­tain’s Pub­lic Re­la­tions and Com­mu­ni­ca­tions As­so­ci­a­tion (PRCA) for du­bi­ous eth­i­cal be­hav­iour, to wit, stok­ing racism in South Africa on be­half of the Gup­tas. Civil-so­ci­ety groups had ac­cused Bell Pot­tinger of us­ing a sleazy cam­paign to de­pict oppo- nents of the Gup­tas, of which there are many, as “white mo­nop­oly cap­i­tal” – and the PRCA agreed.

For op­po­nents of the Gup­tas, KPMG’s maul­ing in South Africa is a big­ger tro­phy than the death of Bell Pot­tinger, whose an­nual billings were tiny in com­par­i­son with those of the au­dit­ing firm. KPMG won’t dis­ap­pear in South Africa, but it has been cleaned out and will have to change its ways. But how rad­i­cally? Au­dit­ing firms have al­ways ar­gued that they are not foren­sic ac­coun­tants, whose main duty is to ex­pose fraud or wrong­do­ing, or rake ex­ec­u­tives over the coals for shabby or de­ceit­ful be­hav­iour.

Still, there is no doubt that KPMG South Africa was too close to the hands that fed them. For in­stance, leaked e-mails showed that the firm al­lowed Linkway Trad­ing, a Gupta com­pany, to ac­count for a 2013 Gupta wed­ding as a com­pany ex­pense. Four KPMG part­ners at­tended the wed­ding, which a KPMG ex­ec­u­tive re­ferred to as the “event of the mil­len­nium.”

That was but one ex­am­ple of the snug re­la­tion­ship be­tween KPMG and the Gup­tas. KPMG’s in­ter­nal re­port also cited ev­i­dence that its South African di­vi­sion was “aware of in­for­ma­tion which called into ques­tion the in­tegrity of the Gup­tas,” but chose to ig­nore it.

Mr. Hoole ac­knowl­edged a few weeks ago that KPMG “should have stopped work­ing for the Gupta com­pa­nies sooner than we did.” Bell Pot­tinger should have never started work­ing for them. When it landed the Gupta ac­count in 2016, it would have known all about the al­le­ga­tions sur­round­ing the Gup­tas and Mr. Zuma. Aware­ness of the risky na­ture of the ac­count was ap­par­ently dulled by the £100,000-amonth fee ($165,000) that the Gup­tas paid Bell Pot­tinger.

Au­dit­ing firms have been rather scan­dal-prone in re­cent years. Bri­tain’s Fi­nan­cial Re­port­ing Coun­cil (FRC) slapped two of the Big Four firms with £6.5-mil­lion in fines last year (the Big Four are KPMG, Deloitte, PwC and EY). Ear­lier this year, the FRC launched a probe into KPMG’s au­dits of Rolls-Royce af­ter the Bri­tish jet-engine maker ad­mit­ted cor­rup­tion and bribe of­fences re­lated to at­tempts to win busi­ness in China, In­done­sia and other coun­tries.

While au­di­tors may be right that they can­not be ex­pected to act as foren­sic ac­coun­tants bent on un­earthing fraud, there is no doubt that the rules de­signed to en­cour­age full au­di­tor in­de­pen­dence need to be clar­i­fied and bol­stered. For in­stance, should a firm that sells au­dit­ing ser­vices to a client also be al­lowed to of­fer other ser­vices, such as strate­gic con­sult­ing? These forms of cross­selling need to be ex­am­ined and prob­a­bly re­stricted more so than they are now.

Com­pa­nies that use au­di­tors should be forced to switch au­di­tors fairly of­ten to avoid in­breed­ing that can lead to the sit­u­a­tion that landed KPMG in trou­ble in South Africa. The new Euro­pean Union rules re­quire switches af­ter 20 years, an ab­surdly le­nient amount of time. A decade or less would be bet­ter, but quicker switches would present an­other prob­lem: Lack of choice among au­di­tors.

The wave of au­di­tor con­sol­i­da­tion in re­cent years re­duced the num­ber of big ac­count­ing firms to four – an oli­gop­oly. More au­dit­ing firms are needed for the health of the cor­po­rate world and trust of their in­vestors. The big au­di­tors may have to be bro­ken up. Or changes to reg­u­la­tion and com­pe­ti­tion-law might have to be made to en­cour­age the launch of new firms. KPMG’s em­bar­rass­ing per­for­mance in South Africa is am­ple proof that the au­dit­ing busi­ness still needs a shakeup.

The wave of au­di­tor con­sol­i­da­tion in re­cent years re­duced the num­ber of big ac­count­ing firms to four – an oli­gop­oly.

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