Ques­tions are now be­ing asked about whether KPMG could go bust within six months — but that would not mean its au­dit­ing role at the big banks would go to smaller firms, whether black- or white-owned

Financial Mail - - COVER STORY - Hi­lary Joffe jof­feh@busi­nesslive.co.za

When KPMG qui­etly re­signed from its role as ex­ter­nal au­di­tor of Oak­bay Re­sources and other Gupta com­pa­nies in March 2016, it ev­i­dently thought the is­sue would just go away and that the firm, now un­der the lead­er­ship of a new CEO, could go back to nor­mal.

In ret­ro­spect, it seems as­ton­ish­ing that the firm could have been so in­sen­si­tive to SA’S po­lit­i­cal re­al­i­ties, or so ar­ro­gant, that it imag­ined it could dodge the bul­let of its 15-year­long in­volve­ment with the Gup­tas — or of the role it played at the SA Rev­enue Ser­vice, where a foren­sic re­port on the so-called “rogue unit” by KPMG was used as a pre­text to fire then fi­nance min­is­ter Pravin Gord­han. Now, after an ever-more-tur­bu­lent 18 months, the “big four” ac­count­ing firm’s very sur­vival is at stake in SA. And there are ques­tions about how much of a hit KPMG’S rep­u­ta­tion might take glob­ally, with par­al­lels be­ing drawn be­tween the way the En­ron scan­dal sank Arthur An­der­sen in 2002.

Re­serve Bank gov­er­nor Le­setja Kganyago warned, in an in­ter­view with the Fi­nan­cial Times on Mon­day, that KPMG’S in­ter­na­tional busi­ness could be im­per­illed if the firm failed to do more to sal­vage its rep­u­ta­tion in SA. He said KPMG had taken a step in the right di­rec­tion by ap­point­ing an in­de­pen­dent in­quiry but urged this should be gen­uinely in­de­pen­dent and the re­sults should be made pub­lic: “KPMG has to own up. South Africans are an­gry with what it has done. It ac­cepted work it should not have. This is a global firm that is sup­posed to have global stan­dards and un­der­stand­ably clients will be ask­ing lots of ques­tions . . . I don’t think that if KPMG goes in SA, it will only go in SA.”

It is a mea­sure of how global the im­pli­ca­tions po­ten­tially are that the Fi­nan­cial Times has given it sig­nif­i­cant cov­er­age in re­cent weeks. It is a mea­sure, too, of how se­vere the po­ten­tial im­pli­ca­tions of a KPMG fail­ure are for SA’S fi­nan­cial sec­tor that the Re­serve Bank has gone pub­lic with its views.

At the same time, the con­tro­versy has high­lighted ques­tions about the au­dit pro­fes­sion it­self, as well as the roles of the boards

What it means: The more im­me­di­ate threat to fi­nan­cial sta­bil­ity is the prospect that more than one big bank would sud­denly be with­out au­di­tors

that sign off the an­nual fi­nan­cial state­ments. No­body should cel­e­brate the chal­lenges

KPMG faces, former fi­nance min­is­ter Trevor Manuel told a Deloitte con­fer­ence this week. Manuel, who is also chair­man of Old Mu­tual Emerg­ing Mar­kets, talked about a cri­sis for the pro­fes­sion and the need for a heal­ing process that would en­sure no fur­ther de­te­ri­o­ra­tion in trust. How­ever, he said the fo­cus should be not just on the ex­ter­nal au­di­tors but must start with the fi­nan­cial man­age­ment in­side any com­pany, and the au­dit com­mit­tee of the board which was sup­posed to be the first safe­guard. Deloitte CEO Lwazi Bam said: “This af­fects all of us as a pro­fes­sion and as a pro­fes­sion we need to in­tro­spect.”

KPMG ad­mit­ted in Au­gust that it had been far too slow to re­act to the con­tro­ver­sies around its re­ports for Sars and its re­la­tion­ship with the Gup­tas. By then it was too late. The In­de­pen­dent Reg­u­la­tory Board for Au­di­tors (IRBA) had ini­ti­ated an investigation. JSE listed Syg­nia had gone pub­lic in late July with its de­ci­sion to fire KPMG as its ex­ter­nal au­di­tor, prompt­ing other clients to re­view their re­la­tion­ships with it.

KPMG’S board re­sponded by sus­pend­ing one part­ner and re­liev­ing two oth­ers of their board and ex­ec­u­tive po­si­tions pend­ing the out­come of a com­pre­hen­sive re­view, and its then CEO Trevor Hoole ad­mit­ted that mis­takes had been made. But that only served to stoke anger against the firm. When it even­tu­ally went pub­lic in mid-septem­ber with the re­sults of a damn­ing investigation by KPMG In­ter­na­tional, and got rid of the top lead­er­ship of the SA firm, it was seen as too lit­tle, too late.

The re­port it­self was more damn­ing, in a way, be­cause while it con­cluded there was no ev­i­dence of cor­rupt or il­le­gal ac­tiv­ity by

KPMG, it found the firm’s qual­ity con­trol pro­cesses had failed, and that its lead­er­ship had shown ex­tremely poor judg­ment and failed to re­spond as it should have to “red flags”.

If clients hadn’t been wor­ried al­ready, they were now, and that was par­tic­u­larly the case for the banks and other fi­nan­cial ser­vices firms that are KPMG’S largest clients. Au­dit firms are there be­cause they are sup­posed to spot red flags and ex­er­cise judg­ment, and as one banker put it, what made it even worse was that

KPMG seemed not to have picked up the signs that the Gup­tas might be laun­der­ing money — a par­tic­u­larly dis­turb­ing fail­ure for the banks, as they are charged by the Re­serve Bank with look­ing out for money laun­der­ing or ex­change-con­trol con­tra­ven­tions.

KPMG looms large in SA’S fi­nan­cial sec­tor. Bank­ing reg­u­la­tions re­quire banks to have two au­di­tors and KPMG is joint au­di­tor for three of the big four banks – Standard, Ned­bank, and Absa – with the lat­ter two hav­ing brought KPMG in only this year. Absa has said it is re­view­ing its re­la­tion­ship in the light of the re­port. So has In­vestec, an­other au­dit client. KPMG is sole au­di­tor for Old Mu­tual and that in­cludes the highly com­plex task of au­dit­ing Old Mu­tual’s man­aged sep­a­ra­tion process, and it is also MMI’S au­di­tor, among oth­ers.

Sas­fin has al­ready said it will dis­miss KPMG as its joint au­di­tor, as have sev­eral other clients, and ques­tions are be­ing asked about whether KPMG could go bust within six months. That would cer­tainly be the case if it were to lose one or more of the big banks that are its largest clients. Some put its chances of go­ing un­der at well over 60%.

It’s a sce­nario that’s of ex­treme con­cern to SA’S fi­nan­cial sec­tor reg­u­la­tors — which is why the bank­ing reg­u­la­tor called the CEOS and chairs of the board au­dit com­mit­tees of the big banks to a meet­ing on the evening of Septem­ber 21, as the heat rose fol­low­ing KPMG’S re­port and its change of lead­er­ship. “We all agreed we should lower the tem­per­a­ture and pro­vide some breath­ing space,” says one who at­tended the meet­ing at the Re­serve Bank.

The trou­ble with SA’S big banks is that they are par­tic­u­larly com­plex and cross-bor­der crea­tures to au­dit, which is why only the “big four” au­dit firms take on those con­tracts. Nor is SA’S bank­ing sec­tor alone in this — in the US, for ex­am­ple, only two of the top 100 banks are au­dited by non-big four au­dit firms. The dom­i­nance of the au­dit­ing big four – KPMG, PWC, EY and Deloitte – tends to be con­tro­ver­sial ev­ery­where, but so far no-one is will­ing to be with­out them.

Nor is it likely that if KPMG were to go down, the busi­ness would go to smaller firms, whether black or white owned.

Fi­nance min­is­ter Malusi Gi­gaba has upped the tem­per­a­ture if any­thing, call­ing for all gov­ern­ment de­part­ments to re­view their re­la­tion­ships with KPMG, and has pointed to the risks posed by the mar­ket dom­i­nance of a few firms in a key in­dus­try. He has called for a “con­certed ef­fort by all stake­hold­ers to open up the sec­tor to more play­ers for a more de-con­cen­trated and trans­formed au­dit sec­tor”.

In the case of the big banks, that’s not go­ing to hap­pen. And one of the big con­cerns at the Re­serve Bank and within banks’ boards is that if KPMG goes un­der, or the banks have to bow to pres­sure to get rid of them as au­di­tors, the risk con­cen­tra­tion will be even worse, be­cause there would be just three firms to choose from.

That would present real prac­ti­cal prob­lems in a con­text in which each bank has to have two au­di­tors – and in which the rules on au­dit independence pre­vent a client tak­ing on a firm that is al­ready pro­vid­ing cer­tain kinds of nonau­dit ser­vices such as IT or hu­man-re­sources con­sult­ing. The chal­lenges will be even greater when manda­tory au­dit firm ro­ta­tion is in­tro­duced, as IRBA has an­nounced it will be from 2023. There are also con­cerns about re­duced choice when it comes to the kind of non-au­dit­ing work which firms such as KPMG do for the banks and for the Re­serve Bank it­self.

The rea­son banks, and large in­sur­ers, are dif­fer­ent when it comes to au­dit­ing has to do with the scale and the risks of au­dit­ing them. Smaller firms are un­likely to have the re­sources to de­vote a dozen or more part­ners and more than 100 staff to a sin­gle client, which is what a big bank au­dit would typ­i­cally re­quire, nor would they nec­es­sar­ily want the ex­po­sure – or to pay the billions of rand in pro­fes­sional in­dem­nity that’s re­quired.

For banks and their reg­u­la­tor, the more im­me­di­ate threat to fi­nan­cial sta­bil­ity is the prospect that more than one big bank would sud­denly be with­out au­di­tors, at least tem­po­rar­ily. No-one wants any ques­tion marks to be raised over the qual­ity of banks’ own fi­nan­cial state­ments. The dam­age KPMG has done to the rep­u­ta­tion of the au­dit pro­fes­sion it­self is al­ready an is­sue for the banks, as it is for the pro­fes­sion and the mar­kets.

Dis­turbingly, SA has al­ready lost the top place it long en­joyed in the World Eco­nomic Fo­rum’s rank­ing of coun­tries’ au­dit and re­port­ing stan­dards, with the WEF’S lat­est global com­pet­i­tive­ness in­dex show­ing SA plum­meted 30 places, from one to 31, on this mea­sure.

Though the Re­serve Bank has not ex­plic­itly come out and said the banks should think twice about dis­miss­ing KPMG, it is said to have pri­vately urged the banks to do so. At the same time, how­ever, it has urged KPMG In­ter­na­tional to take charge and re­store trust in the firm.

Be­lat­edly, KPMG In­ter­na­tional chair­man John Veih­meyer and chair­man-elect Bill Thomas vis­ited SA in the third week of Septem­ber, meet­ing Pravin Gord­han and oth­ers who suf­fered the con­se­quences of the Sars re­port and is­su­ing a pub­lic state­ment to say the firm would launch an in­de­pen­dent investigation, chaired by a “se­nior SA le­gal fig­ure”. It also said KPMG In­ter­na­tional would pro­vide its full sup­port to the SA firm, to re­store trust and re­build con­fi­dence — and en­sure the firm was do­ing busi­ness with the right peo­ple.

Veih­meyer and Thomas have recog­nised the dam­age done and, at last, have un­der­stood the sig­nif­i­cance of the is­sues to SA it­self. They have promised full dis­clo­sure. Whether their in­ter­ven­tion will be enough to save the firm has yet to be seen.

Freddy Mavunda Kiyoshi Ota/bloomberg

Le­setja Kganyago: Clients will be ask­ing ques­tions John Veih­meyer: KPMG In­ter­na­tional chair

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