The reputation of KPMG, one of the Big Four accounting firms, took another hit this week, when it fired five partners, including the head of its audit practice in the United States, for “unethical behavior.” The firings come on top of existing questions about the firm’s policies and practices: KPMG has for years been the auditor of scandal-scarred Wells Fargo and was the longtime auditor of problem-plagued FIFA, the world soccer governing body. Year after year, KPMG auditors saw no evil in either company.
The latest breach deepens doubts about KPMG and, in the process, raises fundamental questions about the integrity of all public-company audits.
The partners and one KPMG employee were fired because they failed to report on leaked information they had received (or knew of) about inspections planned by the firm’s regulator, the Public Company Accounting Oversight Board, which was established after the accounting scandals at Enron. During such inspections, the regulators carefully examine a selection of an accounting firm’s completed audits. The point is to measure compliance with auditing rules, and in that way give investors a benchmark for assessing the quality of a firm’s audits.
The leaked information, which came from an employee at the regulator who no longer works there, enabled the partners to know in advance which audits would be inspected. Advance notice would give them a chance to make sure that any targeted audits were squeaky clean.
KPMG says officials discovered the leak in late February and immediately reported it to the regulator and the Securities and Exchange Commission. KPMG also acknowledged that the leaked information “potentially” undermined the integrity of the regulatory process. The investing public needs a firm answer as to when the leak occurred and which inspections, if any, were affected.
What is clear is that KPMG had good reason to fear its regulator. The firm’s inspection results for 2014 and 2015 were abysmal. In 2014, its deficiency rate was 54 percent, which means that inspectors found more mistaken and unreliable audits than good ones. In 2015, the deficiency rate was 38 percent, which was an improvement, but still worse than that of the other three big accounting firms.
Of course, the proper response to fearing a bad grade is to improve performance, not succumb to the lure of cheating on the test. KPMG had no choice but to fire the partners and the employee. For its part, the regulator now has no choice but to give the public a full picture of what happened, why and when and which audits may be affected.
Good audits are the bedrock of fair and transparent financial markets. They have proved elusive — KPMG is at the bottom of the Big Four pack, but other firms also have disturbingly high deficiency rates. The Public Company Accounting Oversight Board was supposed to help fix that and now it, too, must take steps to ensure its own integrity and, in so doing, the integrity of markets.