KPMG's Big Announcement

If you're ever in the UK or Australia, you'll notice that local newspapers run what seem to be daily articles portraying popular dissatisfaction with the quality of audits being performed.

The Financial Times, back in August, ran a terrific series of articles entitled "The Big Flaw: Auditing in Crisis."  The FT's series, and much of the debate generally, has centered on two broad themes:

1. the potential for consulting arms of the Big Four to jeopardize the independence of their audit function (to the degree they consult for clients they audit too)
2. the lack of competition in the audit sector

These issues are serious and thorny.  They are not, however, new.  

Back in 2002, in the near aftermath of Enron's failure (then big-5 firm Arthur Andersen was the auditor) at a congressional hearing concerning WorldCom's failure, Congressman Bernie Sanders castigated an Arthur Andersen representative:

Mr. Dick, it appears very clearly that Arthur Andersen failed in their audit of WorldCom. You failed in the audit of Enron. You failed in the audit of Sunbeam. You failed in the audit of Waste Management. You failed in the audit of McKesson. You failed in the audit of Baptist Foundation of Arizona. What was Arthur Andersen doing? I mean, how do you—it is incomprehensible to me that a major accounting firm can have such a dismal record in trying to determine what the financial health of a company is. It’s almost beyond comprehension.

Recent, topical examples include perceived deficiencies in the audits of Taylor, Bean & Whitaker (Deloitte); Steinhoff (Deloitte); Wells Fargo (KPMG); GE (KPMG); Carillion (KPMG); Abraaj

(KPMG); Colonial Bank (PWC); Vocation (PWC); and Sino Forest (Ernst & Young).

In the news again this week is the 1MDB saga, said to be among the largest of a new generation of frauds. 1Malaysia Development Berhad (or 1MDB) went through three of the Big Four between 2010 and 2016. Each of E&Y, KPMG and Deloitte was either fired or resigned from the role.  KMPG and Deloitte signed off on 5 annual reports between them, with 1MDB reportedly announcing that its 2013 and 2014 audited financials should not be relied on.  Oh well.

Today, KPMG made a significant announcement. 

Having been criticized by UK accounting regulator, the Financial Reporting Council, for their audits having deteriorated to an "unacceptable level," KPMG decided to limit or stop all consulting work for those large UK clients for which it also acts as an auditor. 

(Interestingly, our understanding is that it was never shown to be the case that this specific conflict undermined the quality of the audit provided; but the possibility remains that it can undermine auditor independence ... and perception can be as important as reality.)

This raises a number of questions:

• If the conflict is real, why only implement this procedure for large clients?  
• Why only in the UK?  
• If this makes sense for accounting firms, would it also make sense for other providers of financial services, like price providers or credit rating agencies: should rating agencies that rate corporates limit their ability to consult for them too (e.g., in the sale of analytics).