KPMG-PCAOB Scandal Raises Questions About Oversight of the Accounting Profession
In an unprecedented event, on January 22, 2018 it was announced that a former Public Company Accounting Oversight Board (PCAOB) staffer, Brian Sweet, who was hired by KPMG in 2015, leaked confidential information about PCAOB's plans to audit the company. Most of the leaked information concerned which audit engagements the PCAOB planned to inspect, the criteria it was using to select engagements for inspection, and on what these inspections would focus.
A bit of background first, following the financial fraud scandals at Enron and WorldCom, in 2004 the SEC decided to remove the peer review system from the accounting profession and formed a public entity -- the PCAOB -- to institute a mandatory quality inspection program for CPA firms that audit public companies. The average audit deficiency rate has ranged between 30-to-40 percent since the program started. The rate for Big-4 firms has gotten as low as 21 percent (Deloitte) and gone as high as 54 percent (KPMG). In the case of KPMG, it was determined that the firm too often failed to gather enough supporting evidence before signing off on a company's financial statements and internal controls.
The alleged conspiracy by KPMG got its start when while preparing to leave the PCAOB, Sweet copied confidential information showing which audits would be reviewed. He shared the information with his new colleagues at KPMG, according to court documents, and continued to acquire and share PCAOB information with KPMG executives through 2017 with the help of at least two other board employees. Three KPMG partners were charged with conspiracy -- David Middendorf, KPMG's former national managing partner for audit quality and professional practice; Thomas Whittle, former national partner-in-charge of inspections; and David Britt, the banking and capital markets group co-leader. As the scheme unraveled, accountants at KPMG deleted messages, and considered hiding their communications using prepaid "burner" phones and codes over Instagram, according to prosecutors. Steven Peikin, the SEC's co-director of enforcement was quoted in saying: "These accountants engaged in shocking misconduct -- literally stealing the exam -- in an effort to interfere with the PCAOB's ability to detect audit deficiencies at KPMG.”
According to the criminal indictment, during Sweet's first week at KPMG the three partners asked, knowing his background with the PCAOB, whether there were any plans to inspect a client of theirs. Reluctant at first to respond, Middendorf is said to have later told Sweet to "remember where [his] paycheck came from" and "to be loyal to KPMG." Sweet was asked about the plans again a few days later, this time by Whittle, who implied that his position within the firm was not secure. Sweet showed Whittle the inspection list later that day. The audit partners used this information to analyze and review audit workpapers relevant to the inspection and suggested revisions to avoid possible findings of deficiencies by the PCAOB.
It seems that KPMG was motivated by a desire to improve its inspection results following a high rate of audit deficiency. The knowledge of PCAOB's audit plans for the firm gave it an unfair advantage over other firms and violates ethical principles of right and wrong.
Blog posted by Steven Mintz, aka Ethics Sage, on January 24, 2018. Dr. Mintz is a Professor Emeritus from Cal Poly San Luis Obispo. Visit his website to find out more about his services and sign up for his newsletter.