U.S. regulators likely won't force more transparency for global auditor failures
Let's compare how Australia is treating PwC with how U.S. regulators treated KPMG for similar regulatory theft. May answer why KPMG pulled off an unassisted bank failure triple-play and a near-miss.
Update
February 14, 2024, AFR: Offshore tax leaks went beyond the ‘dirty six’, Senate told
The Tax Practitioners Board’s ongoing PwC investigation has found the involvement by international partners in sharing confidential Australian Treasury documents was far broader than the six unnamed individuals that the big four firm’s global arm has reported.
It's been more than a year since The Australian Financial Review (AFR) broke the story of PwC Australia's government tax leaks scandal but the story is getting bigger, not going away. PwC, however, is doing everything possible to make sure that big U.S. and U.K names — of partners and client companies —won't hit the headlines outside of Australia.
The firm's tactics are reminiscent of the approach taken by everyone involved to squelch the impact of the 2017-2019 KPMG-PCAOB confidential data theft scandal and to deflect from the auditors' role in not warning investors during the Great Financial Crisis. It’s also a playbook in crisis communications for those dealing with ongoing concerns related to all the KPMG-audited bank failures last March.
That is quite eerily similar to what I had to write about the KPMG-PCAOB scandal in 2018 and 2019. No officials — only our research and teaching case — went beyond naming the indicted KPMG and PCAOB personnel on a public basis.
KPMG indictment suggests many who weren’t charged knew regulator data was stolen June 18, 2019, MarketWatch, Francine McKenna
The KPMG cheating scandal was much more widespread than originally thought June 18, 2019, MarketWatch, Francine McKenna
On January 23, 2023 AFR's Neil Chenoweth wrote that Peter Collins, the former head of international tax for PwC Australia, had been deregistered by the Tax Practitioners Board — these things happen — for dishonesty and for sharing confidential government briefings with PwC partners and clients.
That last part was quite newsworthy.
By that time Collins, the 2016 Tax Institute of Australia corporate tax adviser of the year and the leader of PwC Australia's international tax team, had already left the firm. His registration as a tax agent was cancelled for two years and, as of October 2022, he no longer worked at PwC.
Ever since crack journalists Edmund Tadros, Neil Chenoweth, and their colleagues on the professional services beat at AFR have been revealing and writing non-stop. A few other outlets outside of Australia have mentioned the scandal — Bloomberg puts it behind the Law paywall, Reuters mentions it, and the FT has had a few stories but I see none in WSJ or NYT— but only AFR beats the drum constantly and relentlessly.
PwC former tax partner Peter Collins had been sharing what he heard during confidential government briefings in 2015, 2016, and 2017 with PwC colleagues around the world. The confidential government briefings came during his advisory role to help the Australian government design its Base Erosion Profit Shifting (BEPS) measures to combat international tax avoidance and was bound by confidentiality agreements.
I wrote about how it all started here:
An email cache uncovered by AFR showed that PwC had quickly put together an international swat team, “Project North America,” to market the intel to multinationals interested in avoiding new Australian taxes. By May of 2023 AFR's Tadros was writing about how PwC Australia had charged $2.5 million in fees in 2016 to advise 14 clients how to sidestep new multinational tax avoidance laws based on the intelligence shared by tax partner Collins.
By July 2023 some client names had leaked out. AFR's Chenoweth reported that Uber and Facebook had established new company structures intended to sidestep Australia’s multinational tax avoidance law based on PwC advice, only days before the legislation came into effect in January 2016.
On September 27, 2023, AFR reported on a PwC document drawn from reports it commissioned into the tax leaks scandal by law firms King & Wood Mallesons, Allens, and Linklaters, which outlined PwC’s version of events. On the same day, Tadros wrote a separate article that focused specifically on the Linklater report:
Linklaters has cleared overseas PwC partners of using confidential information related to the tax leaks scandal “for commercial gain”, but disciplined six of the firm’s international operatives for not inquiring about the nature of the data.
The finding that the tax leaks matter is mostly limited to Australian partners is critical for the firm because its senior leadership wants to avoid the intervention of any US regulators.
PwC Australia has already belatedly reported the matter to the powerful US Public Company Accounting Oversight Board.
In a carefully worded statement on PwC’s global website on Wednesday, the firm wrote that “most” of the international PwC people who received the secret information from PwC Australia “did not know the information was confidential”.
However, PwC continues to resist releasing the actual investigation reports, only its own sanitized summary. As of February 9, 2024, AFR's Tadros writes, ‘The reform process at PwC Australia is being derailed by the refusal of its global leadership to identify the so-called ‘dirty six’ international partners punished over its tax leaks scandal, a Senate committee has told the firm."
Why is PwC Global refusing to name the names of the partners outside of Australia that, in its words, " ...should have raised questions as to whether the information was confidential"?
Recall that it has been reported more than once that PwC Global Chairman Bob Moritz swooped in and is leading the crisis management efforts. Moritz steps down in June and newly-elected Global Chairman Mohamed Kande will have to carry the flag after that. Tadros writes:
PwC global is resisting the release of the document in part because it does not want the tax leaks scandal to extend beyond the Australia firm because it could trigger further scrutiny from US and British regulators. The Australian firm reported the matter, belatedly, to the powerful US audit regulator last year.
It’s a pattern.
On April 11, 2017, KPMG announced that six employees would leave the firm, including the head of its audit practice in the United States, four other partners and one Director. In February 2017, an internal whistleblower, a veteran KPMG partner, had informed KPMG’s leadership of an information “leakage” between its regulator, the Public Company Accounting Oversight Board (PCAOB), and KPMG’s national office.
KPMG never disclosed the names of the partners or the employee involved. The WSJ was able to quickly name Scott Marcello, the audit practice head, given his name and title were on the website. The rest of the names could only be guessed. When nearly a year later, the SEC and the Department of Justice filed civil and criminal charges against six individuals, Scott Marcello was not one of them — to the chagrin I would guess of the WSJ which had profiled him — and one employee of the PCAOB, Jeffrey Wada, was added.
KPMG, the SEC, the PCAOB, and DOJ never named anyone other than the indicted KPMG or PCAOB persons who may have also received the stolen information that provided advance knowledge of which KPMG engagements would be inspected by the PCAOB. Even though I asked more than once the PCAOB never issued a report about its remediation activities that, I presume, addressed how the data was able to be stolen in the first place and if they had fired anyone else besides Wada as a result of the scandal.
Later, court filings in the criminal case against those who did not quickly plead guilty provided me more individual KPMG and PCAOB names as well as names of the impacted KPMG's clients. I was the only journalist who would report client names and additional individual names until the trial of David Middendorf and Jeffrey Wada in March 2019 made it all public. The SEC tried to discourage me, in particular from publishing the client names, saying it would be "unpatriotic." The trial was sparsely covered so very little of what was revealed is in the public realm unless you pay for voluminous court documents and do the work.
SEC Chairman Jay Clayton, you see, had done everything possible when his charges were filed on January 22, 2018 to downplay the scandal by reemphasizing KPMG's April 2017 contention that the charges against the KPMG partners and PCAOB professional did not impact any of KPMG's audit opinions or any of its client’s financial statements. Clayton's statement advised KPMG clients, all investors, and the markets in general that he did not believe the charges against the four KPMG senior leadership and National Office partners, one KPMG National Office Director, and a PCAOB inspection staff member would “adversely affect the ability of SEC registrants to continue to use audit reports issued by KPMG in filings with the Commission or for investors to rely upon those required reports.” The indictments were not expected to cause interruptions in the “orderly flow of financial information to investors and the U.S. capital markets, including the filing of audited financial statements with the Commission”.
Discouraging coverage, in particular of additional compromised personnel and the impacted KPMG audit clients — several of which are very big banks — was clearly a government priority. As I have written before, my initial impression was that the SEC was following an informal "too few to fail" policy to avoid contributing to a crisis of client and investor confidence at a Big 4 audit firm, and potentially driving KPMG to Arthur Andersen's post-Enron fate.
However, I now believe it was all about the banks.
In the Australia case PwC does not want it widely known which partners, and which multinationals, used the leaked Australia tax info to implement tax avoidance schemes. The legislators’ attitude in Australia has been much different than Congress’ attitude in the KPMG-PCAOB case. There was never a peep out of the U.S. Congress about the KPMG-PCAOB scandal. No hearings were ever held.
In Australia, the legislature has held numerous hearings, pushed for full disclosure, and dragged the other global accounting firms into the fray with additional revelations of government contract graft and aggressive marketing tactics. PwC Australia even lost a big banking client Westpac, supposedly over th scandal. But not everyone at Westpac was disgusted with PwC.
PwC Australia has hired senior Westpac lawyer Kylie Gray as its permanent general counsel as the firm remakes its leadership team and governance structure following its tax leaks scandal.
PwC has done everything possible to protect its partners, except when throwing them overboard was helpful to feed the legislative sharks.
PwC has protected clients at every turn, saying they did not know that confidential information was the source of PwC's advice. Supposedly, PwC is also worried about the wrath of U.S. and U.K regulators like the SEC, PCAOB, and FRC.
I doubt it.
Let me give you another example from the Great Financial Crisis. The Financial Times December 20, 2010:
I wrote at the time about the Parliamentary hearings that highlighted a meeting between the Big 4 and Lord Myners in December 2008, behind-the-scenes talks that detailed how "banks had been treated as going concerns not on their own merits but because of an informal nod that bail-out funds would be available. Lord Lawson, the former chancellor, said it was 'absolutely astonishing'. Lord Lipsey said the underlying logic was reminiscent of Alice in Wonderland."
Reap what you sow...
Now there’s not one, not two, not three but four banks audited by KPMG giving U.S. regulators headaches. Worse, now we have a KPMG three-fer on KPMG partners running troubled banks where their former firm signs the audit opinion.
What am I talking about? From Marc Rubinstein’s Net Interest newsletter:
Having been burned once, supervisors were keen for it not to happen again. So when New York Community Bancorp (NYCB) shot through the $100 billion asset threshold, regulators were quick to respond. This week, the bank cut its dividend to preserve capital, and bolstered both its loan loss reserves and its liquidity buffers.
“We have pivoted quickly and accelerated some necessary enhancements that come with being a $100 billion-plus Category IV bank,” said its CEO. “With this in mind, during the fourth quarter, we took decisive actions to build capital, reinforce our balance sheet, strengthen our risk management processes, and better align ourselves with the relevant bank peers.”
The market was caught by surprise. NYCB’s stock fell 45% over two days, taking out the long-term low it hit during the regional banking crisis last year...
The irony is that if it wasn’t for the regional banking crisis, New York Community Bancorp may never have triggered the $100 billion asset threshold at all. At the end of 2022, it had $90 billion of total assets, but its acquisition of [fellow KPMG audited] Signature Bank out of receivership tipped it over the edge. The bank didn’t raise fresh capital to do the deal and management thought they had time to adjust.
“We believe there will be some type of implementation period but this company is building capital,” said the CEO in July. “No doubt there’ll be higher needs for capital but we are generating it on an organic basis right now, which is really nice to see,” added the CFO.
Who is the CEO of New York Community Bank?
"Previously, Mr. Cangemi was a member of the SEC Professional Practice Group of KPMG Peat Marwick serving financial institutions."
(Who is the CFO of New York Community Bank?
"From 1993 to 1996, he was a member of the Financial Services Group of Ernst & Young, LLP, based in New York City, providing auditing and consulting services to financial institutions throughout the Northeast...Mr. Pinto holds a Bachelors degree from Fairfield University. He is a certified public accountant and a member of the AICPA.")
Who led the three KPMG audited banks that failed last March? From the Financial Times last May:
KPMG alumni have also gone on to play significant roles in the banking sector, including at former clients. The chief executives of Signature and First Republic were both former KPMG partners.
Accounting professors said regulators were likely to pay close attention to Signature’s appointment of Keisha Hutchinson, who was the lead partner on the KPMG audit team at the bank, to be its chief risk officer in 2021, less than two months after she signed the 2020 audit report. Securities and Exchange Commission rules require a 12-month cooling-off period before an audit partner is hired by a company into a role that oversees financial reporting, although that is usually interpreted to mean chief financial officer or financial controller roles.
And Bloomberg:
Yes, in the past a typical career transition for an audit partner is to CFO, or maybe the Audit Committee of the Board.
For example, a former Global Chairman of KPMG, Tim Flynn, and the former Chairman of EY from 2013-2019, Mark Weinberger are both on JP Morgan's Audit Committee. Former Global Chair of Deloitte Sharon Allen is chair of Bank of America's Audit Committee. Former Chairman of EY Jim Turley is on the Citi Audit Committee. UBS Audit Committee Member Jeremy Anderson was KPMG's Global Head of Financial Services when he retired in 2017.
So, CFO or Audit Committee, but bank audit partners are not running the global banks. Academic research is heavy on CFO's backgrounds. (Thanks to Univ of S.C. Chad Stefaniak for help in surfacing some relevant papers.)1 A lot of that research looks at whether CFOs served in public accounting, but not necessarily whether they were former partners or not.
(Although I did write about how a former PwC partner was CEO of SolarWinds when it was hacked and up until the SEC opened an investigation of the company and its CISO.) From the FT last May, again:
Questions over the quality of its work and independence have mounted in recent days, following the release of a Federal Reserve report into the collapse of Silicon Valley Bank and the forced sale of First Republic. The Big Four accounting firm was auditor to both banks, as well as to Signature, which was seized by regulators in March.In all three cases, KPMG gave the banks’ financial statements a clean bill of health as recently as the end of February.
That's true, also, in the case of the latest KPMG audited bank to nearly keel over, New York Community Bank, where KPMG — auditor since 1993 — has not insisted on any impairments of assets ever, and not issued a material weakness in ICFR since 2004. NYCB has restated its accounts seven times since 2012. KPMG's fees for NYCB nearly doubled in 2022 after the bank swallowed Flagstar Bank. NYCB’s acquisition of KPMG-audited Signature Bank out of receivership last year tipped it over the regulatory edge.
It looks like the question of how we get three regional banks run by former KPMG partners, and also audited by KPMG, to all need regulatory action/support in a year's time is, as yet, unanswered and understudied.
One thing I am pretty sure of is that the U.S. regulators probably do not want me to remind anyone of this.
I encourage more research.
© Francine McKenna, The Digging Company LLC, 2024
Aifuwa, H., and K. Embele, 2019, Board characteristics and financial reporting quality, Journal of International Financial Management and Accounting 5, 30-49.
Google Scholar
Finley, A. R., M. H. J. Kim, P. T. Lamoreaux, and C. S. Lennox, 2019, Employee movements from audit firms to audit clients, Contemporary Accounting Research 36, 1999-2034.
Geiger, M. A., C. S. Lennox, and D. S. North, 2008, The hiring of accounting and finance officers from audit firms: how did the market react? Review of Accounting Studies 13, 55-86.
Geiger, M. A., D. S. North, and B. T. O'Connell, 2005, The auditor-to-client revolving door and earnings management, Journal of Accounting, Auditing and Finance 20, 1-26.
Li, C., L. Sun, and M. Ettredge, 2010, Financial executive qualifications, financial executive turnover, and adverse SOX 404 opinions, Journal of Accounting and Economics 50, 93-110.
Menon, K., and D. D. Williams, 2004, Former audit partners and abnormal accruals, The Accounting Review 79, 1095-1118.
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Ye, P., E. Carson, and R. Simnett, 2011, Threats to auditor independence: the impact of relationship and economic bonds, Auditing: A Journal of Practice and Theory 30, 121-148.
This is shockingly annoying! The US gov has "hammered" small fry individuals, and developing country dual citizens and residents mercilessly for tax avoidance, and here the SEC cries hush for "patriotism" on bank audits, and if Australia helps you avoid taxes well that's "alright mate"! the hypocrisy is sick. Murica!