Why did the SEC, and Chairman Jay Clayton, go easy on KPMG?
Many possible reasons have been floated but serendipity surfaced a new potential rationale
When the Securities and Exchange Commission settled charges with KPMG LLP on June 17, 2019 for soliciting stolen regulatory data and altering past audit work, KPMG may have smarted at some of the comments from Jay Clayton and his team at the SEC:
“KPMG’s ethical failures are simply unacceptable,” said SEC Chairman Jay Clayton. “The resolution the Enforcement Division has reached holds KPMG accountable for its past failures and provides for continuing, heightened oversight to protect our markets and our investors.”
“The breadth and seriousness of the misconduct at issue here is, frankly, astonishing,” said Steven Peikin, Co-Director of the SEC’s Enforcement Division. “This settlement reflects the need to severely punish this sort of wrongdoing while putting in place measures designed to prevent its recurrence.”
“This conduct was particularly troubling because of the unique position of trust that audit professionals hold,” said Stephanie Avakian, Co-Director of the SEC’s Enforcement Division. “Investors and other market professionals rely on these gatekeepers to fulfill a critical role in our capital markets.”
The regulators may have been angry because the inadvertent discover of another test cheating scam forced Jay Clayton’s hand.
I don’t think it was planning on fining KPMG, but the unexpected discovery during the investigation of the KPMG/PCAOB “steal the exam” scandal of an even more egregious violation of public trust, and an open defiance of the SEC’s authority, was just too much.
The SEC’s settlement order said that in 2018, after the firm had discovered and announced the separation of the audit leadership professionals for the PCAOB scandal, numerous KPMG audit professionals had also cheated on internal training exams by improperly sharing answers and manipulating test results. The cheating by audit partners and personnel was on SEC-mandated re-training and testing required by an August 2017 enforcement action against the firm and one partner for audit negligence.
In addition, the SEC learned that prior to November of 2015, certain audit professionals also manually changed the scores required to pass certain exams. By changing a number in a hyperlink, audit professionals could change the score required to pass.
Five former KPMG officials and one PCAOB official were criminally charged in 2018 in the original case that alleged they schemed to interfere with the PCAOB’s ability to detect audit deficiencies at KPMG. Four eventually pleaded guilty and two were found guilty at trial.
Now three more KPMG partners have been sanctioned by the SEC for the additional test cheating scandal.
The original SEC press release and DOJ indictment for the PCAOB “steal the exam” scandal announced in January 2018 “make for some tough reading,” said John Jenkins of TheCorporateConsel.net blog.
However, Jenkins wrote on January 31, 2018, SEC Chair Jay Clayton had gone, at that time, “to great lengths to reassure the market that the scandal didn’t implicate the reliability of KPMG’s audits,” in a separate statement.
As I pointed out in a MarketWatch.com article at the time, some weren’t so sure that KPMG’s audits should be relied upon.
Former SEC Chief Accountant Lynn Turner is not convinced KPMG’s audits should still be relied upon. “This episode raises a serious question about the culture of the KPMG firm. Under the circumstances, how can the SEC expect investors to trust KPMG’s audits?” asked Turner.
Jenkins also asked in January 2018, before anyone knew about the additional test cheating scandal why KPMG hadn’t been indicted?
“The pains that SEC Chair Clayton took to reassure the market about the continued reliability of KPMG’s audits hints at one likely reason – the collateral damage that can result from charges against a major accounting firm.”
Jenkins also speculated that KPMG might still evade criminal charges because it apparently had quickly addressed the situation once it was brought to management’s attention by a Chicago partner whistleblower.
A NYT DealBook article from April 2018 described KPMG prompt actions to self-report to the SEC and PCAOB, retain outside counsel to investigate the matter, ask the implicated individuals — including the head of its audit practice — to leave the firm (they were not fired but allowed to retire we found out later in the trial of two of the individuals,) and KPMG’s apparent cooperation with the regulators.
(The additional test cheating scandal had never been reported by any whistleblower to a KPMG internal hotline or any other regulatory authority, according to the June 2019 settlement document.)
This is not the first time in recent times KPMG has been in big trouble.
The 2005 tax shelter fraud scandal was almost a repeat of Arthur Andersen.
In 2013 Scott London, the firm’s Regional Partner in charge of audit for the Southwest, including California, was convicted of insider trading.
KPMG has also weathered the storm of significant accounting/audit controversies and frauds in the last fifteen years including New Century, Countrywide, Citi, Wells Fargo, FIFA, Deutsche Bank, HSBC, Bank of New York Mellon, and Carillion.
Given KPMG’s previous legal troubles as a result of the tax shelter fraud in particular, Jenkins wrote, “it probably didn’t take the firm’s lawyers long to conclude that it was dealing with a potentially existential threat – and had no alternative but aggressive efforts to cooperate with authorities.”
However, the fine for the KPMG/PCAOB scandal, layered with additional defiance of an SEC enforcement order by cheating on the remediation, was a relative pittance, I think.
This latest fine ties the largest ever imposed by the SEC on an audit firm, but is dwarfed by other recent fines and settlements absorbed by audit firms with no hiccup.
The penalty associated with KPMG’s guilty plea for tax fraud, an arguably much more limited scandal and one that did not touch on the firm’s core regulatory mandate of providing audits for public companies, was a $456 million fine and a deferred prosecution agreement.
That’s nine times larger than the recent fine for what was pervasive criminal corruption of the firm’s audit practice leadership.
The SEC did not want me to name the clients whose audits were manipulated based on the illegal tip-offs. I did it anyway.
The SEC attorney expressed what is now clearly shortsighted faux outrage at potential market disruption and, tut-tut, undeserved notoriety for those companies. Those issuer names and more, including more KPMG personnel and the whistleblower name, all now are public after the trial of David Middendorf and Jeffrey Wada.
Nothing more substantial either civilly or criminally has happened to KPMG, perhaps, because nothing has really changed since 2005, and nothing much changed after the financial crisis period 2008-10.
KPMG remained auditor of Citi, the combined Wells Fargo and Wachovia where it had audited both banks, and Deutsche Bank, to name just the most notorious financial crisis bailout recipients who’ve gone on to more ignominy.
KPMG remains the auditor of the U. S. Treasury.In fact, KPMG recently told the Treasury that it has several significant deficiencies…
KPMG replaced Deloitte as auditor of the Federal Reserve beginning in 2015.
KPMG is also the beleaguered longtime auditor of the Commonwealth of Puerto Rico.
Does that look like the U.S. Federal Government is willing to live without KPMG?
Yesterday, as I was wrapping up my story about SEC Chairman Jay Clayton and the possibility he pulled “Steve Bartman” moves to interfere with SEC investigations of former clients, I found a very interesting Jay Clayton potential conflict for this professional whose career began with stints at KPMG Consulting, BearingPoint and then PwC and a writing focus on the business of the Big 4.
According to Clayton’s biography for his role in the past as an adjunct law professor at University of Pennsylvania, KPMG member firms have been his clients.
Clayton’s Penn Law resume says he provided legal counsel to the KPMG member firm in Germany on the sale of its consulting practices to BearingPoint, and to KPMG the Netherlands and KPMG United Kingdom on their sale of their consulting business to Atos Origin.
A Fortune article adds additional details:
In 2002, Clayton provided legal advice to KPMG Consulting UK and Netherlands when computer services company Atos Origin agreed to acquire the consulting business for $618 million. Goldman Sachs also acted as KPMG’s advisor in the deal.
© Francine McKenna, The Digging Company LLC, 2020