KPMG’s unusual decision to withdraw from all bidding for UK government contracts in the wake of scandals almost too numerous to count is a severe blow to the auditor’s already blemished standing in the sector. As well as the ignominy of having its work declared “unacceptable” by the industry regulator and swallowing a sizable fine for misconduct in the Silentnight debacle, KPMG is also fighting perhaps its biggest fire in the shape of multi-billion-dollar private equity fund Abraaj, which collapsed on its watch.
Despite this maelstrom of controversy, both KPMG in particular and the Big Four auditing firms in general posted their strongest year-end financial results since Enron in 2021. As such, it appears unlikely that there is any hope of the status quo cleaning up its act anytime soon – but the cautionary tale of that fallen giant and its impact upon the auditing industry at the time spells out the clear and present danger of failing to do so.
KPMG in crisis
Given that public sector contracts comprised over 10% of KPMG’s annual revenue in 2020, its move to withdraw from future government projects was an unexpected one. Nonetheless, it’s perhaps not entirely surprising to realists: the Cabinet Office had already sent the company a letter seeking assurances on its conduct going forwards and threatening a public sector ban if more controversies surfaced. In that light, perhaps it can be interpreted as a jump-before-being-pushed approach to the issue.
The announcement comes at the end of a turbulent year in which the firm saw its chair step down amid a staff abuse scandal, had its work branded “unacceptable” by the industry regulator and received a £13 million fine for its role in the Silentnight insolvency debacle. KPMG pushed the mattress manufacturer into insolvency in order to pave the way for US private equity outfit HIG Capital to acquire it minus its pension liabilities. Suspiciously, KPMG then sold its entire insolvency division to HIG Capital earlier this year. The whole sordid affair earned the firm an unprecedented rebuke from the Financial Regulation Council (FRC), who accused it of mounting an “untruthful” defence and withholding crucial evidence.
Abraaj overshadows all
While those woes in its corporate homeland might be troubling enough, they pale in comparison to its struggles in the Middle East. The ever-lingering Abraaj case arguably represents the biggest reputational and legal challenge KPMG is currently confronting, given that the company is accused of complicity and a conflict of interests in the downfall of an investment fund that once controlled assets totalling some $14 billion at its peak.
Key men in the Abraaj empire are being targeted by the authorities. Founder Arif Naqvi is charged with pocketing some $250 million by US law enforcement and faces a staggering 291-year jail sentence if successfully extradited, while ex-CFO Ashish Dave has been hit with a $1.7 million fine by the Dubai Financial Services Authority for participating in “misleading and deceptive conduct”. KPMG’s role in the affair has not gone unnoticed either, with Abraaj suing the company for at least $600 million.
Its Dubai-based arm KPMG LLG gave the ailing equity fund a clean bill of health despite abundant warning signs at the onset of the scandal. Perhaps it wasn’t surprising that these were overlooked, given that the son of the CEO of KPMG LLG worked at Abraaj for an extended spell, as did Dave and at least two other officials – a violation of KPMG’s own code of conduct according to which employees must maintain objectivity, “not allow bias” or let “conflicts of interest” override “professional or business judgements.”
A spectre called Enron
Still, all four of the major auditing companies outdid themselves in 2021, posting cumulative revenues of $167.3 billion, the strongest fiscal performance since the collapse of Enron some 20 years ago. Even so, there remains awareness that the sector is riddled with issues, with European MPs calling for regulators to clamp down on the tax avoidance practices facilitated by the Big Four as far back as 2017. In the UK, the government is making noises about reforming the industry and introducing measures to dilute the Big Four, as well as capping bonuses and dividends for transgressing parties and replacing the FRC with a stronger and stricter body.
In Germany, the ongoing scandal of the Defence Ministry’s horrendous expenditure of taxpayer money on external consultants has only added fuel to the fire. Since mid-2019, the ministry’s use of consultants has been under investigation by the Bundestag, with allegations ranging from improper awarding of contracts to nepotism. In 2020 alone, the government spent close to half a billion on “external expertise”, which some argue is not only unnecessary, but may also lead to undue influence on government work.
In late 2020, the Parliament forced the government to hire less external expertise and increase the number of qualified officials instead. But whether the changes proposed in the UK, the EU and Germany will come to pass remains to be seen – but the potentially catastrophic consequences of not pursuing them are evidenced by the aforementioned Enron episode, which rocked the auditing world at the turn of the millennium. Once one of the biggest companies in the US, Enron executives used accounting chicanery and rampant malpractice to cover up its mounting debt. When the bubble burst, Enron took their auditors Arthur Andersen with them, turning the Big Five into a Big Four.
Given the lengthy list of litigation battles and regulatory admonishments which have followed KPMG around for the last few years, it’s not outside the realms of possibility that the industry elite could be whittled down to a Big Three in the foreseeable future. Certainly, KPMG HQ needs to find a way to improve control over its regional offices in order to prevent blatant misconduct. If and how this is done will be critical to the firm’s, if not the industry’s, future, yet the question remains: will it be enough?
Image credit: www.solvencyiiwire.com
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