The Securities and Exchange Commission (SEC) and prosecutors pursued civil and criminal charges against six accountants, including former KPMG employees and one former regulator. The SEC expects to vote on the settlement this month.
The penalty looks set to be one of the biggest fines ever imposed on an auditor in an SEC case. As part of the settlement, KPMG has to admit all the facts in the SEC order and hire an independent compliance consultant to review its ethics and integrity controls.
“The key to preventing such schemes in the future is to shake up people’s confidence that they can get away with it,” said Jeff Hauser, director at the Centre for Economic and Policy Research (CEPR). “I suspect there are many undiscovered frauds.”
“We cannot guarantee that any institution is impervious to manipulation,” he said, “but we can make it much less likely”.
The case dates back to January 2018 when the US Department of Justice charged six former KPMG executives and PCAOB employees with sharing confidential information about audits. The SEC claimed PCAOB employee Cynthia Holder began leaking information to Brian Sweet in 2015 when Sweet left the board to join the firm.
Later, Holder also joined KPMG. The SEC claimed that regulator Jeffrey Wada began leaking “grocery lists” of upcoming inspections to Holder and that KPMG partners David Middendorf, Thomas Whittle and David Britt oversaw audits of several banks before the PCAOB came knocking.
The PCAOB discovered there was a leak in February 2017 and KPMG fired the employees one month later. The Big 4 firm concluded that the employees either had “improper advance warning” of inspections or they “failed to report” what was going on.
“We need a greater cooling off period between working for the PCAOB and working for the firms one oversaw while at the board,” Hauser said. “It would benefit the system as a whole if regulators saw their job as a calling and didn’t revolve back and forth with industry.”
The US government established the PCAOB, sometimes jokingly referred to as ‘Peekaboo’, after the Enron scandal brought down Arthur Andersen and exacted heavy losses on investors. The Big 5 became the Big 4, and the SEC had to sharpen its tools.
This case threatens the reputation of the watchdog and the industry it watches over, so the US authorities have been keen to make an example and safeguard the credibility of the board given its important role. Likewise, KPMG has set out to contain the damage of this case.
“KPMG has taken remedial actions to assure that such conduct cannot happen again,” the firm explained when the case began. “Integrity and quality are paramount for KPMG, including operating with the utmost regard for the critical importance of the regulatory process to our profession.”
KPMG “fared poorly in its PCAOB inspections in or about 2013 and 2014”, the court documents claim. This included approximately 28 comments in connection with 51 audits inspected by the board – around twice the average number received by the Big 4 firm’s rivals. The documents claim that the firm began hiring PCAOB employees to “assist in predicting which of KPMG’s engagements would be inspected”.
This alone does not prove any wrongdoing on the firm’s part. It’s also claimed that KPMG put in place incentives for teams who did not receive any comments on audits and used data analytics as part of its “efforts to improve its performance”.
The SEC has stressed that the allegations do not mean investors cannot rely on KPMG’s audits. In fact, the commission itself often relies on the firm’s work. Nonetheless, the case has raised questions about the level of oversight the US has over the accounting industry.
The case so far
In March, a federal jury convicted David Middendorf and Jeffrey Wada of wire fraud and conspiracy to commit wire fraud. The jury acquitted Middendorf and Wada on the charge of conspiracy to defraud the US.
Middendorf has launched an appeal against the charge of wire fraud. “We appreciate the one not guilty verdict,” said Nelson Boxer, who represents Middendorf. “But overall we’re very disappointed with the result.”
“What occurred here was not a wire fraud, and we intend to continue to vigorously press that argument on appeal,” the attorney said.
At the time, PCAOB Chairman William Duhnke told the press: “The misconduct that led to the trial directly contradicts the public’s expectations of the auditing profession, as well as the mission, vision, and values of the PCAOB.”
Brian Sweet and Thomas Whittle accepted plea deals and testified against Middendorf in the case. Fellow defendant Cynthia Holder pled guilty, but did not agree to testify. The courts are due to hand down sentences in July and August.
David Britt is expected to face trial in October 2019. “The allegations in the indictment against David involve conduct that is simply not a crime and we look forward to proving his innocence in court,” said Melinda Haag, who represents Britt.
The case continues.