Wednesday, December 19, 2018

Who Will Audit the Auditors?

KPMG/PCAOB Theft Scandal Casts Doubt on Audit Quality

Graphic: Pixabay/mohamed_hassan

By Hannah Ross and Tony Gelderman, Guest Columnists

Investors rely on auditors to provide neutral, independent, and accurate assessments of the financial condition of public companies. Reliable outside accounting and an auditor’s signed statement are the bedrock of company valuation.

However, despite a wave of major accounting scandals and legislative fixes in recent years, audits of public companies contain a shockingly high rate of errors and new scandals have arisen undermining public confidence.

A 2017 inspection of public company audits by The International Forum of Independent Audit Regulators found that 40 percent contained serious errors, including issues pertaining to accounting estimates and internal control testing, and a 2014 analysis by the Public Company Accounting Oversight Board found that one third of audits were so deficient that they should not have been issued.

In the face of these misrepresentations, ensuring the validity of audits has become even more important. Unfortunately, within the past year, KPMG, a “Big Four” audit firm, was embroiled in a scandal regarding the theft of confidential information from the PCAOB, which also brings into question the ability of the PCAOB to do its job and meaningfully “audit the auditors.”

In January 2018, the SEC and DOJ initiated an enforcement action against several former KPMG employees and one PCAOB employee in connection with attempts by KPMG to cheat on PCAOB inspections. At the same time, in a parallel proceeding, the DOJ issued an indictment against the same individuals in USA v. Middendorf et al., in federal court in the Southern District of New York. Earlier this year, defendants in the DOJ criminal action tried but failed to have several counts from the case dismissed. In October 2018, two of the defendants in the DOJ action pled guilty. One, KPMG’s former partner-in-charge of inspections, admitted that he and “other partners and employees of KPMG…agreed to share and use confidential information from PCAOB, to which we were not entitled.”

In his January 2018 statement announcing the actions, SEC Chairman Jay Clayton wrote that, based on discussions with SEC staff, he believed that investors could continue to rely on KPMG’s audit reports — despite the fact that KPMG was attempting to steal information from the PCAOB specifically in order to game the PCAOB’s inspection of its audits.

Since that time, court filings have revealed details about some of the KPMG clients whose audits were implicated in the scandal, and experts believe that Chairman Clayton’s statement should be re-evaluated in light of these disclosures. According to Nell Minow, a corporate governance expert, the “breadth and seriousness of the charges and the importance to the financial markets of the companies affected should require a thorough internal investigation with results made public. If the SEC or KPMG do not insist on it, investors and clients should.” Lynn Turner, the SEC’s former chief accountant, echoed such sentiments, stating: “I believe chairman Clayton misled investors when he said they could rely on the audits report issued by KPMG. In my opinion, the information that has come to light raises a serious question with respect to the integrity, objectivity and professionalism of the audits.”

Trial in the ongoing litigation is scheduled for February 2019, and given the conflicting views from the SEC and governance experts, investors and their counsel should think carefully about how much faith to put in these audits.

The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of Bernstein Litowitz Berger & Grossmann LLP or TEXPERS.  

Hannah Ross
Tony Gelderman
About the Authors:
Hannah Ross is a partner and Tony Gelderman is counsel at Bernstein Litowitz Berger & Grossmann LLP. They specialize in advising and representing institutional investors in securities fraud and corporate governance matters in state and federal courts nationwide.

No comments:

Post a Comment