KPMG Scandals: The Demarketing of a Mega Brand
In business, companies cannot afford to slip-up several times. With the latest scandal linked to KPMG, it has become clear that the professional service company, one of the Big Four auditors, along with Deloitte, Ernst & Young (EY), and PricewaterhouseCoopers (PwC), is surely coming to the point of no return.
KPMG, whose history in South Africa dates back to 1895, is facing calls for closure, and an uncertain future, as a consequence of the damage done to the South African economy, allegedly as a result of its activities.
KPMG had been working with a Gupta family company in the mining sector, Oakbay Resources and Energy, for 15 years prior to the revelations of corruption and collusion in 2016. The full impact and financial profit that KPMG received are yet to be determined.
In 2015, KPMG issued a controversial report that implicated former finance minister, Pravin Gordhan, in the creation of an illegal intelligence gathering unit of the South African Revenue Service (SARS). This report was widely seen to be part of a wider Gupta-linked state capture conspiracy, with the aim of forcing Gordhan out of his post. The report was withdrawn by KPMG in September 2017, earning the ire of the Commissioner of SARS, Tom Moyane.
After an internal investigation that found work done for Gupta family fell “considerably short” of the firm’s standards and amid rising political and public backlash, KPMG’s senior leadership in South Africa – including its chairman Ahmed Jaffer, CEO Trevor Hoole, COO Steven Louw and five partners – resigned in September 2017.
Numerous South African companies have either fired KPMG in the immediate aftermath of the scandal, or were reconsidering their relationships with the firm with the international chairman of KPMG, John Veihmeyer, apologising for the conduct of the South African arm and the firm donated fees earned from Gupta businesses, as well as the withdrawn SARS report to anti-corruption activities.
Alluding to the Arthur Andersen saga, the governor of the South African Reserve Bank, Lesetja Kganyago, said if KPMG fails to control the situation in South Africa, the crisis could spread to its international business.
“I don’t think that, if KPMG goes in South Africa, it will only go in South Africa,” he said.
In 2002, Arthur Andersen, then a Big Five accountancy firm, collapsed after alleged complicity in a $100bilion scandal at Enron, the United States energy company. “It didn’t pull down Arthur Andersen in the US,” Kganyago said. “It pulled down Arthur Andersen, period.”
KPMG audits or co-audits four of the biggest five banks in South Africa, including Investec and Barclays Africa, both of which are reviewing their relationship with the firm. If KPMG were fired by those banks or drummed out of South Africa altogether, Kganyago said, it would leave the country vulnerable. “Ending up with three firms is not good for competition,” he said.
For many financial sector observers and analysts, KPMG’s litany of corruption, across the globe, is breathtaking.
In 2003, KPMG agreed to pay $125 million and $75 million to settle lawsuits stemming from the firm’s audits of Rite Aid and Oxford Health Plans Inc., respectively. Separately, the firm will pay $75 million to settle lawsuits related to its audit of Oxford Health, whose woes can be traced to a computer system problem in 1997 that left it delinquent in paying doctors and hospitals and put it behind in collecting premiums from customers. KPMG denied any wrongdoing in both settlements, saying that it was settling them to avoid protracted litigation costs and “for practical business reasons.”
Three former top officers of Rite Aid went through trial on charges of accounting fraud, and a fourth pleaded guilty. The Securities and Exchange Commission called the accounting fraud at Rite Aid one of the most egregious ever and filed a civil suit against the three officers. KPMG resigned as the company’s auditor in November 1999, saying it couldn’t trust the information provided by management.
In the other case, investors claimed that KPMG gave a false and misleading opinion in a 1996 audit of Oxford, a Trumbull, Conn., firm that provides health-benefit insurance programs in New York, New Jersey and Connecticut.
The settlement follows Oxford’s agreement to pay $225 million to the same shareholders to settle the suit. Investors sued Oxford and KPMG after Oxford’s stock fell 63 percent Oct. 27, 1997, after an announcement that there would be a third-quarter loss because of billing delays and errors.
Again, in 2004, KPMG agreed to pay $115 million to settle lawsuits stemming from the collapse of software company Lernout & Hauspie Speech Products NV.
Lernout & Hauspie Speech Products, the Belgian company, was founded in 1987 and became a highflying symbol of new technology in the late 1990’s before collapsing into bankruptcy at the end of 2000 amid charges of accounting irregularities and criminal fraud.
At its peak, Lernout’s stock topped $70 on Nasdaq, valuing the company at more than $10 billion, and Lernout used its overvalued shares to acquire rivals like Dictaphone. Scan Soft, based in Boca Raton, Fla., acquired Lernout’s major technology assets in 2001 for $51 million.
The agreement ended KPMG’s involvement in a shareholder class-action lawsuit filed in 2000 in the United States District Court in Boston. The lawsuit charged KPMG with misconduct in failing to stop Lernout from filing misleading financial statements. KPMG was also sued by former shareholders of companies acquired by Lernout in swaps for inflated stock that became worthless when Lernout went bankrupt.
The class-action settlement with Lernout’s shareholders would be the second-largest ever paid by KPMG, after the $125 million resolution reached in connection with its role as auditor of Rite-Aid, a drug store chain that inflated the sales and earnings it reported in the late 1990’s. In both cases, KPMG denied all accusations of improper conduct.
Yet in another scandal in 2006, Fannie Mae sued KPMG for malpractice for approving years of erroneous financial statements. Fannie Mae alleged that KPMG’s failures led to one of the biggest accounting restatements in history, involving “virtually every key accounting policy” affecting its business. The problems were so extensive that the mortgage-finance giant spent more than $1 billion to redo its books, Fannie Mae said.
Fannie Mae’s lawsuit covered audits for 2001 through 2003, including work performed after the accounting debacle at Enron heightened awareness of audit risks and led to the downfall of KPMG’s rival, Arthur Andersen.
Fannie Mae employed KPMG for more than 30 years, and it paid KPMG more than $28 million from 2001 through 2003, the suit said. The accounting firm wore two hats in the relationship -for example, advising Fannie on how to comply with a new accounting rule and then auditing Fannie’s compliance, the lawsuit said.
In February 2007, in Germany, KPMG was also investigated for ignoring questionable payments in the Siemens bribery case. German prosecutors investigating alleged bribery at Siemens AG suspected its longtime auditor, KPMG’s German affiliate, ignored questionable payments on the conglomerate’s books.
The scrutiny was prompted by allegations by two Siemens executives under investigation in the probe. Their claims raise questions about whether KPMG Germany could have told authorities and investors that the Munich-based company’s systems for preventing accounting mistakes and fraud were flawed before news of the investigation surfaced late last year.
At least two veteran Siemens executives, who were jailed late in 2006 as part of the criminal probe alleged to prosecutors that KPMG Germany detected questionable payments in recent years, but chose to ignore them. In November 2008, the Siemens Supervisory Board recommended changing auditors from KPMG to Ernst & Young.
In August 2011, KPMG conducted due diligence work on Hewlett Packard’s $11.1 billion acquisition of the British software company Autonomy. However, in November 2012, HP announced an $8.8 billion write off due to “serious accounting improprieties” committed by autonomy management prior to the acquisition.
A shareholder’s lawsuit over Hewlett-Packard’s acquisition of British software firm Autonomy named the Big Four audit firms Deloitte and KPMG as defendants, alleging they missed numerous red flags about Autonomy’s accounting.
The lawsuit, filed in federal court in San Jose, California, also named HP’s board of directors, officers, and former executives, alleging breach of duty and negligence for their role in HP’s acquisition Autonomy. HP faced a barrage of lawsuits by investors seeking to recoup losses. Its shares fell 12 percent to a 10-year low after it announced an $8.8 billion write-down on its acquisition of Autonomy.
HP Chief Executive Meg Whitman repeatedly blamed the majority of its $8.8 billion write-down on improper accounting at Autonomy. Whitman also said HP relied on KPMG’s audits of Deloitte’s work.
In response, KPMG said it was not engaged to do any audit work or oversee the Deloitte audit work being questioned. KPMG provided limited services not related to Autonomy’s audit and “we can say with confidence that we acted responsibly and with integrity,” the firm said.
In April 2013, Scott London, a former KPMG LLP partner in charge of KPMG’s US Los Angeles-based Pacific Southwest audit practice, admitted passing on stock tips about clients, including Herbalife, Skechers and other companies, to his friend, Bryan Shaw, a California jewelry-store owner. In return, Shaw gave London $60,000 as well as gifts that included a $12,000 Rolex watch. On May 6 Shaw agreed to plead guilty to one count of conspiracy to commit securities fraud. He also agreed to pay around $1.3 million in restitution and will continue to cooperate with the government as part of a plea deal with federal prosecutors. This scandal led KPMG to resign as auditor for two companies.
In 2015, KPMG was accused by the Canada Revenue Agency of tax evasion schemes. “The CRA alleges that the KPMG tax structure was in reality a “sham” that intended to deceive the taxman.” CRA alleged that a wealthy Victoria, B.C., family paid virtually no tax over a span of eight years – and even obtained federal and provincial tax credits – while being involved in an offshore tax “sham” developed by KPMG.
Court documents show that in 2000, Peter Cooper and his two adult sons, Marshall and Richard, signed up for a KPMG tax product in the Isle of Man that targeted “high net worth” Canadian residents, promising they would pay “no tax” on their investments.
In 2013, the CRA obtained a judicial order demanding KPMG hand over the names of all the wealthy clients, who set up shell companies in the Isle of Man, a small, self-governing territory in the Irish Sea between England and Ireland.
Documents show that between 2002 and 2010, the Cooper family paid little or no tax, despite receiving nearly $6 million from an offshore company. KPMG lawyers claim any money the Coopers received were “gifts” and therefore non-taxable.
The CRA alleges that the KPMG tax structure was in reality a “sham” that intended to deceive the taxman – and that both the Coopers and KPMG knew that $26 million hidden in offshore accounts actually belonged to the Coopers.
“The parties to the structure willfully presented its transactions as being different from what they knew them to be,” the Revenue Agency said in tax court filings in Vancouver.
The CRA also alleged that the Coopers received federal and provincial tax credits during the years they were not declaring the income from the Isle of Man. In 2009, for example, Richard Cooper claimed the full home renovation tax credit on a home in Victoria. The CRA thus slapped the Cooper family with an order to repay millions in unpaid taxes and penalties in a “grossly negligent” scheme the CRA said was set up to “avoid detection” by tax authorities.
According to CRA documents filed in court, Marshall Cooper lived in a posh home in Victoria but paid only $3,049 in total taxes between 2002 and 2011. He even received tax credits worth $5,420, the CRA alleges.
Government auditors discovered the family invested in excess of $26 million back in 2002 and 2003 with help from KPMG. The money was handed to an offshore company called “Ogral” set up in the Isle of Man, but registered in other people’s names.
The CRA alleges the Coopers first “purported to gift their wealth” to the offshore company. However, for years they received millions in non-taxable “gifts” back from Ogral that the CRA alleges were never reported on tax returns.
In 2017, KPMG terminated five partners in its audit practice, including the head of its audit practice in the United States, after an investigation of advanced confidential knowledge of planned audit inspections by its regulator. This followed criticism about KPMG’s failure of uncovering illegal sales practices at Wells Fargo or potential corruption at FIFA, the governing international body of soccer. It is reported in 2017 that KPMG had the highest number of deficiencies, among the Big Four, cited by its regulator in the previous two years.
In 2017, KPMG paid a $6.2 million fine to the SEC for inadequacies in its audit of the financial statements of oil and gas company, Miller Energy Resources. KPMG and PwC were both been handed multi-million-pound fines for auditing failures, amid growing concerns about the quality of audits from the major providers.
SEC fined KPMG for failing to properly audit the energy company that had grossly overstated the value of its assets. KPMG issued an unqualified audit of oil and gas company Miller Energy Resources in 2011, despite the fact that the company had overvalued various assets bought in Alaska by 100 times their real worth. The facts presented to auditors “should have raised serious doubts,” the SEC had said.
Earlier this year, the watchdog issued a damning report stating that KPMG, Deloitte and Grant Thornton were producing below-quality audits. The fines will do little to dispel fears that auditing standards are slipping, leaving investors exposed.
Director of the SEC’s Atlanta Regional Office, Walter E. Jospin, said KPMG “failed to grasp how it valued oil and gas properties, resulting in investors being misinformed that properties purchased for less than $5 million were worth a half-billion dollars.”
Miller Energy Resources’ hugely overblown valuation resulted in the company being listed on the New York Stock Exchange. In 2015, it was charged with accounting fraud and later settled charges against it.
Both KPMG and the partner in charge of Miller Energy, John Riordan, agreed to settle charges against them without admitting or denying the findings.
This, in essence, summarises the unethical history of the international accounting firm.
Meanwhile, the consequences of its latest infraction continue to unfold, with South Africa’s Wits University on October 4, 2017 dropping KPMG as auditor.
Vice-Chancellor Adam Habib said: “It was agreed that KPMG had not been sufficiently transparent and that it is hard to reconcile KPMG’s conclusion that no one did anything illegal when senior individuals have been dismissed.”
For now, no one can precisely predict how deep the KPMG brand would sink, after being caught with its hands in another slush fund jar.
All said and done, the whirlwind of scandals that have trailed KPMG over the years and the current saga in South Africa are nothing but symptoms of a failing brand, whose life oxygen is hinged on trust. Now that the audit giant’s brand persona is being emasculated of trust and integrity through ghastly corporate misgovernance, it goes without saying that the mega brand is on its death bed awaiting the nunc dimitis. What a tragic repeat of history!
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