Just recently, an indictment of five accountants became unsealed.
This isn’t just any old document. It is proof of just how cozy relationships and revolving doors add to the epidemic of funky accounting practices.
The accountants named include three big-shots from KPMG, one 2015 hire at KPMG who came over from the Public Company Accounting Oversight Board (the regulatory body controlled by the SEC that oversees accounting firms), and a KPMG wannabe who was working at the PCAOB.
Add that to the fact that General Electric’s (NYSE:GE) outside auditor has always been KPMG, and maybe investors will start to understand that audits aren’t foolproof. Sometimes, even the audits that are supposed to be irreproachable are factually lacking and fraudulent.
There’s a lot going on behind the scenes when it comes to GE, the PCAOB, and the Big Four of Accounting (Deloitte & Touche LLP, Ernst & Young LLP, Pricewaterhouse Coopers, and KPMG).
As always, I’ll be your guide…
The Call is Coming From Inside the House
The United States District Court’s unsealed indictment on conspiracy alleges that the group engaged in fraudulent activities to benefit KPMG.
These individuals are:
- David Middendorf (former National Managing Partner at KPMG)
- Thomas Whittle and David Britt (both former audit partners at KPMG)
- Cynthia Holder (former PCAOB inspector and 2015 hire at KPMG)
- And Jeffrey Wada (former PCAOB inspector).
Brian Sweet, a former inspector at the PCAOB who was hired by KPMG, already plead guilty to conspiracy charges. It’s likely he will testify against the others.
The scheme was simple enough. The PCAOB oversees supposedly independent outside accounting firms that audit public companies. Up until recently, the chairperson and board never came from the Big Four accounting firms.
The PCAOB, while technically independent, is overseen by The Office of the Chief Accountant, a position under the auspices of the SEC. For longer than most anyone can remember, the Chief Accountant has come from one of the Big Four accounting firms and usually returns there when they leave.
It’s a revolving door into regulatory power.
Allegedly, when Cynthia Holder was at the PCAOB, she gave KPMG bigwigs a heads-up on which audits conducted by KPMG the PCAOB investigative team was going to ask to take a look at. In theory, it’s to make sure KPMG wasn’t deficient in doing their job. That’s what the PCAOB does.
For her good work at the PCAOB, Holder got a coveted job at KPMG (cough, revolving door) and allegedly enlisted Jeffrey Wada, who was still at PCAOB,but wanted to join KPMG, to continue supplying KPMG with lists of audits that PCAOB inspectors were going ask for.
Apparently, the scheme was uncovered – perhaps internally, it hasn’t been disclosed – and all Hell broke loose. The accountants involved at KPMG and the PCAOB were fired and later indicted.
GE’s Honest Auditor Deficit
Why would so many high-ranking KPMG partners risk their careers over audits of their audits if the PCAOB has no authority to fine them? They can only shame them by lowering their rankings on some scale that the public probably doesn’t know even exists.
Either the Big Four accounting firms aren’t that good at what they do, or they’re too good because they’re buddies with the firms they audit.
Of the Big Four firms, Deloitte & Touche LLP, Ernst & Young LLP, Pricewaterhouse Coopers, and KPMG, it was KPMG that had the highest number of “deficiencies” (auditing issues) cited by the PCAOB in the past two years.
In 2016, twenty of KPMG’s inspected audit (about 38%) were found to be deficient, and 28% of all the Big Four’s audits were found to be deficient.
In 2015, twenty-eight of KPMG’s inspected audits (54%), were found to be deficient and the comparative Big Four deficient audits totaled 35%.
The Sarbanes-Oxley law that created the PCAOB effectively barred a practicing public accountant from serving as chairman. The restriction was intended to boost the regulator’s independence from the accounting industry.
The new chair of the PCAOB, William Duhnke, isn’t from a Big Four firm, he’s a specialist in securities law and financial reporting, having worked on Senate panels for Intelligence, Banking, and Rules committees.
But, for the first time, the PCAOB board now has two Big Four (revolving door) reps; Duane DesParte, a former audit partner at accounting firms Deloitte and Arthur Andersen, and James G. Kaiser who had been with PwC for 38 years and held numerous leadership roles with the firm.
Now, KPMG just happens to be GE’s outside auditing firm.
About that reported $15 billion black hole just discovered in GE’s accounting, and whatever other accounting bogeymen lie in their basement – why did KPMG never notice anything wrong?
It’s not like they were newbies looking over GE’s complex books. They’d been GE’s auditor for forever, and GE loved them. In fact, GE just reappointed them, citing reasons such as “high audit quality” and “efficient fee structure.”
The bottom line is that there’s just no trusting anyone anymore, at least anyone who the SEC oversees. That’s my takeaway.
What’s sad in that realization is that the SEC is everyone’s frontline against all kinds of fraud, by public companies, by their auditors, by their rating agencies, and this is how they roll?
There’s more dirt coming. Count on it.