KPMG on the ropes
Questions are now being asked about whether KPMG could go bust within six months — but that would not mean its auditing role at the big banks would go to smaller firms, whether black- or white-owned
FREE TO READ: Given the importance of this story, we have decided to make this week's FM cover articles free to read.
Want to read our columnists and other Financial Mail exclusives regularly? Subscribe now to BusinessLIVE Premium for less than R4 a day. First-time subscribers get the first month for only R10. Take a look at our subscription options to find one that suits you.
When KPMG quietly resigned from its role as external auditor of Oakbay Resources and other Gupta companies in March 2016, it evidently thought the issue would just go away and that the firm, now under the leadership of a new CEO, could go back to normal.
In retrospect, it seems astonishing that the firm could have been so insensitive to SA’s political realities, or so arrogant, that it imagined it could dodge the bullet of its 15-year-long involvement with the Guptas — or of the role it played at the SA Revenue Service, where a forensic report on the so-called "rogue unit" by KPMG was used as a pretext to fire then finance minister Pravin Gordhan. Now, after an ever-more-turbulent 18 months, the "big four" accounting firm’s very survival is at stake in SA. And there are questions about how much of a hit KPMG’s reputation might take globally, with parallels being drawn between the way the Enron scandal sank Arthur Andersen in 2002.
The more immediate threat to financial stability is the prospect that more than one big bank would suddenly be without auditors
Reserve Bank governor Lesetja Kganyago warned, in an interview with the Financial Times on Monday, that KPMG’s international business could be imperilled if the firm failed to do more to salvage its reputation in SA. He said KPMG had taken a step in the right direction by appointing an independent inquiry but urged this should be genuinely independent and the results should be made public: "KPMG has to own up. South Africans are angry with what it has done. It accepted work it should not have. This is a global firm that is supposed to have global standards and understandably clients will be asking lots of questions ... I don’t think that if KPMG goes in SA, it will only go in SA."
It is a measure of how global the implications potentially are that the Financial Times has given it significant coverage in recent weeks. It is a measure, too, of how severe the potential implications of a KPMG failure are for SA’s financial sector that the Reserve Bank has gone public with its views.
At the same time, the controversy has highlighted questions about the audit profession itself, as well as the roles of the boards that sign off the annual financial statements. Nobody should celebrate the challenges KPMG faces, former finance minister Trevor Manuel told a Deloitte conference this week. Manuel, who is also chairman of Old Mutual Emerging Markets, talked about a crisis for the profession and the need for a healing process that would ensure no further deterioration in trust. However, he said the focus should be not just on the external auditors but must start with the financial management inside any company, and the audit committee of the board which was supposed to be the first safeguard. Deloitte CEO Lwazi Bam said: "This affects all of us as a profession and as a profession we need to introspect."
KPMG admitted in August that it had been far too slow to react to the controversies around its reports for Sars and its relationship with the Guptas. By then it was too late. The Independent Regulatory Board for Auditors (IRBA) had initiated an investigation. JSE listed Sygnia had gone public in late July with its decision to fire KPMG as its external auditor, prompting other clients to review their relationships with it.
KPMG’s board responded by suspending one partner and relieving two others of their board and executive positions pending the outcome of a comprehensive review, and its then CEO Trevor Hoole admitted that mistakes had been made. But that only served to stoke anger against the firm. When it eventually went public in mid-September with the results of a damning investigation by KPMG International, and got rid of the top leadership of the SA firm, it was seen as too little, too late.
The report itself was more damning, in a way, because while it concluded there was no evidence of corrupt or illegal activity by KPMG, it found the firm’s quality control processes had failed, and that its leadership had shown extremely poor judgment and failed to respond as it should have to "red flags".
If clients hadn’t been worried already, they were now, and that was particularly the case for the banks and other financial services firms that are KPMG’s largest clients. Audit firms are there because they are supposed to spot red flags and exercise judgment, and as one banker put it, what made it even worse was that KPMG seemed not to have picked up the signs that the Guptas might be laundering money — a particularly disturbing failure for the banks, as they are charged by the Reserve Bank with looking out for money laundering or exchange-control contraventions.
KPMG looms large in SA’s financial sector. Banking regulations require banks to have two auditors and KPMG is joint auditor for three of the big four banks – Standard, Nedbank, and Absa – with the latter two having brought KPMG in only this year. Absa has said it is reviewing its relationship in the light of the report. So has Investec, another audit client. KPMG is sole auditor for Old Mutual and that includes the highly complex task of auditing Old Mutual’s managed separation process, and it is also MMI’s auditor, among others.
Sasfin has already said it will dismiss KPMG as its joint auditor, as have several other clients, and questions are being asked about whether KPMG could go bust within six months. That would certainly be the case if it were to lose one or more of the big banks that are its largest clients. Some put its chances of going under at well over 60%.
It’s a scenario that’s of extreme concern to SA’s financial sector regulators — which is why the banking regulator called the CEOs and chairs of the board audit committees of the big banks to a meeting on the evening of September 21, as the heat rose following KPMG’s report and its change of leadership. "We all agreed we should lower the temperature and provide some breathing space," says one who attended the meeting at the Reserve Bank.
The trouble with SA’s big banks is that they are particularly complex and cross-border creatures to audit, which is why only the "big four" audit firms take on those contracts. Nor is SA’s banking sector alone in this — in the US, for example, only two of the top 100 banks are audited by non-big four audit firms. The dominance of the auditing big four – KPMG, PwC, EY and Deloitte – tends to be controversial everywhere, but so far no-one is willing to be without them.
Nor is it likely that if KPMG were to go down, the business would go to smaller firms, whether black or white owned.
Finance minister Malusi Gigaba has upped the temperature if anything, calling for all government departments to review their relationships with KPMG, and has pointed to the risks posed by the market dominance of a few firms in a key industry. He has called for a "concerted effort by all stakeholders to open up the sector to more players for a more de-concentrated and transformed audit sector".
In the case of the big banks, that’s not going to happen. And one of the big concerns at the Reserve Bank and within banks’ boards is that if KPMG goes under, or the banks have to bow to pressure to get rid of them as auditors, the risk concentration will be even worse, because there would be just three firms to choose from.
That would present real practical problems in a context in which each bank has to have two auditors – and in which the rules on audit independence prevent a client taking on a firm that is already providing certain kinds of non-audit services such as IT or human-resources consulting. The challenges will be even greater when mandatory audit firm rotation is introduced, as IRBA has announced it will be from 2023. There are also concerns about reduced choice when it comes to the kind of non-auditing work which firms such as KPMG do for the banks and for the Reserve Bank itself.
The reason banks, and large insurers, are different when it comes to auditing has to do with the scale and the risks of auditing them. Smaller firms are unlikely to have the resources to devote a dozen or more partners and more than 100 staff to a single client, which is what a big bank audit would typically require, nor would they necessarily want the exposure – or to pay the billions of rand in professional indemnity that’s required.
For banks and their regulator, the more immediate threat to financial stability is the prospect that more than one big bank would suddenly be without auditors, at least temporarily. No-one wants any question marks to be raised over the quality of banks’ own financial statements. The damage KPMG has done to the reputation of the audit profession itself is already an issue for the banks, as it is for the profession and the markets.
Disturbingly, SA has already lost the top place it long enjoyed in the World Economic Forum’s ranking of countries’ audit and reporting standards, with the WEF’s latest global competitiveness index showing SA plummeted 30 places, from one to 31, on this measure.
Though the Reserve Bank has not explicitly come out and said the banks should think twice about dismissing KPMG, it is said to have privately urged the banks to do so. At the same time, however, it has urged KPMG International to take charge and restore trust in the firm.
Belatedly, KPMG International chairman John Veihmeyer and chairman-elect Bill Thomas visited SA in the third week of September, meeting Pravin Gordhan and others who suffered the consequences of the Sars report and issuing a public statement to say the firm would launch an independent investigation, chaired by a "senior SA legal figure". It also said KPMG International would provide its full support to the SA firm, to restore trust and rebuild confidence — and ensure the firm was doing business with the right people.
Veihmeyer and Thomas have recognised the damage done and, at last, have understood the significance of the issues to SA itself. They have promised full disclosure. Whether their intervention will be enough to save the firm has yet to be seen.