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Accounting firm KPMG issued a clean bill of health on the audits of SVB, Signature, and First Republic Banks, just two weeks before they collapsed.
Practically all corporate blow-ups begin with some creative accounting. Unfortunately, the industry best positioned to monitor malfeasance in corporate accounting hasn’t fulfilled its responsibility.
In the aftermath of the FDIC’s venture capitalist bailout, Big Four accounting firm KPMG is under fire for issuing a clean bill of health on the audits of SVB, Signature, and First Republic Banks, just two weeks before their collective implosions. Until 2019, KPMG also audited Credit Suisse, which nearly went bankrupt this past week due to long-standing underlying issues, before it secured a stage-managed buyout.
KPMG’s botched audits are just the most recent failures by the auditing industry that has repeatedly missed nearly every major corporate meltdown in recent decades, from Enron to Lehman Brothers to FTX. KPMG, in particular, has been a repeat offender. The firm got hit with a $17 million lawsuit following the collapse of its client, the British multinational Carillion, in 2020, and lost both Deutsche Bank and GE’s accounts after fines were imposed on the firms for a series of violations. And there’s the infamous “steal the exam” scandal, where top KPMG auditors went to prison for acquiring advance information on what audits would be scrutinized by a federal regulator.
The latest KPMG debacle renews decades-old questions about whether the current business model of accounting may dissuade auditors from effectively evaluating the filings of their corporate clients, and risk losing their business. Conflicts of interest abound, especially given the recent trajectory of the industry. The Big Four (KPMG, Ernst & Young, PricewaterhouseCoopers, or PwC, and Deloitte) now make most of their money from consulting, legal services, and even lobbying instead of audits. The growth of these more lucrative business lines, experts argue, erodes the quality of auditing, relegated to an almost boutique practice compared to overall operations.
Raising further doubts about the industry, accounting firms joined ranks with many of their banking clients in 2018 to lobby for financial deregulation bills in Washington, rather than adequately monitoring them for systemic risk.
THE BUSINESS OF AUDITING is unconventional. Though the Big Four take in billions of dollars each year, they function as semi-public institutions, with extensive certifications from government entities and oversight. Investors, government agencies, and the public rely on accounting audits to evaluate risk. These routine failures, SVB being the latest, undermine the credibility of the accounting firms, which are supposed to act as the first line of defense in the multilayered though broken system for overseeing corporate fraud.
“They are not acting with any incentive to warn the public when one of their clients is going to screw up because they’re afraid of precipitating a run,” said Francine McKenna, a former auditor and now a lecturer at the University of Pennsylvania who runs the accounting blog The Dig.
Though purportedly independent, accounting firms share a revolving door with the financial institutions and companies they audit. Signature Bank’s chief risk officer Keisha Hutchinson signed off on KPMG’s audit as recently as 2021, when she was still a senior partner at the accounting firm, before leaving for the New York bank. Signature’s top executive and founder Joseph DePaolo previously worked as an audit manager for KPMG.
Though purportedly independent, accounting firms share a revolving door with the financial institutions and companies they audit.
The rot goes far deeper than KPMG though. Last year, the SEC brought litigation against PwC for helping staff the internal accounting team at one of its clients, Mattel, which was fined $3.5 million for financial misstatements.
For years, watchdogs have sounded the alarm that auditors may look the other way on clients’ filings in the hope of landing a more elevated job down the road; the conflict is not unlike how government officials eye the private sector to cash in on their public service.
In Washington, both accounting firms and their partners on Wall Street march in lockstep when it comes to government lobbying. SVB is a case in point. While the banks worked tirelessly to gut Dodd-Frank during the Trump administration, their hired accountants were at the same time lobbying to undercut auditor independence rules, often working together with their banking clients on the very same pieces of legislation. Big Accounting even threw its weight behind the 2018 banking deregulation bill that delivered the SVB collapse, spending hundreds of thousands of dollars and working with partner banks on the effort.
For two decades, large accounting multinationals have tried to overturn an obscure though critical set of reforms imposed on the industry in response to the Enron disaster. Enron’s auditor, Arthur Andersen, which went bankrupt from the fiasco, provided both consulting and tax services to the energy company at the same time as it conducted its audit, which was par for the course at the time.
The Sarbanes-Oxley Act passed in 2002 created bright-line rules for auditor independence, prohibiting a firm from offering audit and non-audit services to the same company, so as to prevent conflicts of interest. The bill also formed a new regulatory body, the Public Company Accounting Oversight Board (PCAOB), to oversee the implementation of the rules, in coordination with the SEC.
The sweeping new reforms were so extensive that several firms actually sold off their burgeoning consulting services, out of fear they wouldn’t be able to comply. But almost immediately after implementation, regulators came under pressure from accounting executives and effectively stopped enforcing many key provisions. In a massive tax shelter fraud case in 2005 brought against KPMG, the Department of Justice chose to forgo a criminal prosecution against another top accounting firm, explicitly because of stated concerns that the industry couldn’t sustain another bankruptcy and might collapse. The remaining firms wouldn’t be able to absorb all the companies that require auditor opinions, KPMG insisted. The DOJ essentially enshrined that accounting was too big to fail.
After that case, accounting circumvented auditor independence with impunity. When the Obama administration began tepidly reinforcing the Sarbanes-Oxley guardrails, each of the four major firms repeatedly faced violations. In 2014, KPMG paid the highest charge at the time, $7 million, which amounted to a slap on the wrist.
In response, the firms sought to remove the remaining provisions of Sarbanes-Oxley standing in their way and undermine the authority of the PCAOB. Firms would prefer to return to the pre-Oxley era when the industry was effectively self-regulated.
The big accounting firms saw the Trump administration as a window of opportunity to roll back the measures. Of the Big Four accounting firms, Deloitte spearheaded the counterreform effort in 2017, doling out half a million dollars for lobbying on issues related to “modernizing independence rules,” along with other issues. KPMG came in a close second with $490,000 to track legislation pertaining to auditor independence. That year, in the wake of the “steal the exam” scandal, Donald Trump’s SEC chair Jay Clayton completely overhauled the PCAOB’s five board members, putting in a former Republican Senate staffer as chair and surrounding him with accounting firm lifers and inexperienced subordinates.
In 2018, KPMG spent nearly $2 million on a host of legislative issues related to accounting including “implementation of the Sarbanes-Oxley Act” and auditor liability.
That same year, the accounting firms proactively worked on another piece of legislation called the Financial CHOICE Act, a House Republican-backed bill to undermine large sections of the Dodd-Frank financial reform. Over the course of 2017 and 2018, large accountants led by KPMG were embedded in the legislative process, helping to draft provisions of the bill. The final legislation would have slashed key Dodd-Frank regulations while raising penalties for certain remaining restrictions. Republicans wrote adjustments to the regulations for the accounting industry into the bill, upping penalties for faulty audits but limiting the punishments that auditing firms could be charged for. It also included provisions that would have threatened the independence of the PCAOB, an overhaul long sought by the accounting lobby.
The bill eventually passed the House on a party-line vote. Though it never got taken up in the Senate, the framework would be a forerunner for the deregulation bill in 2018, S.2155, that many experts say led to the SVB collapse. Among other changes, the bill, supported by Donald Trump and all Republicans along with several key Democrats, raised the threshold for banks subject to the Dodd-Frank stress tests to those with more than $250 billion in assets.
In 2018, Ernst & Young, the accounting giant with the largest lobbying arm, worked on behalf of Citigroup, which had an interest in one piece of the legislation, to get it passed. Ernst & Young’s lobbying on the bill demonstrates the limits of auditor independence. Though Ernst & Young only collected a paycheck from Citigroup, the firm did auditing for other midsized banks that stood to gain from the passage of the bill.
KPMG that year paid two separate lobbying groups nearly $150,000 to advise and monitor the passage of the banking deregulation bill.
The accounting lobby also continued its efforts to roll back Sarbanes-Oxley and found a sympathetic ear with Clayton. In 2019, the SEC issued new rules on auditor independence that gutted parts of original Sarbanes-Oxley guidelines. For example, an accountant that helped consult a startup filing for an IPO couldn’t also then do an audit of that firm’s IPO. The new SEC rules relaxed those restrictions.
