KPMG Knowledge of PCAOB Inspections: A Good Business Decision orViolation of Ethics?

Editorial Note: We are delighted to publish this “opinion piece” by Dr. Steven Mintz, a frequent contributor to our social media blog. As always, when you read his contribution, we ask that you keep in mind that the opinions expressed therein are those of the author. They do not represent the position of the AAA or of any other party.

With this piece, we are launching our “Contributing Columnist” series at AAAPublicInterest.org. It is adapted from a 2018 article that appears in the CPA Journal.

We thank the New York State Society of CPAs, the publisher of The CPA Journal, for permission to publish this essay. Richard Kravitz, the Editor-In-Chief of the Journal, will join Dr. Mintz as session panelists during the AAA’s upcoming 2018 Ethics Symposium.

Recent revelations that KPMG had help in its quest to prepare for audits from the PCAOB
raises the question whether it was a good business decision to hire a former PCAOB staffer to help it determine the target of audit inspections by the PCAOB or an unethical act. I would say while it may have seemed to be a good business decision at the time, KPMG’s actions to gain access to possible PCAOB inspections was unethical because it violates the public trust. The key ethical issue is intent. The intent of KPMG was to “cheat the system” by gaining an unfair advantage. In this regard it reminds me of the Volkswagen defeat device case.

Why did KPMG do it? It is because their audit deficiency rate was the highest of all the Big Four firms. The average audit deficiency rate for the Big Four since the inception of the inspection process has ranged between 30-to-40 percent. The rate for Big-4 firms has gotten as low as 21 percent (Deloitte) and gone as high as 54 percent (KPMG). In the case of KPMG, it was determined that the firm too often failed to gather enough supporting evidence before signing off on a company's financial statements and internal controls.

Let’s look at the indictment against KPMG’s partners. After being hired by KPMG, Brian Sweet, the former PCAOB staffer, was asked by three KPMG partners, knowing his background with the PCAOB, whether there were any plans to inspect a client of theirs. Reluctant at first to respond, David Middendorf, KPMG's former national managing partner for audit quality and professional practice, is said to have later told Sweet to "remember where [his] paycheck came from" and "to be loyal to KPMG." Sweet was asked about the plans again a few days later, this time by Thomas Whittle, former national partner-in-charge of inspections, who implied that his position within the firm was not secure. Sweet showed Whittle the inspection list later that day. The audit partners used this information to analyze and review audit workpapers relevant to the inspection and suggested revisions to avoid possible findings of deficiencies by the PCAOB.

A CPA’s loyalty should be to the public, not the firm. Otherwise, the public cannot trust that CPAs and their firms will act in the public interest, not those of the client or the firm.

There is an issue to consider with respect to quality controls. Quality controls relate not only to audit engagements but ethics as well. One such example is independence. Firms have quality controls to ensure their staff are independent of clients. I also believe quality controls should extend to integrity issues. KPMG’s actions lack integrity because they were unprincipled and violate the public trust. I believe KPMG’s actions border on being an act discreditable to the profession. Just imagine if all firms acted this way. The audit inspections would be relatively useless because the ethical rule that the audits selected by the PCAOB should not be known in advance by the inspected firm would be compromised.

I’m also troubled by the contingent fee issue. KPMG hired Palantir, the data analytics firm, to help it predict which of its engagements would be inspected and agreed to pay it $250,000, contingent on a certain rate of success. While contingent fees are acceptable in non-audit engagements, with certain exceptions related to tax practice, it is not unreasonable to evaluate the arrangement from a broader lens. Again, it smacks of being an act discreditable to the profession. It has elements of insider trading, in my view.

Another ethical issue is fairness. If we consider that all the other firms, including the non-Big-Four, may not have access to former PCAOB-staffers, or may have a higher ethical standard than KPMG, those firms are not being given the same opportunity to know in advance which audits might be inspected by the PCAOB. Simply stated, they are not playing on a level playing field because KPMG had a competitive advantage, albeit one based on improper actions. The result could have been that other firms wound up with a higher deficiency rate than KPMG because of its advantage and the steps it took to capitalize on it.

At the end of the day, KPMG’s actions should lead to a state board of accountancy investigation whether the firm violated its ethical commitment to standards of professional behavior and protecting the public interest.

Dr. Steven Mintz is a Professor Emeritus at Cal Poly San Luis Obispo. You are welcome to visit him at StevenMintzEthics.com.

Lise Valentine, Deputy Inspector General

Editorial Note: Dr. Lise Valentine is the Deputy Inspector General for Audit and Program Review for the City of Chicago. As a follow-up to her plenary appearance at the 2018 AAA Public Interest Section Midyear Meeting in Chicago, we asked Lise to respond to four questions.

With our Annual Meeting less than four weeks away, we hope that the quality of Dr. Valentine’s responses will remind our Section members of the value of our intellectual content. You are welcome to join us at our Section Business Meeting, at the Ethics Symposium, and at our research presentation sessions during the Annual Meeting in order to enjoy more such content.

(1) How much control do you maintain over defining your own audit and investigatory priorities? Are they strictly defined by statute and regulation? Or do you enjoy some latitude in applying resources where you believe they would do the most good?

Our jurisdiction, which is established by the Chicago Municipal Code, extends to all employees and elected officers of City of Chicago government performing their official duties, as well as contractors providing goods or services to the City. Interestingly, although City Council voted in 2016 to place itself under our jurisdiction, it limited our oversight authority—we have the power to investigate allegations of wrongdoing by aldermen and their staffs, but we may not audit their activities.

With respect to City entities under our jurisdiction, we have complete control over our audit and investigatory priorities. Our investigative staff receives and triages tips from the public, and we often open cases on the Inspector General’s own initiative. Each year we publish an audit plan identifying potential projects selected using our prioritization criteria. We thus have great freedom, but also great responsibility to apply our resources where we believe they will best promote economy, effectiveness, efficiency, and transparency in City operations.

(2) To what extent has budget pressures changed the nature of your procedures? Do you ever feel pressure to “find money,” as taxation authorities in certain jurisdictions are sometimes asked to do?

As a watchdog for the taxpayers, we take very seriously our responsibility to be good stewards of public funds. We apply the same critical eye to our own spending that we do to other departments; the sort of pressure you describe is primarily self-imposed. While we’re not a revenue-generating function, our audits and investigations often identify savings opportunities or result in restitution of City funds.

Pursuant to the Municipal Code, our annual budget is no less than 0.14% of the total City budget. This funding floor largely insulates us from budget cuts. However, we don’t have complete freedom. Our line-item budget is subject to City Council approval, and we cannot fill vacant positions without approval from the Mayor’s budget office.

(3) What kind of student should consider a career in the public sector? How can professors identify such students, and how should we encourage them to consider exploring such opportunities?

Students who are more motivated by mission than by money are the best candidates for the public sector.  While a public sector career won’t make you rich, you will generally have a reliable middle-class income and you’ll be serving the greater good. We all need and use government services—from ambulances to expressways to economic policy—and we all pay taxes. So, proper accounting for these expenditures and revenues, and their accurate reporting, is in everyone’s interest.

All levels of government need accounting and finance experts who will safeguard our shared public assets and promote economy and efficiency in governmental operations. Of course, no job is perfect; everyone has some bad days at work. But in a public sector career you can get through those days by remembering the positive contribution you are making to society.

Governments don’t spend money on advertising and recruiting the way accounting firms do. Professors play the critical role of helping to bring these public service career options to their students’ attention, since they may not even know the jobs exist. Professors can invite public sector accounting professionals to speak to their classes. They can reach out to professional organizations like the Government Finance Officers Association, the National Association of State Auditors, Comptrollers, and Treasurers, or the Association of Local Government Auditors to solicit speakers and collect information on internships or jobs.

For example, the U.S. Government Accountability Office and the Government Accounting Standards Board have excellent intern and fellowship programs. Students should also consider following @ChicagoOIG on Twitter or connecting with the Office of Inspector General on LinkedIn, where our office regularly posts job vacancies. We also publish reports and promote our work, which helps students better understand what we do and discover that they may want to be a part of it. Our office regularly recruits interns, for both legal and IT roles, so be sure to visit our website for those details.

(4) Why did you leave the academic world for your current position? Was it more of a personal decision, or a professional one? And do you ever miss the opportunity to teach and to engage in research?

It was more of a professional decision. During my five-year Ph.D. program I had the good fortune to publish a single-authored article in a major journal, to design and teach 10 stand-alone courses, and to serve on several committees. I appreciated having these experiences while still a student because they made me realize I didn’t want an academic career. To be frank, I burned out on undergraduate teaching and I wasn’t motivated by the publishing race.

But my love for learning, teaching, and service persisted. Happily, my current role provides me with ample opportunities to teach and train others, to research ways to improve government, and to serve on committees working to advance OIG and the profession. What I miss most about academia is roving the real and virtual library stacks, marveling at all there is to know.

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Dr. Lise Valentine is Deputy Inspector General for Audit and Program Review for the City of Chicago. To support the Inspector General's mission, her office conducts independent evaluations of municipal programs and operations, and makes recommendations to strengthen and improve public services. She has taught Public Finance for the Master’s in Public Administration Program at the University of Illinois at Chicago, and is an instructor for the Inspector General Institute®.

Prior to joining OIG, Valentine served as Vice President and Director of Research at the Civic Federation, a non-partisan governmental research organization, where she led research on government efficiency, transparency, and tax policy. She was elected to the post of Commissioner and Treasurer of the Park District of Oak Park, IL and served on advisory task forces for the Governmental Accounting Standards Board.

Dr. Valentine is a Certified Public Accountant, a Certified Internal Auditor, and a Certified Inspector General Auditor®.