• KPMG In The News – Not The Good Kind

    By • Nov 28th, 2008 • Category: Pure Content

    The Friday after Thanksgiving should be a quiet news day.  But not in this crisis environment.  In addition to heartbreaking news from Mumbai, two more stories about KPMG were caught in my newsnet in the last twenty-four hours.

    The first story is the latest in a long series of stories I’ve written about Siemens.  The recent news has Siemens deciding to finally replace KPMG as their auditor with… Drum beat please.
    I guess by process of elimination, they’re the only ones left. Deloitte and PwC (and here and here) are fairly well conflicted out. But I wouldn’t wish this ongoing mess on anyone.  Given EY’s loss of Lehman and ongoing litigation expected, I suppose Siemens is the booby prize.
    And in news from Canada, it looks like KPMG started to grow a pair but may be vulnerable to “influence” regarding their “non-solvency” “preliminary” opinion that put the kibosh on the takeover by the Ontario Teacher’s Pension Plan of telecom company BCE, Inc. According to The Globe and Mail, it would have been “the world’s largest leveraged buyout.”
    Will they or won’t they “rollover?”
    The kicker is that the KPMG Managing Partner who authored the now famous solvency valuation that has all but sunk BCE’s planned $35-billion sale is a woman. Susan Glass is being challenged on her opinion by BCE heavyweights Thomas O’Neill, chairman of the audit committee and former chairman of PricewaterhouseCoopers, and Siim Vanaselja, the telecom company’s chief financial officer and a former KMPG tax partner. I applaud Susan Glass for following the numbers and making a by the book call, if it’s proved that was the pure motivation.
    So will another Big 4 firm dare take the very risky position of reversing KPMG’s opinion?  And how much does a “solvency” opinion cost?  Is BCE solvent enough to pay the bill and defend against the likely litigation when they eventually fail, if the numbers are to be believed?  Who will have the last laugh and is any of this funny?
    (Various comments and message boards accuse BCE of trying to evade Canadian taxes and also of a conspiracy for KPMG opinion to somehow benefit Royal Bank of Scotland and Citibank, other KPMG audit clients.  Judge for yourself.)
    “…The KPMG team spent four months running the numbers on what BCE would look like after being taken over by the Ontario Teachers’ Pension Plan, and concluded the company didn’t pass solvency tests after it shouldered $32-billion of new debt. Sources close to KPMG said the BCE decision, while weighty, was a by-the-book call for Ms. Glass, a former accounting professor at McMaster University who joined the firm in 1989 and quickly rose up the ranks, in part owing to her skill in assessing the value of takeover targets.



    And in an earlier article in the Globe and Mail:

    “I think this is one of the most controversial calls in auditing history in Canada,” said Anthony Scilipoti, executive vice-president of Veritas Investment Research Corp., an independent research firm with expertise in accounting issues.

    Early morning news of KPMG’s decision sent BCE’s stock into a deep swoon, wiping out $10.6-billion in market value as the company’s stock fell 34 per cent to close at $25.25 after more than 47 million shares were traded.

    While investors were caught off guard by the auditor’s decision, it appears that BCE’s executives knew FOR WEEKS that KPMG had concerns about BCE’s solvency.

    Sources said KPMG’s auditors had been meeting with BCE and Teachers for weeks to gather data to test the company’s solvency, or ability to pay all of its debts as they came due…

    From Reuters:

    Ironically, BCE’s board inserted the solvency requirement into the definitive agreement, one source familiar with the situation said. BCE, however, said both sides agreed the clause should be written into the agreement.

    Once it becomes part of the merger agreement, a court would likely view it as strongly as any other requirement in the deal — such as regulatory or shareholder approval — which would make it difficult for BCE to argue that the provision was subject to interpretation …

    “There’s been no angst or rancour in the relationship [with KPMG]; it’s all been very professional,” said one source close to BCE who declined to be identified…”

    Now, that solvency opinion could be the undoing of the largest leveraged buyout in history.

    Since KPMG’s view still remains preliminary, BCE could try to satisfy the requirements before the Dec. 11 closing date, launch a challenge against KPMG, or convince the buyers to proceed with the deal regardless. All of those options are fraught with problems, lawyers said.

    “Even in the face of litigation, KPMG will just say ‘I’m the neutral messenger,'” Columbia University Law School Professor John Coffee.

    BCE could try to find another accounting firm to give an independent solvency agreement or launch a legal challenge that KPMG’s opinion was flawed, legal experts said.

    “BCE will likely bring in another consulting accounting firm to evaluate KPMG’s assumptions and show they made XYZ errors or incorrect assumptions,” said Donald Zakarin, head of litigation at Pryor Cashman.

    “There will likely be challenges to the assumptions that KPMG used and potentially challenges to KPMG to re-evaluate its assumptions,” Zakarin said. “Accounting isn’t cut and dry. There’s more than mathematical rigor involved.”

    The condition to have a solvency opinion by a third party is rare in large deals, said Joel Greenberg, a partner at law firm Kaye Scholer, who specializes in mergers and acquisitions.

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    24 Responses »

    1. Good move KPMG and Susan Glass. That might just be the first step in restoring faith in the accounting profession. Not sure why Francine thought that this was not good news for KPMG – i think it casts them in a positive light. It shows auditors/advisers performing their work professionally and taking a stand.

    2. @1:31
      I agree. It’s a very good sign and I applaud Ms. Glass. My fear however, is that they will change the opinion under pressure, since it is preliminary, and then it will look even worse for KPMG than if they had approved deal.

    3. I agree – good for KPMG holding steady on this. I’ll be joining the firm next fall. Does anyone in the profession know whether KPMG has a stricter reputation than the other firms? In one of my classes we discussed how they held steady on their opinion on Callaway Golf Co. over a warranty reserve dispute and ended up losing the engagement to Deloitte. I’d be even prouder to join a firm that doesn’t give into management over disputes just to keep their audit fees.

    4. Good for Susan Glass! Surely, she and the KPMG team did not undertake this decision lightly. Finally, someone gets the balls (a woman) to do the right thing. Perhaps the other Big 4 could learn a lesson here. Unfortunately, auditing has turned into selling an opinion to fund the multimillion dollar homes of the partners.

    5. I wrote about this and took the Globe to town for calling this “preliminary”.

      Whatever. I’ve seen other firms coming on to do an audit after replacing the first auditor. If they’re going to disagree, they’ll have a damned good reason, whether it’s a high profile case or not. Though in this case you’ll probably be extra-sensitive to disagreeing with what no doubt was a very careful decision!

    6. Francine:
      I caught this story in the NY Times and Wall Street Journal and will comment on it. Good show for KPMG! It looks like KPMG made the right call. It’s the least KPMG can do after botching the Citigroup audit for years.

    7. If only the other audit firms will follow KPMG’s lead. Some of the Deloitte audits in which I have participated have been a joke. It was all about the gathering the papers (documentation) to put and reference in the files, rather than asking the right questions. Partners even told me that there was not enough time in the budget to drill down deeper. It was clear that it was about making budget and money.

    8. Speaking of Mumbai, I wonder how it impacts the U.S. companies who have outsourced their jobs to India (although to destinations far from Mumbai). It appears that the terrorists are targeting Westerners and if I were an expat in India, I would be extremely nervous. Perhaps the cost of doing business in India is not as low as the U.S. companies estimated. In this unstable world, it is hard to know (or anticipate) what will happen next.

    9. Thanks for the defense Francine (saw your post on Twitter re: “poor baby”). I agree reputation and the ability to stand up to clients is all relative. It seems to me that so much is dependent on the individual partner running the engagement. Perhaps Susan Glass is the one to praise here instead of KPMG as a firm. They have not been without their share of recent problems (Cast Art, New Century, tax shelters, etc.) I only hope when I join the profession I’m able to be one of those “good guys”.

    10. Susan Glass, if you happen to come across this site, you’ll see that many of us admire you for doing what you believe to be the right thing. It must be extremely difficult and stressful to have these big bad boys come after you, likely, relentlessly. You know what the right thing to do is, and you should follow your integrity. There’s little money in doing the right thing. However, you can help reassure the skeptical young minds that there are people willing to do the right thing.

    11. To Anonymous who is thinking of joining KPMG. Here is a bit of history (from Wikipedia, and personally verified by me):

      # In 2003, KPMG agreed to pay $125 million to settle a lawsuit stemming from the firm's audits of the drug chain Rite Aid.[8]

      # In 2004, KPMG agreed to pay $115 million to settle lawsuits stemming from the collapse of software company Lernout & Hauspie Speech Products NV.[11]

      # In 2005, the U.S. member firm admitted criminal wrongdoing in a multi-billion dollar tax shelter fraud.[12]

      # In 2006, Fannie Mae sued KPMG for malpractice for approving years of erroneous financial statements.[13]

      # In February 2007, KPMG Germany investigated for ignoring questionable payments in Siemens bribery case.[14]

      # In March 2008, KPMG accused of enabling “improper and imprudent practices” at New Century Financial, a failed mortgage company.[15]

      # In March 2008, KPMG agreed to pay $80 million to settle suits from Xerox shareholders over manipulated earnings reports.[16]

      Mark Dionne (former employee of Lernout and Hauspie who has no love for KPMG)

    12. To any Anonymous thinking of believing Mr. Dionne:

      Well surely Mark you don't have an axe to grind and are not bias in anyway…therefore your information (nice job picking it up from Wikpedia) has that much more veracity.

      Here's a thought – why not come up with an original thought on the firms (all 4 of them) as Francine does and get back to us instead of regurgitating a list from Wikipedia. It's not helpful to anyone considering seeking a job since we are all capable of going to Wikipedia. Nor does it further the discussion on this blog in any way shape or form.

      Care to share some specifics on your interaction with KPMG and why you are no longer an employee of L&H? That should take more effort but be more valuable than some laundry list from wikipedia.

    13. Despite Mark’s list, it is nonetheless comforting to see one of the public accounting firms (KPMG in this case) take a step in a much needed right direction. Firms are made up of people, and it takes good people to do the right thing. Good people who look the other way undermines the firms.

    14. I read this post last night and wanted to comment. I was in a bad mood then and decided to sleep on it. I apparently woke up on the wrong side of the bed. I apologize in advance for this post.

      First, to everyone:

      We’re suddenly rushing to Susan’s side without all the facts. What if she did botch this up? I like that she’s sticking to her guns right now. However, I want more information before I can judge this either way. Let’s just wait for the facts to shake out.

      To Francine:

      You’re afraid that KPMG after doing the “right thing” will then do the wrong thing? That is suddenly bad news? A bit premature, no?

      To Anon @ 4:59:

      Oh, to be young again.

      To Anon @ 7:02 and Mark Dionne:

      I may respond ad nauseam here only because I hear this criticism all too often. While “there’s not enough room in the budget” is not a valid excuse for overlooking something in an audit, balancing the cost of information with the value of information is a valid reason not to dig deeper.

      I will type this in bold and uppercase to get my point across, AUDIT FAILURE IS NORMAL. Reducing audit risk to zero does not help shareholders, employees, or the public at-large. There is a reason why auditors use the term “reasonable assurance”. Again, auditors try to balance the cost of information to the value of the information. Pointing out audit failures doesn’t mean an auditor isn’t doing his or her job per se. If you want more information on this, please find an introductory text on auditing.

      Regards.

    15. @Chicago Accountant

      Very measured of you, sir…

      I agree. All the facts are not obvious but the details of the methodology and data used is available. We’ll see if “questioning assumptions” means anyone can find sufficient error in the conclusions.

      My inclusion of the BCE story as “bad news” for KPMG is for two reasons:
      1) The auditor is being blamed for blowing the “good” deal. Too much publicity and the perception that publicity and pressure can change principles. Also there are accusations that KPMG opinion was not for pure principled reasons. This is bad publicity that KPMG and Ms. Glass have to defend themselves out of. It’s especially disappointing if it proves true she did the right thing and they were the right conclusions. Firms can’t win these days doing wrong thing for sure and can’t win doing right thing either, a la FAS 157.

      2) Given the pressure, publicity, and perception that the decision can be changed or overruled by another firm, it’s more bad news and more bad publicity in the future for KPMG and Ms. Glass if either of these scenarios occur. I’m thinking there’s a good chance of either.

      You have raised this issue of acceptable “audit failure’ before and now it’s suddenly piqued my interest. How much faiulure is acceptable given the franchise the firms have, government sanctioned services required as an inextricable part of being a public company? What are the historical percentages of “audit failure?” Is a percentage of “failures” on one client acceptable or X number of total failures as an percentage of total audits performed by all firms in a year? Or is it a percentage of failures by each firm? I’m going to go back and look at the textbooks and also look for some historical data, statistics of what has occured in the past and more recently. Interesting subject. Some would argue that Arthur Andersen was taken out because their percentage of “audit failures” and reputedly stubborn, arrogant attitude of non-acknowledgement of anything needing changing had become suddenly unacceptable to the Justice Department with Enron. Thanks for the idea.

    16. It is this very notion of “acceptable audit failure” that gives the abusers the ammunition to “look the other way” when an issue can negatively impact their budget. Collect the big fees, but don’t deliver.

      The whole structure of an audit is a recipe for failure. Who ends up doing the heavy lefting in an audit? Why, the staff and seniors who simply tick and tie. Same as last year. No rhyme, reason, or basic understanding of the issues.

      When an auditor knows something does not seem right, but choose to look the other way (i.e., pick another sample)… Isn’t this following audit procedures? How does it protect the shareholders? It does not. It does protect the hefty audit fees and the profit margin.

    17. To Anon 8:30:

      Like I said before, not having enough room in the budget is never a reason by itself to not dig deeper. Also, picking a new sample because something was wrong in the other sample is a cardinal sin. If I witnessed that on one of my jobs, there would be hell to pay. Odds are the person would lose his or her job.

      To Francine:

      I can’t say that I know what an acceptable failure rate is. It is also unknown how many failures occur. We now of some, but how many do we not know of? How many public companies have materially misstated financials that we aren’t even aware of?

      There is a lot of research on this subject. I’m not an auditing PhD. The experts are just two and a half hours south of us at the University of Illinois. My own approach to evaluate firms would be to take the number of known failures over the past decade over total revenue. You would get a known failures per dollar metric. That would be a start. However, that doesn’t speak to the magnitude of the failure. It’s a complicated subject and I would be happy to discuss further.

    18. Francine:
      I’ve been a CPA since 1975. I’ve audited firms up to in 2008$ $15 billion in assets and $5 billion in sales. I’ve seen hundreds of sets of workpapers. Having followed the various Big 87654 firms on audits, I can say there are very few audit failures which are exposed. I’d guess 15% of audits are strictly tick and tie operations of no substance. My off the cuff estimate, based on public company restatements is that only about 10% of failed audits are revealed. It’s that bad out there. It’s much worse in some industries. The worst audits are done in financial services, the best in manufacturing. My estimate of audit failures in financial services: over 50%. By the way, put no hope in the PCAOB improving things. It’s another SEC coverup operation from my perspective.

    19. @Chicago Acc’s earlier post re ‘jumping to conclusions w/o facts': DBRS, media reports say today, also did the math in October, reached the same conclusion. That backs up Susan’s conclusion.

      DBRS ran the number on this kind of doomsday forecast in October, and said the value of the assets didn’t meet the debt. DBRS managing director Paul Holman wrote: “This base case default scenario results in a decline in enterprise value of BCE … to roughly $34.4-billion or 33 per cent lower than the $52-billion enterprise value when the privatization was announced on June 30, 2007.”

      In an interview, Mr. Holman said: “In a default scenario, we show total assets would be less than total liabilities and senior lenders would be covered but the unsecured and subordinate lenders would not be covered.

    20. @IA

      Being a new-hire for the past 3 months at Big4 I can already backup the tick and tie claim. We are told to follow the guidelines with a critical mind and not simply go through the motions. The only problem is – critical thinking involves time I don’t have in order to audit to the degree I feel comfortable with.

      The problem with the budgeting process is the bias is almost always to cut hours. In many cases this means cut and past PY and critical investigating be damned.

    21. Thanks, Krupo. I don’t know Susan personally, but would believe that someone at her level would not be stupid enough to express such an unpopular conclusion w/o really doing her homework. There are easier ways to get fired than issue an adverse valuation opinion.

      Chicago Accountant, when the team is full of fraudulent people and you, there is not much you can do. They’ll simply exclude you from the audit and any information and continue on their merry way. My advice is to excuse yourself from the audit, but in a nice way so that you don’t get blackballed. You can only tell someone so many times that something is black and have them look at you with a straight face and claim its white, when you both know it is black.

    22. Having been at a big 4 firm for the past 4 years, I’ve been lucky enough to work with some pretty amazing people who really do exhibit the ideals that are preached everywhere…professional skepticism, commitment to quality, getting it right over just getting it done. Granted I haven’t had the same amount of experience in this industry as the more seasoned professionals who have contributed their thoughts, but from my own limited experience I have to disagree with the claim that our audits are essentially designed to fail. Every year we spend countless hours devising strategy and the most efficient but also effective ways to do our jobs. I can honestly say that I come to work every day and have the sense that I am doing my part to help protect the public and that the efforts of my firm are not in vain, nor are they all for show. Maybe I’ve been extremely lucky to have worked with very ethical people…maybe I just haven’t been exposed to the true inner workings of my firm…I guess only time will tell. For the time being though, I hope that the efforts of Ms. Glass prove to be motivated purely by her efforts play by the book and hopefully public accounting can start to gain some good publicity for the work that we do.

    23. […] This post was mentioned on Twitter by Francine McKenna, Thomas Fox. Thomas Fox said: For Re:theauditors perspective on Siemens, see most article @ http://ht.ly/3pxpN […]

    24. […] KPMG was relieved of their duties as auditor in 2008, as a result of preliminary accusations of possible negligence in preventing or mitigating the scandal. The attorney who conducted the internal investigation on behalf of Siemens, Bruce Yannett of Debevoise, had this to say regarding the results of their investigation of KPMG and any ongoing matters between KPMG and Siemens: “We looked at KPMG’s role over the years in question and reported our findings to the Supervisory Board.  Those findings are not public.  Siemens’ public statement at this time is that certain investigations are ongoing and Siemens will not comment.” […]

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