How the auditors keep dodging the fraud bullet

Of the roughly 1,000 people attending the virtual release of the latest Open Secrets report titled The Auditors, a good number were likely from the accounting profession. They must have been squirming in their seats as their crimes were read out in excruciating detail.

For example, in 2005 KPMG was fined $456 million (R10 billion) for defrauding the US tax authorities by designing, marketing and implementing illegal tax shelters to help wealthy individuals and corporations escape tax liabilities.

For this, KPMG received a deferred prosecution and paid a fine much smaller than the profits it made from the schemes.

KPMG wasn’t alone. The Big Four were all in on one of the biggest profit spinners of the last 20 years – ‘tax shelter’ structuring. In 2013 Ernst and Young (EY) paid $123 million (R2.1 billion) after admitting to US regulators that it had helped clients dodge taxes worth $2 billion (R34 billion). The other two members of the Big Four cartel – PwC and Deloitte – were likewise involved in schemes to escape tax.

Not all of these were illegal, but they were pervasive enough to characterise the Big Fours’ institutional behaviour as “skirting the rules and placing profit above principle for the sake of consulting clients,” says the Open Secrets report.

All this is lent a patina of respectability through the use of terms such as ‘tax neutrality’ and ‘tax minimalisation’ – euphemisms for paying no tax at all.

Nor are these tax avoidance schemes without human cost. They deprive the state of tax revenue for spending on social development, healthcare, education and pensions.

Also read: Former KPMG auditor Jacques Wessels struck off the register for shoddy Gupta audits

Closer to home, the auditors’ rap sheet is long and sad

Here’s a sampling:

• KPMG auditor Sipho Malaba failed to raise any red flags in VBS Bank statements and provided a falsified regulatory audit opinion.
• Deloitte failed to report suspicious activities and fraud at both Steinhoff and Tongaat Hulett. The Steinhoff fraud resulted in an overnight loss of R120 billion, to the detriment of 948 pension funds. The Government Employees Pension Fund (GEPF) alone lost over R21 billion.
• PwC failed to identify major misstatements while the external auditors at SAA. PwC and its partner, Nkonki, earned R19 million for their work at SAA, but were only fined R200 000 for failing to disclose SAA’s noncompliance with legislation.
• Deloitte’s audit of African Bank failed spectacularly in 2014. Deloitte missed red flags in the overstated future cash flow predictions for the bank and ignored the red flags raised in its own internal reports.
• Deloitte earned R207 million in fees for an Eskom tender based on an irregular contract. In March 2020, Deloitte agreed to pay back R150 million, which allowed them to keep over R57 million earned between April 2016 and September 2017.

There’s no shortage of fodder for a report into the audit profession’s malfeasance in SA, most of it well reported, but when compiled into a single document it reads like a well-crafted crime novel.

Says the Open Secrets report: “In early 2019, former VBS chairperson Tshifhiwa Matodzi was allegedly trying to hide his Ferrari from liquidators and to stop them selling his R7 million mansion. They had already secured and were planning to sell at least four other luxury vehicles Matodzi owned. It is little surprise he was sitting on so many luxury assets: Motau’s report alleges that Matodzi was the number one beneficiary from the looting of VBS – taking R325 million.”

The VBS heist was not particularly sophisticated. Its financial statements in 2018 were signed off by KPMG, already under a monsoon of devastating evidence related to its involvement with the Guptas. For that you need to look at Steinhoff and its dazzling bouquet of complex financial instruments designed to hide the relative absence of actual value inside the company.

Lack of independence

One of the Open Secrets authors, Michael Marchant, said at the launch of the report on Thursday that audit firms are faced with a clear conflict of interest when allowed to conduct both audits and consulting for the same client.

Outgoing CEO of the Independent Regulatory Boards for Auditors (Irba), Bernard Agulhas, said auditors had stopped being skeptical and asking the right questions of clients.

“We’re very strong on this. Internal audit committee members are also telling us that they have been hoodwinked by management. Those charged with governance should be equally skeptical.

“Most auditors are too close to their clients to ask the right questions,” says Agulhas.

“Lack of independence is a major reason for the failures where they happen. It results not from lack of technical competence but that they are not behaviourally competent.”

Internal auditors suffer from the same level of confliction as external auditors. The report recommends that they be sufficiently independent of the entity where they work, and that their central task is to evaluate and improve “the effectiveness of risk management, control, and governance processes”.

Slap on the wrist

The continued role of the Big Four in enabling corruption and other economic crimes is unsurprising given the tender treatment they receive from regulators – and, as things stand, a maximum fine of R200 000.

New legislation being considered by parliament should allow for fines with no upper limit, but the accounting profession is fighting this tooth and nail.

And therein lies another massive conflict of interest – audit and accounting regulations are heavily influenced by auditors and accountants.

It is a fraternity looking after its own interests. With just four major firms to pick from, you will eventually cycle back to the old clients in this decade or the next. Irba has introduced Mandatory Audit Firm Rotation to force companies to change auditors every 10 years, and expects this will force auditors to adopt a more skeptical and independent approach to clients.

What to do

Open Secrets recommends several steps to reform the profession:

• Separate audit from consulting services to prevent conflicts of interest;
• Force the Big Four to higher levels of transparency as to the source of their revenue and relationships, with greater powers for Irba to conduct search and seizure raids (already before parliament);
• Provide the Auditor-General with greater powers, and make audit firms answerable to the AG for the quality of their work;
• Resist the cocked and loaded pushback from the Big Four as they vigorously defend their turf and cartel privileges; and
• Don’t allow the foxes (the audit firms) to guard the henhouse. In other words, don’t let them capture the reform process.

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