KPMG Knowledge of PCAOB Inspections: A Good Business Decision or Violation 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.

***

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®.

Introducing Our Contributing Columnists

In the early days of the global economic meltdown of 2008 and 2009, Peter J. Wallison, the Arthur F. Burns Fellow in Financial Policy Studies at the American Enterprise Institute, declared:

Fair value accounting is clearly the reigning orthodoxy among accountants, but is that the right test? Accounting is simply a measurement system. What we want to know determines what and how we measure.

Which is more important, the balance sheet or the income statement? Do we want to measure financial strength or earnings per share or cash flows? Is the purpose to inform equity investors or creditors and counter parties? Does one measurement system meet all of these objectives?

Given its impact on institutions and whole economies, common sense suggests that we consider whether one means of measurement is the only one we should be looking at. The world view of accountants at a particular time should not determine the answers to these questions. It is important to recall the famous remark of Clemenceau that war is too important to be left to the generals.

Many such issues impact the public interest. We, the Public Interest Section of the American Accounting Association, believe in addressing such topics with vigorous and spirited discussion in a social media forum.

Accordingly, we are proud to announce the introduction of a new feature for our social media network. Five distinguished thought leaders have agreed to serve as Contributing Columnists for the Section’s blog, newsletter series, and web site.

The five Columnists are:

Steven Mintz, Emeritus Professor, California Polytechnic San Luis Obispo, USA; Prem Sikka, Emeritus Professor, University of Essex, UK.

Michael Kraten, Associate Professor, Providence College; Richard (Rick) Kravitz, Editor-In-Chief, CPA Journal; Sri Ramamoorti, Associate Professor, University of Dayton.

Each of these individuals has agreed to contribute two editorial essays per year for publication by the Public Interest Section. Our current plans include the distribution of two guest editorials per year from other colleagues, resulting in a full year of monthly thought pieces.

We are immensely grateful to these individuals for supporting our growing presence in social media. Please join us in welcoming their contributions to our intellectual content.

Source Credits: We thank Sri Ramamoorti for suggesting the quote by Peter J. Wallison. It appeared in the April 30, 2008 edition of the Financial Times, in an article entitled “Judgment too important to be left to the accountants.”

Unintended Consequences of Supreme Court Whistleblowing Decision

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.

The U.S. Supreme Court may have turned whistleblowing on its head with the decision on February 21, 2018 in the case Digital Realty Trust, Inc. v. Somers. The ruling is likely to encourage employees, managers, and compliance officials to blow the whistle on retaliation as soon as it begins, and not after a sometimes-lengthy process plays out to convince superiors to change the accounting and financial reporting. Essentially, employees who choose to inform the SEC of financial wrongdoing under the Dodd-Frank Financial Reform Act must now inform the SEC while the issue with the employer is unfolding to be eligible for Dodd-Frank protections.

The key issue in the Digital Realty case is the interpretation of who is a whistleblower under Dodd-Frank, and when does a would-be whistleblower qualify for protection against retaliation. The statute defines a whistleblower as a person who reports potential violations of the securities laws to the SEC.

The SEC had been interpreting the Act with respect to the retaliation provision broadly, thereby allowing the protections to apply to internal company reporting even if the individual did not report to the SEC. The Supreme Court disagreed with that interpretation. Writing for the Court in its 9-0 unanimous decision, Justice Ruth Bader Ginsburg put it this way: “A whistleblower is any person who provides … information relating to a violation of the securities laws to the Commission” [emphasis added]. “That definition,” she added, “describes who is eligible for anti-retaliation protection if the individual engages in any of the protected conduct enumerated in the [Act]. Moreover, she observed, “this interpretation is consistent with the ‘core objective’ of Dodd-Frank’s robust whistleblower program,” … [which] is ‘to motivate people who know of securities law violations to tell the SEC.’”

Ginsburg also made an interesting observation about the Sarbanes-Oxley Act. She said: “By comparison, SOX had a broader mission to “disturb the ‘corporate code of silence’ that ‘discourage[d] employees from reporting fraudulent behavior not only to the proper authorities, such as the FBI and the SEC, but even internally.’”

One thing that Ginsburg failed to address is that SOX retaliation claims must be filed within 180 days of discovering the act, not much time to get the information straight. Dodd-Frank, on the other hand, has a three-year period to file. The reality is that very few SOX filings have been successful, in part due to the fact that filings go to the Department of Labor whereas Dodd-Frank filings go the SEC. We may not be a fan of the SEC’s regulatory speed and efficiency. but it’s light years ahead of the DOL.

Prior to the ruling in the Digital Realty case, employees would almost automatically first report the alleged violation internally and take the matter up the chain of command all the way to the board of directors before going to the SEC. Informing the SEC was seen as a last resort. A typical scenario is: an employee jumps through the hoops internally, fails to induce change, may be demoted, treated badly, or fired, and then files for whistleblower protections under Dodd-Frank. If successful under the SEC process, the whistleblower could be reinstated and receive back pay. There is even an award if the SEC brings a lawsuit based on original information voluntarily provided to the SEC that leads to sanctions in excess of $1 million. The award is between 10%-30% of the total sanctions. This provision does not seem to be disturbed by the ruling since the SEC, presumably, would have first been informed of the retaliation.

Here’s the problem in a nutshell. Let’s assume an employee reports wrongdoing. Will that employee go to the SEC first before informing his or her supervisor? If I were the CEO and found out one of my managers went straight to the SEC without giving me a chance to first fix the matter, well you fill in the blanks. Just imagine an employee goes to the SEC to qualify for whistleblower protections, the organization finds out because the SEC starts investigating, the employee is then fired. What should the employee do next? Go back to the SEC and say, “Now look what you’ve done.”

The Supreme Court ruling is counter-productive to the intent of Dodd-Frank, which is to protect whistleblowers, but also to encourage internal reporting. In fact, the SEC has openly promoted internal reporting, especially for compliance officials. The bottom line is that the ruling will have unintended consequences, whether it is to heighten the pressures internally on an employee who wants to do the right thing and must now first report to the SEC, or to create a floodgate of reports that the SEC won’t be able to handle because its resources are limited. Either way, the ruling is a loss for whistleblowers and, most likely, companies because more employees will run to the SEC.

Dr. Steven Mintz is a Professor Emeritus at Cal Poly San Luis Obispo. His website is stevenmintzethics.com.

How Should We Teach Sustainability?

It’s difficult to teach a topic like sustainability, isn’t it? On the one hand, it’s one of the most important public policy challenges of our era, a topic that has inspired the development of the Sustainability Accounting Standards Board (SASB) and other organizations. But on the other hand, it’s difficult to fit its content within one of the silos that define our accounting courses.

That’s why the AAA Public Interest Section has dedicated the Teaching segment of our web site to pedagogical materials regarding sustainability and CSR. At the moment, the segment features URL links to content that has been shared by Professors Irene Herremans of the University of Calgary and Michael Kraten of Providence College.

Irene has shared a five module online learning activity entitled Sustainability Reports: Making Sense of Sustainability. It features text, graphics, video, and other content at an introductory level.

And Michael has shared his interdisciplinary graduate-level teaching case Save The Blue Frog. Developed with PwC Partner John Formica, it is an integrated accounting case involving valuation, sustainability, controls and risk, and ethics.

Do you have an effective teaching resource that addresses the topic of sustainability? Do you believe that it can be used by our colleagues in their own accounting courses?

If you do, please consider sharing it with your AAA Public Interest Section colleagues. Simply use our Contact Us blog page to let us know what you have in mind; we’ll be delighted to share it with others!

Note: The blue frog image is available in the public domain.

Critical Auditing Studies and “The Bigger Picture”

For many years, accounting researchers have studied the culture, the technology, and the regulation of audit firms. We’ve observed and explained the complex factors that have shaped the profession.

But while studying these details, is it possible that we have missed the bigger picture? Should we be critically appraising the audit function instead of simply understanding it? In order to assess its future relevance to our society, and to its role within it?

The Elsevier journal Critical Perspectives on Accounting is addressing these questions by publishing a special issue entitled “Critical Auditing Studies: Adopting a Critical Lens toward Contemporary Audit Discourse, Practice and Regulation.” The editors are Anna Samsonova-Taddei of the Alliance Manchester Business School of the University of Manchester and Yves Gendron of the Faculté des sciences de l’administration of Université Laval.

The editors are calling for manuscript submissions that focus a critical lens on our profession, addressing such topics as: (1) the consequences of the rise of audit firms’ commercialism, (2) the ongoing changes in regulatory approaches to auditing, (3) claims about auditors’ knowledge base, (4) auditing and the public interest, (5) the shifting identities of auditors, and (6) control and surveillance within accounting firms.

What type of content is suitable for the special issue? Anna cites a recent report and notes that:

The strong impression is that now is not a time for complacency but nor is it a time for knee-jerk reaction or base political point scoring. Substantive change and developments in the competencies and capabilities of audit and auditors requires more fundamental action than are offered by ‘quick fix’ solutions, audit rebranding exercises, tinkering with professional examination syllabi or the promotion of ‘new’ audit testing/analytical techniques.

In light of such concerns, there is a call for:

 … a fundamental contemplation of the overall competence of the audit function itself and what is required for the longer-term sustainability of audit as a service of high professional standing and broader public worth.

Skills, Competencies, and the Sustainability of the Modern Audit, by Turley, Humphrey, Samsonova-Taddei, Siddiqui, Woods, Basioudis, and Richard (2016)

And according to Yves:

Critical accounting research is a complex endeavor and it may be articulated in a range of relevant ways. That being said, one of the distinguishing features of critical accounting research is a high level of reflexivity in analyzing, from a “phronetic” viewpoint, socially-important phenomena – such as the trajectories (past, present and future) that surround the financial auditing concept … this phronetic exercise implies the following questions: “Where are we going? Is this desirable? What should be done?” – which we may translate as “Where is financial auditing going? Is this desirable? What should be done?”

On the Elusive Nature of Critical (Accounting) Research, Gendron (2018)

These are the critical issues that challenge the future of the auditing profession. We are gratified that our colleagues at Critical Perspectives on Accounting are dedicating a special issue to the topic, and we encourage you to contact them with any questions about potential submissions.

Mark Your Calendars! Our Mid-Year Conference Begins On March 23rd

Have you begun to mark your calendars for the next two months? Then please keep in mind that a pair of noteworthy events will occur in late March. One is the arrival of Spring in the northern hemisphere. And the other is the mid-year conference of the Public Interest Section of the American Accounting Association.

What if you are feeling impatient for Spring? To accelerate its arrival, you can always root for Punxsutawney Phil to fail to see his shadow. If this occurs, Spring will begin on February 2nd, just two days from today.

Regrettably, our favorite groundhog is powerless to advance the date of our mid-year conference. However, there are other ways to begin enjoying this academic experience before you join us in Chicago on March 23rd. You can volunteer, for instance, to serve as a reviewer, a moderator, or a discussant.

And you can register to attend the conference at any time.

You’ll undoubtedly find it worthwhile to join us in the Windy City. For instance, in addition to our manuscript presentation sessions, our conference will feature an Editor’s Panel. Richard Kravitz of The CPA Journal, Pamela Roush of Accounting and the Public Interest, and Marcia Annisette of Critical Perspectives on Accounting will provide valuable commentary about the publishing environment.

In response to attendee feedback at our previous conferences, we’ll dedicate our Friday lunch period to catching up with old and new friends. And the President of the American Accounting Association will deliver an address on Saturday at noon.

We have also invited a spokeswoman from the Roosevelt Institute to discuss their projects. In addition, she will describe how the Institute is working with students on college campuses to “make a difference” in society. Our attendees are sure to discover that the Institute’s agenda matches our own values and beliefs.

So please join us on March 23rd and March 24th. And in the meantime, if you’re able to serve as a volunteer, we’ll be delighted to hear from you!