Three US Bank Failures Cast Pall over Quality of KPMG’s Audit

According to a Financial Times report, three bank failures since March have cast a pall over KPMG’s lucrative business as the largest auditor of the US banking sector.

The big four competitive accounting firms in the U.S which compromise of Deloitte, PricewaterhouseCoopers (PwC), Ernst & Young, and KPMG, manage over 78 percent of all U.S. public audits and 99 percent of all public company sales. 

The report said questions over the quality of the firm’s work and independence have mounted in recent days, following the release of a Federal Reserve document into the collapse of Silicon Valley Bank and the forced sale of First Republic.

One of the ‘Big Four’ accounting firms was auditor to both banks, as well as to Signature, which was seized by regulators in March, FT said.

In all three cases, it stated that KPMG gave the banks’ financial statements a clean bill of health at end of February before their collapse.

“It’s a dubious achievement . . . and we need tough action to back up tough talk from regulators,” said Francine McKenna, a former KPMG auditor who now lectures at the Wharton School of the University of Pennsylvania.

Kecia Williams Smith, a former auditor and current assistant professor of accounting at North Carolina A&T State University said, “You can’t expect auditors to know a bank run is coming. What is fair is to ask about an auditor’s risk assessment and whether they had the right audit procedures,” said 

According to accounting experts scrutiny of KPMG’s work was likely to fall on whether its staff were sufficiently independent from the banks they audited, whether they paid proper attention to red flags, or if they had the right skills to judge the quality of financial statements in an environment that had changed significantly because of rising interest rates

Data from Audit Analytics has shown that the firm holds a singular role as auditor of more US banks than any of the other Big Four, and it audits a larger proportion of the country’s banking system by assets than any other firm.

As well as being auditor to Wells Fargo, Citigroup, Bank of New York Mellon and three dozen other listed banks, it also audits the Federal Reserve.

“This is something that reverberates across the banking industry,” said Williams Smith. “Given the public interest around this you can expect there will be more oversight.”

Banking clients are particularly significant to KPMG. Publicly listed banks paid the firm more than $325 million in fees in 2021, the last year for which full data is available, with the sector accounting for about 14 per cent of KPMG’s fees from public clients. That compared to 8 per cent at PwC, 3 per cent at EY and 2 per cent at Deloitte.

KPMG alumni have also gone on to play significant roles in the banking sector, including at former clients. The chief executives of Signature and First Republic were both former KPMG partners, the report added.

Accounting professors speculated that regulators were likely to pay close attention to Signature’s appointment of Keisha Hutchinson, who was the lead partner on the KPMG audit team at the bank, to be its chief risk officer in 2021, less than two months after she signed the 2020 audit report.

Securities and Exchange Commission rules require a 12-month cooling off period before an audit partner is hired by a company into a role that oversees financial reporting, although that is usually interpreted to mean chief financial officer or financial controller roles.

KPMG has said previously that it stands behind its audits of SVB and Signature. It declined to comment further, citing client confidentiality.

“KPMG has long had a substantial and dynamic audit practice in the financial services industry. We conduct our audits in accordance with professional standards,” one of their spokespersons said.

The Fed’s report last week revealed the extent of weaknesses in SVB’s risk management and internal audit functions, both of which need to be assessed by a company’s external auditors.

A former PwC partner , Jeffrey Johanns, who teaches auditing at the University of Texas at Austin, said that could raise a question of whether KPMG should have highlighted these failings to investors as material weaknesses that could affect the financial results.

“If you have significant deficiencies in the risk function, how can the bank assert that it does not have a weakness in its internal controls?” Johanns said.

Depositors fled SVB amid concern it would have to sell assets previously designated as “hold to maturity”, potentially triggering a $15 billion loss because higher interest rates had cut their market value.

Banks are allowed to mark such assets at cost as long as they have the “intent and ability” to hold them to maturity, and KPMG’s agreement to that designation has been a focus of criticism, including in a class-action lawsuit filed by SVB investors against the auditor.

Smith said higher interest rates had changed the environment for banks, and there was a question about whether KPMG had properly assessed this and other risks when planning their audit.

“This is a clarion call to all auditors to make sure they understand that the client’s environment is changing, and they have got to be thinking ahead,” Smith added.

Emmanuel Addeh

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