KPMG has been fined £3.4m (approx. $4.2m) by the Financial Reporting Council (FRC), the UK’s accounting regulator, for serious failings in its audit of Rolls-Royce’s 2010 accounts.
Anthony Sykes, KPMG’s Audit Engagement Partner, was additionally fined £112,500 for the same misconduct. Sykes, was the Statutory Auditor of Rolls-Royce and signed the FY2010 Audit report on behalf of KPMG.
Widespread Corruption at Rolls Royce
Five years ago, Rolls Royce, the UK’s aerospace giant and engine maker reached a settlement with UK, US and Brazil authorities to settle investigations into widespread corruption allegations. Rolls Royce agreed at the time to pay £671m in penalties.
In 2016, a joint Guardian and BBC Panorama investigation identified at the time 12 countries in which Rolls-Royce hired commercial agents or advisors to help it land lucrative corrupt contracts: Brazil, India, China, Indonesia, South Africa, Angola, Iraq, Iran, Kazakhstan, Azerbaijan, Nigeria and Saudi Arabia.
KPMG’s Failures in the Audit
It is worth noting that the list of misconduct allegations against KPMG and Big Four accountants is getting longer by the day. In the UK alone, and just this year, this is the fourth significant fine imposed on KPMG by the UK regulator. Other fines this year involved KPMG’s audits of Conviviality, Revolution Bars and a fine for misleading regulators during an inspection of its audits of Carillion.
But what’s particularly concerning about this case, is that the Financial Reporting Council found KPMG had failed to deal properly with indications of corruption at Rolls-Royce.
In particular it found KPMG was not complying with legal requirements in relation to bribery payments made by Rolls Royce to agents in India.
These payments were part of the criminal investigation of Rolls-Royce by the UK’s Serious Fraud Office (SFO) in 2017, which resulted in the £497mn settlement with the SFO.
According to the regulator, allegations of bribery and malpractice were prominent at the time of the Rolls-Royce audit. Allegations of bribery and malpractice through the use of intermediaries and “advisers” by large multi-national companies in the defence sector were a common scheme in the years leading up to 2010.
The UK regulator mainly makes reference to an “unnamed FTSE 100 UK defence-sector company”, who following malpractice allegations and UK and US investigations in 2007, appointed a committee to review its compliance with anti-corruption legislation.
The Committee issued a report in April 2008. Its report noted that “The Company is not alone in having to focus on these issues”.
According to the regulator, KPMG and its auditing partner Sykes who also audited this “unnamed defense company” were “well aware” of the report and its contents.
KPMG and the partner were also aware that in March 2010, the defense company paid a fine of £0.5 million in the UK and a fine of $400 million in the US to settle criminal investigations resulting from the use of intermediaries.
I don’t know why the UK is suddenly developing an appetite for “unnaming” corporate offenders, but the notable enforcement action I can think of that took place against a prominent UK Defense company in 2010, is the US enforcement action against BAE Systems. The UK Defense company pleaded guilty to conspiring to defraud the United States by impairing and impeding its lawful functions, to make false statements about its Foreign Corrupt Practices Act (FCPA) compliance program, and to violate the Arms Export Control Act (AECA) and International Traffic in Arms Regulations (ITAR).
Anyways, according the UK regulator, KPMG was also well aware the “unnamed defence company” had paid large fines to settle US and UK criminal investigations into the use of intermediaries and “advisers”, a common structure for bribery payments.
With regards to the Rolls Royce audit, and the payments to agents in India, the Adverse Findings against each of KPMG and its auditing partner were determined by the regulator to be failures to address matters identified in the Audit which indicated risk of non-compliance by the Company with laws and regulations.
The Adverse Findings, which were accepted by the respondents, amounted to serious failures to exercise professional skepticism, to obtain sufficient, appropriate audit evidence and document this on the audit file, and to achieve sufficient Engagement Quality Control.
Claudia Mortimore, Deputy Executive Counsel to the FRC, said:
“It is essential that auditors are alive to the risks of companies’ non-compliance with laws and regulations, and conduct work in this area with care and sufficient professional skepticism. This is particularly so when the audited entity is in a sector where such risks are known to be prevalent. The package of financial and non-financial sanctions imposed in this case should help to improve the quality of future audits.”
The watchdog did not find that Rolls-Royce’s 2010 accounts were materially misstated because of the audit failures. It also investigated the audits for the years from 2011 to 2013 but did not find any wrongdoing.
Because the breaches were considered serious in this case, the FRC’s Executive Counsel decided to initially impose financial sanctions of £4.5 million and £150,000 on KPMG and Sykes respectively.
However, taking into account aggravating and mitigating factors, the sanctions were discounted for admissions and early disposal by 25% to £3,375,000 and £112,500 respectively.
A severe reprimand was issued in relation to both.
KPMG will also pay the Executive Counsel’s costs of the investigation (£726,000).
Failure to Audit, a Common Theme?
And so the string of scandals and sloppy audits allegations within Big Fours continues…
When all is said and done, after being the subject of massive scandals, paying fines and/or having their license suspended, Big Fours must also contend with private lawsuits from aggrieved parties.
A recent example is happening in the UAE, were KPMG is being sued for at least $600 million over its alleged role in the insolvency of Dubai private-equity firm Abraaj Group.
The claimants in the Dubai lawsuit, two units of Abraaj now in liquidation, allege that KPMG accountants “failed to maintain independence and an appropriate attitude of professional skepticism” and breached their duty of care when auditing the private-equity firm, according to court documents filed in Dubai on November 3 2021. If KPMG and its local Lower Gulf subsidiary had complied with their duties then “irregularities” relating to the firm’s financial statements would’ve been identified sooner, the claimants said.
The concept of failure to maintain “professional skepticism” seems to be a common theme as of late in the accounting world. All we seem to read about lately, is how Big Four auditing firms went rogue in their greed for profit.
The spectacular collapse of accounting firm Arthur Andersen over its sloppy auditing of Enron in 2001, should have served as a cautionary tale, but it seems not much has changed since.
What we won’t read in enforcement actions, is the intimate relationship Big Fours develop with their clients.
As long as Audit companies continue expanding beyond their scope and are allowed to “cross-sell” their consulting and advisory services to their audit clients while becoming “buddy buddies” with them, this will continue happening.
Audit is about scrutiny, and consulting is about advice… and therein lies the conflict: either you hold a legally independent role or you hold a supportive consultancy role.
Unfortunately, given the recurrence of these scandals, the fines seem to be a slight slap on the wrist for these Big Fours.
Correction Notice: There was an error describing the industry of Rolls Royce in the original article. The entity concerned here is Rolls-Royce Holdings plc, a British multinational aerospace and defence company, not Rolls-Royce Motor Cars Limited the British luxury automobile maker.