Big (4) Audit Firms Blasted By PCAOB And Gary Gensler, Head Of SEC (#GotBitcoin)
Fired KPMG Audit Head Fined Over Failure To Supervise Senior Auditors (Updated: 4-5-2022) Big (4) Audit Firms Blasted By PCAOB And Gary Gensler, Head Of SEC (#GotBitcoin)
The PCAOB said it is the first time the U.S. audit watchdog has brought such a charge against an individual.
The Public Company Accounting Oversight Board said it fined the fired former head of KPMG LLP’s U.S. audit business $100,000, the largest monetary penalty it’s ever imposed on an individual in a settled case.
Scott Marcello in 2017 was fired as the professional-services firm’s vice chair of audit over a leak of confidential information. KPMG at the time said it terminated Mr. Marcello and four other partners for mishandling a tip that gave the firm improper advance word about which of its audits the PCAOB planned to scrutinize in its annual inspections.
The so-called “steal the exam” scandal led to KPMG paying a $50 million settlement with the Securities and Exchange Commission in 2019 and a one-year prison sentence for Mr. Marcello’s deputy, David Middendorf, who later appealed his conviction.
The U.S. audit watchdog on Tuesday said Mr. Marcello failed to reasonably supervise senior auditors who engaged in the scheme to improve KPMG’s inspection results. The PCAOB said the case marks the first time it has imposed sanctions for a failure to supervise employees. The SEC, which oversees the PCAOB, rarely charges firms or people with failure to supervise in its enforcement actions.
Previously, the largest fine on an individual in a PCAOB settlement was $75,000, which it imposed in 2009 against former Deloitte & Touche partner Thomas J. Linden for allegedly helping a client avoid restating financial results.
The biggest penalty on an individual subject to litigated disciplinary proceedings was $100,000, which was imposed in 2015 against Hamid Kabani, president of accounting firm Kabani & Co.
“The PCAOB is committed to sanctioning top-level personnel at the largest firms when they fail to take sufficient supervisory steps aimed at preventing violations by their subordinates,” PCAOB Chair Erica Williams said in a statement. “The board believes it is important to hold Mr. Marcello accountable as their supervisor for contributing to a culture that led to this serious misconduct.”
KPMG, in response to the sanctions Tuesday, said it is a stronger firm as a result of the actions taken since 2017 to bolster its culture, governance and compliance program. “Integrity and quality are paramount for KPMG, including operating with the utmost regard for the critical importance of the regulatory process to our profession,” a KPMG spokesman said.
Mr. Marcello didn’t immediately respond to a request for comment.
The sanctions come months after Ms. Williams took the helm of the PCAOB and three others joined the five-member board. The SEC last November appointed new PCAOB board members after firing the former chair, William Duhnke, in June.
The PCAOB disciplines audit firms and individual auditors for violations in addition to setting audit standards and inspecting audits.
The PCAOB disclosed 18 enforcement actions in 2021, up from 13 the prior year but down from the previous five-year average of nearly 29, according to a calendar-year analysis of regulatory data by Cornerstone Research, a financial-consulting firm.
The PCAOB under new leadership is expected to increase its scrutiny of audit firms, further incorporate investor concerns into its work and potentially strengthen its approach to enforcement, accountants and former regulators have said.
KPMG Is Fined $17.3 Million In U.K. For Audit Shortfalls
The fine came in relation to two audits, one involving the now-defunct Carillion. Four former KPMG employees were also fined and temporarily banned from the profession, and a fifth was reprimanded.
The U.K.’s audit and accounting regulator fined KPMG LLP and sanctioned five former employees for providing false and misleading information in relation to two audits, one of them of the now-defunct Carillion PLC.
On Monday, the Financial Reporting Council said KPMG was fined £14.4 million—equivalent to $17.3 million—for failings related to the audits of construction and outsourcing giant Carillion and Regenersis PLC, a data-security company that has been renamed Blancco Technology Group PLC. The fine was reduced from £20 million to acknowledge KPMG’s own reporting of misconduct as well as its cooperation with the regulator.
An audit and accounting industry tribunal imposed the fine, saying KPMG provided false and misleading information and documents to the FRC. The tribunal also ordered KPMG to appoint an independent reviewer to consider the effectiveness of the firm’s policies and its engagement with audit inspectors. KPMG agreed to pay £3.95 million in costs related to the investigation.
Four of the accounting firm’s former employees were fined and banned from the auditing profession for varying numbers of years. A fifth was “severely reprimanded,” the FRC said.
“I accept the findings and sanctions of the tribunal in full,” Jon Holt, chief executive of KPMG UK, said in a statement. “The behavior underlying this case was wrong and should never have happened.”
Of the five former employees, Peter Meehan, a former partner, received the most severe penalty, with a ban of 10 years from auditing and a £250,000 fine.
Mr. Meehan, who led the fiscal 2016 Carillion audit, acted alongside Adam Bennett, Alistair Wright and Richard Kitchen to mislead audit inspectors with respect to year-end clearance meeting minutes and an audit working paper, according to the FRC. Pratik Paw followed instructions from Mr. Wright to create the false meeting minutes, the FRC said.
Mr. Meehan’s representatives didn’t respond to a request for comment.
The tribunal found Messrs. Bennett and Wright either had a role in or made false or misleading representations to audit inspectors related to Regenersis’s fiscal 2014 audit. Both men were banned from auditing for eight years and fined: Mr. Wright £45,000, and Mr. Bennett £40,000.
Representatives for Mr. Bennett and Mr. Wright didn’t respond to requests for comment.
Mr. Kitchen, whose representatives declined to comment, was banned from accounting for seven years and fined £30,000.
Representatives for Mr. Paw—a 25-year-old junior auditor when he worked on the Carillion account—noted that the tribunal found that he had failed to question the instructions given him, but not that he had acted dishonestly.
“Pratik deeply regrets not questioning these instructions from his superior and has learned a great deal from his conduct at the time, especially so early in his career,” the representatives said.
Separately, Stuart Smith, who had led the Regenersis audit for KPMG, in January reached a settlement with the FRC in which he agreed to a £150,000 fine and a three-year ban from the profession.
The £14.4 million fine was the second largest ever issued by the FRC, after a £15 million penalty against Deloitte in 2020 in relation to its audits of software company Autonomy Corp. Deloitte is a sponsor of CFO Journal.
Spurred by the collapse of Carillion in early 2018, the U.K.’s audit and accounting sector is set to be overhauled.
The revamp, which includes creation of a new regulator to replace the FRC—called the Audit, Reporting and Governance Authority—has been criticized by industry observers for being slow to take form.
Misconduct that thwarts the FRC’s ability to monitor and inspect audit quality is “extremely serious,” Elizabeth Barrett, the FRC’s executive counsel, said in a statement.
The tribunal’s full report is expected out in “due course,” an FRC spokesman said. A separate investigation into the quality of KPMG’s audits of Carillion’s financial statements remains ongoing, he added.
SEC’s Gensler Says PCAOB Has Been Sluggish In Rulemaking
The chair of the U.S. securities regulator also urged audit firms to review and enhance their independence protocols with respect to their auditing and consulting practices.
Securities and Exchange Commission Chair Gary Gensler said the U.S. audit regulator has been slow to update its rules, in a speech marking the 20th anniversary of the law that created it.
The Public Company Accounting Oversight Board, created as part of the Sarbanes-Oxley Act, continues to work with interim standards that it was allowed to use from the American Institute of Certified Public Accountants, a professional association whose guidelines and rules are often used as fallbacks for the industry.
“The expectation was that the board would produce a more appropriate set of standards going forward,” Mr. Gensler said on Wednesday at an event hosted by the Center for Audit Quality, a U.S. accounting-industry group. “Historically, though, the PCAOB has been too slow to update auditing standards.”
Mr. Gensler, during the speech, also said the Chinese government needs to decide whether to comply with U.S. law in order for Chinese companies to remain listed on U.S. stock exchanges.
The issue arose after the U.S. passed a law that bans foreign businesses from its exchanges if their auditors haven’t been inspected by the PCAOB for three years in a row.
Erica Williams, who became the PCAOB’s chairwoman in January, in recent months has been working with other board members and staff to advance the body’s strategy.
The PCAOB in May said it would craft proposals this year on audit quality controls and auditors’ consideration of potentially illegal acts in the audit by their clients.
The watchdog last month adopted a rule strengthening the requirements for lead auditors in supervising other auditors outside their firms, the first standard to pass under Ms. Williams.
The SEC in November appointed four new board members to the PCAOB, including Ms. Williams, after firing the former chairman, William Duhnke, and moving to replace the board in June 2021.
“While they have their work cut out for them, I believe that Chair Erica Williams and the Board can live up to Congress’s original vision with respect to standard-setting,” Mr. Gensler said.
Mr. Gensler has previously said the PCAOB wasn’t living up to its role as a setter and enforcer of auditing standards.
Ms. Williams and the board have laid out an aggressive standard-setting agenda and she welcomes Mr. Gensler’s support as they work to modernize and strengthen its standards, a PCAOB spokesperson said.
Mr. Gensler said in Wednesday’s speech that U.S. audit quality has improved since 2002 but noted that certain areas, such as auditor independence, are still lacking.
Mr. Gensler said he has asked the PCAOB to look into updating audit independence standards and said the SEC might need to take a fresh look at its own auditor independence rules.
The U.S. securities regulator in 2020 gave auditors more discretion in assessing conflicts of interest in their relationships with businesses they audit. The PCAOB’s rules are currently aligned with those of the SEC.
Mr. Gensler also urged audit firms to review and enhance their independence protocols with respect to their auditing and consulting practices. “Given the growth in the size and complexity of nonaudit services, it is important that audit firms maintain a culture of ethics and integrity—placing the highest priority on auditor independence throughout the firm, not just in the audit practice,” he said.
Ernst & Young is considering a breakup of its business into separate audit and consulting businesses that will provide audit and advisory services to clients.
Lack of Crypto Audit Regulation Raises Questions About PCAOB Authority
Watchdog says it lacks jurisdiction on audits of private companies, but some accountants and academics say there are ways to strengthen its crypto oversight.
The Public Company Accounting Oversight Board is facing calls to be the regulator that brings supervision to bear on auditors of cryptocurrency companies, even as the majority of crypto businesses fall outside its jurisdiction.
Cryptocurrencies in the U.S. are largely unregulated, leaving investors at risk of market manipulation and fraud, and most crypto exchanges are privately held, so they aren’t required to produce audited financial statements or file the reports with the Securities and Exchange Commission.
Additionally, there isn’t a regulatory framework for audits for many crypto companies.
The SEC, which oversees the PCAOB, is reviewing how crypto companies portray reports from audit firms in the aftermath of the FTX collapse. The regulator is especially concerned about so-called proof-of-reserves reports, which aim to show sufficient assets to cover customer funds.
“It is the Wild West in the sense that nobody is requiring audits of financial statements and no one is specifying the standards that ought to apply to proof-of-reserves reports,” said Douglas Carmichael, a Baruch College accounting professor and former PCAOB chief auditor.
“It’s a big concern when investors get a report from an audit firm that seems to provide assurance when it doesn’t.”
Privately held crypto exchanges such as Binance Holdings Ltd., Kraken and Crypto.com, have moved to bolster efforts around these reports, which fall short of full audits.
Additionally, different FTX units secured full audits from auditors Armanino LLP and Prager Metis CPAs LLC before the crypto exchange’s implosion, in contrast with other privately held exchanges.
The PCAOB lists inspection reports on registered audit firms, including Prager Metis and Armanino, on its website.
The PCAOB—which sets audit standards, inspects audits and disciplines audit firms—has said it can only oversee audits of public companies and SEC-registered broker-dealers. The watchdog in 2019, however, set up a team of inspectors who focus on emerging audit risks, including in the cryptocurrency field.
“The PCAOB prioritizes cryptocurrency-related inspections and is committed to vigorously enforcing our standards wherever they apply, including registered broker-dealers,” spokesman Kent Bonham said.
Those efforts aren’t enough for Sens. Ron Wyden (D., Ore.) and Elizabeth Warren (D., Mass.). In a letter last month to PCAOB Chair Erica Williams, they said the watchdog ignored what they called questionable practices by auditors of crypto companies.
The lawmakers cited PCAOB rules requiring registered accounting firms to meet the regulator’s standards when preparing any audit, even if an audited firm falls outside the watchdog’s jurisdiction.
Their view ignores the PCAOB’s statutory authority and hasn’t been applied by the regulator, said Coy Garrison, a former counsel to SEC Commissioner Hester Peirce who now is a partner at law firm Steptoe & Johnson LLP focusing on crypto regulation.
A Senate aide countered that the PCAOB “has a responsibility to ensure PCAOB-registered auditors treat crypto companies with the same scrutiny other companies face, or they’ll lose their credibility.”
Accountants and academics say there might be ways to strengthen the PCAOB’s crypto oversight.
Some accountants say it is accurate to classify centralized crypto exchanges as broker-dealers and the SEC could designate them as such so their audits would fall under the PCAOB’s oversight.
That would require the SEC to classify crypto assets as securities through a rule-making process, Mr. Garrison said.
SEC Chair Gary Gensler has said most crypto tokens are securities falling under his agency’s jurisdiction and should comply with investor-protection laws. But many crypto firms are broker-dealers that haven’t registered with the SEC, he has said.
Mr. Gensler has also said it is possible some crypto intermediaries would need to register with the SEC and the Commodity Futures Trading Commission, similar to some mutual funds and brokers. The SEC declined to comment.
The PCAOB’s Mr. Bonham said authority to register broker-dealers lies with the SEC.
“The PCAOB welcomes Chair Gensler’s comments and stands ready to inspect any newly registered broker-dealers as part of our overall efforts to prioritize cryptocurrency oversight,” he said.
The PCAOB in 2011 launched an interim program to inspect audits of broker-dealers after the Dodd-Frank Act expanded its mandate. Mr. Bonham said the program, while still interim, is working well and is an important part of PCAOB inspections.
The deficiencies of broker-dealer audits remained “unacceptably high,” according to an annual PCAOB report released last August.
The audit regulator’s powers could be expanded if Congress moves to amend the Sarbanes-Oxley Act of 2002 that created the watchdog, potentially allowing PCAOB-registered audit firms to apply PCAOB standards to audits of nonpublic companies, accounting professors said.
That is a good idea in principle, but Congress might not further expand the PCAOB’s authority, and the regulator likely doesn’t have the resources to tackle a related surge in workload, said Vivian Fang, professor of accounting at the University of Minnesota and chief adviser of tax, accounting and policy at crypto software firm Ledgible Inc.
The PCAOB is funded by public companies and broker-dealers, and it would gain fees from private companies under an expansion, but “I’m not sure that is a challenge the PCAOB is ready to take on right now,” she said.
Even potential improvements to crypto audit regulation might not prevent fraud in the crypto industry, said Andrew Kitto, an assistant professor of accounting at the University of Massachusetts Amherst and a former PCAOB economic research fellow.
“If you have auditors that are subject to more stringent auditing oversight, you still have a lot of incentives for individuals to try and evade their auditors,” he said.
China Urges State Firms To Drop Big Four Auditors On Data Risk
* SOEs Encouraged To Use Local Auditors When Contracts Expire
* Guidance Reiterated Even After China Reached Us Audit Deal
Chinese authorities have urged state-owned firms to phase out using the four biggest international accounting firms, signaling continued concerns about data security even after Beijing reached a landmark deal to allow US audit inspections on hundreds of Chinese firms listed in New York.
China’s Ministry of Finance is among government entities that gave the so-called window guidance to some state-owned enterprises as recently as last month, urging them to let contracts with the Big Four auditing firms expire, according to people familiar with the matter.
While offshore subsidiaries can still use US auditors, the parent firms were urged to hire local Chinese or Hong Kong accountants when contracts come up, one of the people said, asking not to be identified discussing private information.
China is seeking to rein in the influence of the US-linked global audit firms and ensure the nation’s data security, as well as to bolster the local accounting industry, the people said.
Beijing has been giving the same suggestion to state-backed firms for years, but recently re-emphasized that companies should use other auditors than the Big Four, the people added. No deadline has been set for the changes and replacements may happen gradually as contracts expire.
While the China-US audit deal last year was hailed as a sign that the competitive superpowers can still work together on some issues, Beijing’s audit guidance is a reminder that decoupling is still proceeding in sensitive areas like SOEs and advanced technology.
One risk for China is that shifting to lesser-known auditors will make it harder for SOEs to attract capital from international investors.
“It builds in a further hurdle for Chinese SOEs in terms of appealing to international capital,” said Richard Harris, chief executive officer of Hong Kong-based investment business consultancy and fund manager Port Shelter Investment Management.
“I’m not sure if the data held secret as a result is likely to be important enough to justify inhibiting that access to international capital as accountants have a legal obligation to be confidential.”
China’s finance ministry and representatives of the Chinese offices of PricewaterhouseCoopers LLP, Ernst & Young, KPMG and Deloitte & Touche LLP — collectively known as the Big Four auditing firms — didn’t respond to requests seeking comment.
As for the global arms, PwC, KPMG and Ernst & Young declined to comment, and Deloitte didn’t immediately respond to a request for comment.
The frosty relationship between China and the US shows no signs of abating, with the episode over an alleged Chinese spy balloon adding further tension.
But the audit breakthrough last year was seen as a positive sign, ending decades-long spat that threatened to kick more than 200 Chinese firms off the American exchanges.
The US Securities and Exchange Commission on Wednesday declined to comment on Chinese authorities’ move on accounting firms. Generally, SEC rules don’t require companies to work with one of the Big Four accounting firms.
But companies must use accounting firms registered with the US Public Company Accounting Oversight Board, an auditor watchdog agency overseen by the SEC.
Companies traded on US exchanges risk being delisted if the PCAOB isn’t able to fully inspect and investigate the work papers of their auditors after three years in a row.
“The PCAOB continues to demand complete access to inspect and investigate all registered firms in China, and there will be no loopholes and no exceptions whether those firms are part of a global network or not,” Erica Williams, the board’s chair, said in a statement Wednesday.
“Should PRC authorities obstruct or otherwise fail to facilitate the PCAOB’s complete access at any point, in any way, the board will act immediately.”
The PCAOB in December completed its first-ever on-site work paper inspection of some of the largest Chinese companies and said it was able to sufficiently review audit documents during the trip to Hong Kong, which was hosted by PwC and KPMG. The PCAOB is planning further reviews this year.
Several big state firms including China Eastern Airlines Corp., China Life Insurance Co. and Petrochina Co. have voluntarily applied to delist from the American exchanges.
Voluntary delisting, however, doesn’t protect issuers’ “audit engagements from being selected for PCAOB inspections or investigations,” a PCAOB spokesperson said.
“PCAOB inspections of firms are retrospective. So if a company delists in a given year, PCAOB may still inspect audits from previous years while it was listed or investigate the audit work.”
Winners And Losers
Getting shut out of Chinese state-owned business would be a blow to the accounting firms. The Big Four earned combined revenue of 20.6 billion yuan ($3 billion) from all Chinese clients in 2021, according to the finance ministry.
Some 60 Hong Kong-listed companies with Chinese headquarters — state-owned and private — have changed auditors since September last year, when the PCAOB started its historic review.
Smaller Chinese and Hong Kong firms gained almost 20 jobs from the Big Four, according to Hong Kong exchange filings.
Those changing to smaller audit firms in recent months include property developer Sino-Ocean Group Holding Ltd. and its subsidiary Sino-Ocean Service Holding Ltd., which dropped PwC, citing good governance practices to rotate auditors after long years of service.
Furniture maker Red Star Macalline Group Corp. proposed to end a contract with EY because they “failed to reach consensus on the work schedule and expenses.”
While the Big Four dominate China at the moment, smaller rivals are edging up. Potential winners of new business could include close rivals such as Pan-China Certified Public Accountants, BDO China Shu Lun Pan CPAs, Moore Global, and RSM China.
More than 80 listed companies in Shanghai and Shenzhen also changed auditors since December, Chinese news outlet Jiemian reported. Chinese regulators have expressed concerns over some smaller firms’ quality of work and ability to handle troubled listed clients.
“The Big Four have grown because of their perceived independence and size, and being global and subject to different regulators reinforces this perception of trust, on which the Western financial system depends,” Harris said.
“While smaller firms should adopt the same internal controls and external regulation, they have to try much harder to justify that trust that it has taken the big names decades to build.”
KPMG Faces Scrutiny For Audits of SVB and Signature Bank
Accounting firm blessed books of two banks weeks before failure.
Silicon Valley Bank failed just 14 days after KPMG LLP gave the lender a clean bill of health. Signature Bank went down 11 days after the accounting firm signed off on its audit.
What KPMG knew about the two banks’ financial situation and what it missed will likely be the subject of regulatory scrutiny and lawsuits.
KPMG signed the audit report for Silicon Valley Bank’s parent, SVB Financial Group, on Feb. 24. Regulators seized the bank on March 10 after a surge of withdrawals threatened to leave it short of cash.
“Common sense tells you that an auditor issuing a clean report, a clean bill of health, on the 16th-largest bank in the United States that within two weeks fails without any warning, is trouble for the auditor,” said Lynn Turner, who was chief accountant of the Securities and Exchange Commission from 1998 to 2001.
Two crucial facts for determining whether KPMG missed the banks’ problems are when the bank runs began in earnest and when the bank’s management and KPMG’s auditors became aware of the crisis.
What is known about Silicon Valley Bank is that deposit outflows accelerated last month. In its March 8 statement, Silicon Valley Bank said “client cash burn has remained elevated and increased further in February.”
The bank said its deposits at the end of February were lower than it had predicted in January.
Both bank audits were for 2022, so auditors weren’t scrubbing the banks’ books when they ran into trouble. But auditors are supposed to highlight risks faced by the companies they audit.
They are also supposed to raise important issues that occur after companies close their books and before the audit is completed.
A spokesman for KPMG declined to comment on the specific audits, due to client confidentiality. In a statement, the firm said it isn’t responsible for things that happen after an audit is completed.
Silicon Valley Bank’s deposits peaked at the end of the first quarter of 2022 and fell $25 billion, or 13%, during the final nine months of the year. That means deposits were declining during the period of KPMG’s audit.
If the decline was affecting the bank’s liquidity when KPMG signed off on the audit report, that information likely should have been included. Since it wasn’t, the question becomes, did KPMG know or should have known what was going on?
Auditors are supposed to warn investors if companies are in trouble. They are required to evaluate “whether there is substantial doubt about the entity’s ability to continue as a going concern” for the next 12 months after the financial statements are issued.
Auditors also use their reports to highlight “critical audit matters” that involve challenging, subjective or complex judgments. KPMG in that section of its report focused on the accounting for credit losses at Silicon Valley Bank.
But it didn’t address Silicon Valley Bank’s ability to continue holding debt securities to maturity—which, in the end, the bank lacked.
Even if the bank wasn’t struggling last year, KPMG was required to evaluate developments that occurred after the balance-sheet date so the company’s financials were presented fairly.
Signature Bank, which was seized by regulators on Sunday, also faced a run last week but it didn’t have the same balance-sheet issues as Silicon Valley Bank. KPMG signed off on its audit on March 1.
Signature’s bet on crypto assets led to a surge in deposits, which went into reverse as that market struggled. A large amount of its deposits were uninsured, making it more likely the customers would flee at any sign of trouble.
But it hadn’t suffered the same losses on its investments as Silicon Valley Bank, giving it a greater ability to pay depositors.
The auditing firm could face additional scrutiny. KPMG also audited First Republic Bank, whose shares were down 76% Monday morning, even after the bank got a liquidity boost from JPMorgan Chase and the Federal Reserve.
KPMG’s audit work likely will be scrutinized by regulators, including the Public Company Accounting Oversight Board and the SEC, as well private litigants that lost money when Silicon Valley Bank collapsed, said Erik Gordon, a professor at the University of Michigan’s Ross School of Business.
A shareholder lawsuit against the firm concerning its Silicon Valley Bank audit “won’t be an easy one for people to win, even though the timing is spectacularly embarrassing for KPMG,” Mr. Gordon said.
A PCAOB spokeswoman said the regulator “cannot comment on ongoing inspection or enforcement matters.” An SEC spokesman declined to comment on the Silicon Valley Bank audit.
One argument KPMG could try in court is that the run on the bank started after the firm signed its audit report. A state banking regulator, the California Department of Financial Protection and Innovation, in a filing Friday said the bank was “in sound financial condition prior to March 9,” when depositors withdrew $42 billion.
Douglas Carmichael, the PCAOB’s chief auditor from 2003 to 2006, said it was unclear how the California regulator could have determined the bank’s financial condition. “It seems like a premature analysis. How could they know without examining?” he said.
“Auditors are always under the microscope when the company fails shortly after the issuance of a clean opinion,” Mr. Carmichael said. “The shorter the period the greater the concern would have to be.”
Silicon Valley Bank almost doubled its assets and deposits during 2021. It got in trouble because it bought long-term, low-yielding bonds with short-term funding from depositors that was repayable upon demand.
Accounting rules said it didn’t have to recognize losses on the assets as long as it didn’t sell them.
When rising interest rates caused the bonds’ value to drop, it got stuck in them, and they kept falling. Silicon Valley Bank still had to maintain enough liquidity to pay withdrawals, which became increasingly difficult.
The $1.8 billion investment loss Silicon Valley Bank disclosed last week stemmed from Silicon Valley Bank’s decision to sell all its “available for sale” securities during the first quarter.
Silicon Valley Bank didn’t say when it started or when it completed the sales. It isn’t clear if Silicon Valley Bank used the proceeds of those sales to help cover withdrawals.
In the March 8 disclosure, Silicon Valley Bank said it expected to reinvest proceeds from the sales. But money is fungible, and it is unclear if selling the available-for-sale securities may have freed up other sources of cash to help pay departing customers.
Most of the capital hole in Silicon Valley Bank’s balance sheet was in government-sponsored mortgage bonds that Silicon Valley Bank classified as “held to maturity.”
That label allowed Silicon Valley Bank to exclude unrealized losses on those holdings from its earnings, equity and regulatory capital.
In a footnote, Silicon Valley Bank said the fair-market value of its held-to-maturity securities was $76.2 billion as of Dec. 31, or $15.1 billion below their balance-sheet value.
The fair-value gap was almost as large as Silicon Valley Bank’s $16.3 billion of total equity—which, KPMG could point out, is something anyone reading the financial statements could have seen.
Silicon Valley Bank stuck to its position that it intended—and had the ability—to hold those bonds to maturity. KPMG allowed the accounting treatment. Now it will be up to the Federal Deposit Insurance Corp. to sell the securities.
The bank’s troubles put KPMG in a no-win situation. If it had called attention to Silicon Valley Bank’s falling deposits, or issued a warning about Silicon Valley Bank’s ability to continue as a going concern, it could have set off a run on the bank.
By not raising these issues, it will face questions about how it missed the signs that the bank was headed for trouble.
One of the agencies likely to ask pointed questions of KPMG is the FDIC. After a bank fails, the FDIC’s Office of Inspector General regularly conducts investigations and publishes detailed reports called failed-bank reviews that identify the causes of the collapse and the parties most responsible.
Such reports are studied carefully by private litigants eyeing defendants to sue for damages. On that front KPMG caught a break over the weekend: The government said it would backstop all of both banks’ uninsured depositors, in effect helping to bail out KPMG as well. The backstop won’t affect losses suffered by the banks’ investors.
Banks, Investors Revive Push For Changes To Securities Accounting After SVB Collapse
The Financial Accounting Standards Board after the financial crisis weighed fair-value requirements for financial institutions that planned to never sell their debt securities, but reversed course amid widespread industry objections.
Some bank executives and investors are reviving calls for changes to U.S. accounting rules around held-to-maturity securities in the wake of the collapse of Silicon Valley Bank, a move that was considered after the financial crisis but largely abandoned after hundreds of banking-industry objections.
If banks designate bonds as held-to-maturity securities, the firms are allowed to exclude unrealized losses on them from equity as long as they don’t sell. Banks have to carry HTM instruments at amortized cost, or an adjusted version of the original price they paid.
Bonds the banks plan to sell need to be classified as available-for-sale securities and accounted for at fair market value. If banks sell any HTM securities, they must reclassify all of their HTM securities as available for sale and potentially take a big loss on the securities they didn’t sell.
SVB had designated 43% of its total assets as HTM securities, which fell in value and led to a buildup in unrealized losses as interest rates rose last year at one of the fastest paces in U.S. history.
Selling those HTM-branded assets—mostly government-backed mortgage bonds—before maturity would have reduced capital to virtually nothing.
But as the bank struggled to maintain its liquidity to fund withdrawals, SVB was able to avoid recognizing the losses by not switching the classification, a position permitted by its auditor, KPMG.
The collapse of SVB, the largest bank to fail since the 2008 financial crisis, recalls accounting issues that plagued that period.
The Financial Accounting Standards Board, which sets accounting rules for U.S. companies, in 2010 proposed requiring banks to record all financial instruments at fair value, or marked to market, a move to provide investors with more information in the fallout of the financial crisis.
Much of the crisis stemmed from illiquid, toxic subprime assets that had to be marked to market. The issue previously came under debate in the early 1990s, in the aftermath of the savings-and-loan crisis.
“Every time there’s stress, the issue comes up,” said Robert Herz, who served as the FASB’s chair when it issued the 2010 proposal.
“If the FASB were to decide to address the issue, it will likely be very controversial and the same arguments on either side will likely be raised again,” said Mr. Herz, who is chairman of Morgan Stanley and Fannie Mae’s audit committees.
Mr. Herz declined to comment on whether the FASB should change accounting rules now.
The FASB doesn’t have a project on its standard-setting agenda related to held-to-maturity accounting. But a FASB spokeswoman said, “as part of our continuing efforts to improve accounting and financial reporting, we’re always open to engaging with our stakeholders on accounting issues.”
Banks vehemently opposed the 2010 plan, saying it would have hurt lending and inaccurately portrayed their business strategies. Opponents of the proposal far outweighed its supporters, who said it would have improved transparency and revealed potential bank weaknesses.
The CFA Institute, which represents investment professionals designated as chartered financial analysts, public pension fund California Public Employees’ Retirement System and the World Bank were among those that backed fair value as the best measure for financial instruments.
The FASB in 2011 scrapped its plan and decided to largely stick with its existing so-called mixed-measurement model, which allows for financial instruments to be treated in a mix of ways.
Financial institutions are permitted to classify debt securities based on management’s intent, business model and their ability to hold them until maturity if the assets’ value were to drop.
More than a decade later, the banking industry’s views are largely unchanged, with industry experts saying that the use of fair-value accounting for all financial instruments with a requirement to reflect the changes each period through the income statement doesn’t reflect the banking business.
The existing rules are sufficient, said Charles Levingston, chief financial officer at Bethesda, Md.-based Eagle Bancorp Inc.
“I’m OK with the designations as they sit today, but I would not be surprised to see additional conversation about this particularly given the nature with which SVB managed its balance sheet,” Mr. Levingston said.
Some bank executives, however, want the FASB to revisit the issue.
Brent Beardall, chief executive of Seattle-based bank Washington Federal Inc., criticized the current mixed-measurement model, saying it allows investors to receive only partial information.
He said the FASB should consider requiring financial institutions to present two balance sheets, one at amortized cost and one at fair value, so that the information is comparable across all classes of assets and liabilities.
“Fair value is a useful piece of information, but it’s only useful if you get all of the information. Picking and choosing is a disaster,” Mr. Beardall said. “I think it’s time that the FASB look at it and provide information to investors the way they want it.”
Timothy Spence, chief executive of Cincinnati-based Fifth Third Bancorp, said in a recent television interview the accounting designations in the differences in the available-for-sale or held-to-maturity treatment need to be addressed.
“There’s no question that what triggered the outflows at Silicon Valley Bank last week was the surprise on the unrealized losses on their securities portfolio because such a significant share of it was embedded in held-to-maturity securities,” Mr. Spence said on CNBC March 13. Fifth Third declined to comment for this article.
Meanwhile, some investors continue to push for accounting requirements they say reflect economic reality. SVB’s billions of dollars in unrealized losses tied to HTM securities would have been clearer to investors if the bank had been obligated to record them at fair value, said Sandy Peters, head of financial reporting policy at the CFA Institute.
Carrying HTM securities at amortized cost can make a bank look good “while the market value of the assets on the balance sheet implodes,” she wrote in a recent report. “SVB would have had virtually no book value if they had marked them to market, but nobody was paying attention,” Ms. Peters said.
The Council of Institutional Investors, which represents pension funds and other large money managers, has long believed that fair-value accounting with robust disclosures provides investors with more useful information than amounts that would be reported under amortized cost or other existing alternative accounting approaches, said Jeff Mahoney, CII’s general counsel.
But it doesn’t oppose existing accounting standards providing for the categorization of held-to-maturity securities, he said.
US lawmakers Reiterate Concerns About ‘Sham’ Crypto Firm Audits To PCAOB
Two U.S. senators cited the collapse of FTX when writing to Public Company Accounting Oversight Board chair Erica Williams in January, but now suggest improper auditing could have affected three banks as well.
United States Senators Elizabeth Warren and Ron Wyden have cited the recent collapse of three major banks to call on the Public Company Accounting Oversight Board (PCAOB) to “rein in” audits of crypto firms.
In a March 21 letter to PCAOB chair Erica Williams, Warren and Wyden reiterated the concerns over “shady audits” of crypto companies that the pair raised in January, this time referencing the failures of Silvergate Bank, Silicon Valley Bank and Signature Bank.
The two senators requested Williams respond to questions on whether improper audits and proof-of-reserve reports “may have played a direct or indirect role” in the collapse of the banks.
“You have ample authority to establish standards for auditors that require any SEC-registered auditor to only conduct audits of crypto firms that comply with existing standards for audit quality,” said the letter.
“Based on the obvious threats to investors and the public interest posed by sham audits, any audits and reviews of crypto firms done by SEC-registered auditors must maintain a high level of scrutiny. Otherwise, these sham audits must be addressed by PCAOB.”
Congress and the Fed weakened stress tests and other rules to prevent big banks from taking on too much risk and crashing the economy — all so banks could make bigger profits. Banks can’t be trusted to regulate themselves. Congress and our regulators need to step up. https://t.co/AVcFr7g3GB
— Elizabeth Warren (@SenWarren) March 21, 2023
Warren and Wyden suggested that defunct crypto exchange FTX, currently in bankruptcy court for Chapter 11 proceedings, could have impacted the events around Silvergate and Signature, given the firm “received sham financial reviews” by auditors registered with the PCAOB, writing:
“In assessing the risks associated with the FTX’s deposits, as well as those of other crypto-related customers, the banks may have relied on the misleading and faulty financial information provided by proof-of-reserve examinations.”
The two senators requested Williams provide a staff-level briefing on March 31 and respond to the questions raised by April 4.
Warren, an outspoken critic of many aspects of the digital asset space, has been pointing to a lack of regulatory oversight as part of the reason behind the failure of the aforementioned banks.
On March 15, she requested that Federal Reserve Chair Jerome Powell recuse himself from any review of regulatory failures leading to the collapse of Silicon Valley Bank.
PwC Probes Security Incident Tied To Russian-Speaking Clop Cyber Gang
* Accounting Firm Says Event Had ‘Limited Impact’ On Business
* MOVEit Software Flaw Haunts Businesses, Us Government Agencies
A criminal hacking gang has added more names to its lists of alleged victims from a recent campaign that exploited a vulnerability in a popular file-transfer product.
The group, known as Clop, threatened to post internal data from professional services firms Pricewaterhousecoopers LLP and Ernst & Young LLP unless they pay a ransom fee. The scope of the incidents weren’t immediately clear.
The Russian-speaking gang has in recent weeks launched scores of attacks after discovering a vulnerability in MOVEit, a file-sharing software from Progress Software Corp.
Pricewaterhousecoopers in a statement confirmed it used MOVEit software, and that the hack had a “limited impact” on PwC. The firm stopped using the MOVEit platform upon learning of the incident, it said.
“We have reached out to the small number of clients whose files were impacted to discuss the incident,” a company spokesperson said. “Data security is a key priority for PwC and we continue to put the right resources and safeguards in place to protect our network.”
Ernst & Young has previously said it had launched an investigation into its use of the MOVEit tool and “took urgent steps to safeguard any data.”
“We have verified that the vast majority of systems which use this transfer service across our global organization are secure and were not compromised,” the spokesperson said in a statement from June 16.
“We are manually and thoroughly investigating systems where data may have been accessed. Our priority is to first communicate to those impacted, as well as the relevant authorities. Our investigation is ongoing.”
The largest US public pension fund, the California Public Employees’ Retirement System, or CalPERS, also said the personal data of about 769,000 members — including Social Security numbers, dates of birth and potentially the names of family members — have been exposed due to the same MOVEit issue.
CalPERS said a third-party vendor that CalPERS used to help make payments to retirees and other beneficiaries notified the company on June 6 that a MOVEit vulnerability allowed data to be downloaded by an unauthorized party.
“This external breach of information is inexcusable,” said CalPERS Chief Executive Officer Marcie Frost in a statement. “Our members deserve better.”
The US Cybersecurity and Infrastructure Security Agency on June 1 issued an advisory about a vulnerability in MOVEit software, warning that “a cyber threat actor could exploit this vulnerability to take over an affected system.”
Progress has since released a patch to fix the vulnerability, but about 90 companies are so far known to have been affected by the hack, according to cybersecurity researchers.
Last week, Shell Plc said it was investigating a possible data breach after it was targeted by Clop. The gang listed Shell among dozens of other victims including a US university, insurance and manufacturing firms, as well as banks, investment and financial services companies.
US government agencies have also been affected.
Clop has been among the most prolific cybercriminal gangs in recent years, causing hundreds of millions of dollars of damage internationally, according the cybersecurity firm Trend Micro Inc.
In a statement posted on its dark web page last week, Clop invited victims to reach out and negotiate. “We have information on hundreds of companies so our discussion will work very simple,” the gang said, claiming it had downloaded “a lot of your data as part of exceptional exploit.”
McKinsey Starts Cutting 1,400 Jobs This Week in Restructuring
* It’s One Of The Biggest Rounds Of Cuts At The Consulting Giant
* Firm Aims For Attrition Or Voluntary Exits For More Reductions
McKinsey & Co. is embarking on a rare round of major job cuts, with plans to eliminate about 1,400 roles.
The consulting giant, which has seen rapid growth in its headcount over the past decade, is restructuring how it organizes its support teams starting this week, including workforce reductions or moving people into other roles.
The total cuts will amount to about 3% of headcount that has ballooned to almost 47,000 from 28,000 just five years ago and 17,000 in 2012.
Consulting giant McKinsey is embarking on a rare round of major job cuts with plans to eliminate about 1,400 roles.@EdLudlow has more https://t.co/am9iDnxtYF pic.twitter.com/cOztmByRrO
— Bloomberg TV (@BloombergTV) March 28, 2023
“The painful result of this shift is that we will have to say goodbye to some of our firm functions colleagues, while helping others move into new roles that better align to our firm’s strategy and priorities,” Bob Sternfels, global managing partner, wrote in a note to staff.
“Starting now, where local regulations allow, we will begin to notify colleagues who will depart our firm or be asked to change roles.”
The total number of cuts were described by a person with knowledge of the matter, who asked not to be identified because the information isn’t public. A spokesperson declined to comment.
Unlike some of the major financial firms it works with, McKinsey rarely carries out job cuts in its own ranks. Even underperforming employees in client-facing roles tend to depart after being “counseled to leave” — a phrase that indicates the company doesn’t want them on client projects and recommends they try to find a different employer.
The company, where it can, is “implementing reductions through attrition or voluntary departures,” Sternfels wrote.
The firm — known for devising workforce-reduction plans for its clients — had been looking at eliminating about 2,000 jobs, people familiar with the plans told Bloomberg News last month, adding that the number of people to be cut from the firm could still change. Most of the affected roles don’t have direct contact with clients.
McKinsey posted a record $15 billion in revenue in 2021, and surpassed that figure in 2022, a person familiar with the matter said last month.
Consulting firm Accenture Plc said last week it will cut 19,000 jobs — about 2.5% of its workforce — over the next 18 months, one of the largest rounds of dismissals in the sector.
Companies in industries from finance and technology to retailing are reducing staff amid a slowdown in demand and predictions of a looming recession.
Tech giants including Amazon.com Inc. and Microsoft Corp. are making deep cuts, and Goldman Sachs Group Inc., Morgan Stanley and other top banks have been eliminating thousands of positions. Facebook parent Meta Platforms Inc. has undertaken two rounds of mass layoffs.
McKinsey’s move comes two years after Sternfels took over as global managing partner following a vote by its roughly 650 senior partners to oust his predecessor, Kevin Sneader.
The management shift was the culmination of a tumultuous period for the firm, which took flak for its role in advising the makers of the painkiller OxyContin and faced scrutiny of various other business ties.
U.S. Audit Watchdog Proposes Move To Get Inspections Started Faster
The PCAOB proposed slashing the period auditors have to assemble final documents on audits to 14 days from 45. That might get material information into investors’ hands faster, the group said.
The Public Company Accounting Oversight Board proposed cutting by more than half the amount of time auditors have to assemble final audit documentation, which might allow the audit watchdog to start its inspection process up to a month earlier and provide key information to investors sooner.
The U.S. audit regulator has been working to update more than 30 standards that have gone largely unchanged since they were adopted on an interim basis roughly 20 years ago from the American Institute of Certified Public Accountants.
With the proposal released Tuesday, the PCAOB suggested consolidating and modernizing four interim standards into one standard on auditors’ core responsibilities, including areas such as professional skepticism, independence, competence and professional judgment.
As part of that update, auditors would have up to 14 days to assemble their final set of audit documentation, as opposed to the 45 days they are now granted. These documents usually help show whether the audit work complied with PCAOB standards.
Most of the documentation in this process, known as archiving, is now occurring electronically, the PCAOB said. Many firms documented at least a portion of their procedures using paper-based systems in 2004, when rules on archiving were set.
Some firms compile the documents in as little as two to four days, while others take the full 45 days.
The PCAOB can’t begin its inspection of any given registered accounting firm until its auditors have put together a final set of audit documentation, a task that has to be done as close as possible to the end of a particular audit.
The PCAOB’s inspection teams select certain completed audits conducted by a firm for review.
By shortening the window to 14 days, the PCAOB could begin its inspection process earlier than usual, putting possibly material information in the hands of investors more quickly.
“This would lead to a waterfall effect that ultimately would provide the opportunity for us to get our inspection reports to investors sooner, enhancing their protection,” PCAOB Chair Erica Williams said on Tuesday.
Ms. Williams, who took the helm of the PCAOB in January 2022, has led several other initiatives at the regulator including dialing up enforcement of rules against audit firms and individual auditors that violate them.
The proposal would also seek to clarify the role of the partner in charge of an audit, particularly when planning, supervising and documenting audit-engagement activities.
This partner needs to review sufficient documentation to make sure that the engagement was performed as planned, a requirement more explicitly laid out under the proposal.
Consolidating the standards is aimed at helping to ease auditors’ understanding and compliance, the PCAOB said.
The public will have until May 30 to weigh in on the proposal, the PCAOB said.
EY Breakup Plan’s Fate May Rest On Executive Showdown This Week
Retired U.S. partners are also fighting the deal, worried about payouts they are owed.
The fate of Ernst & Young’s proposed split may be determined in Silicon Valley this week when feuding executives meet to hash out a deal that is acceptable to all factions.
One of those powerful factions won’t be represented at the meeting and doesn’t even work for the global auditing firm. Yet some of EY’s retired partners are playing a key role in trying to block the deal.
EY this month paused its preparations for the multibillion-dollar breakup, after its U.S. arm demanded a blueprint for the deal be reworked to give auditors a bigger share of the lucrative tax practice.
The unexpected revolt, putting the deal in jeopardy, has provoked infighting and rifts within the 390,000-person firm, according to people familiar with the matter.
This week’s meeting in Palo Alto, Calif., sets the stage for a potential showdown between the breakup plan’s architect, EY’s global leader Carmine Di Sibio, and the person most likely to derail it, EY’s U.S. leader Julie Boland.
Tensions between the two senior executives have escalated sharply in recent weeks, the people familiar with the matter said.
Ms. Boland, EY’s U.S. chair and managing partner, last week said the firm still needed to resolve questions affecting the financial strength of both businesses that will be created by the split.
Mr. Di Sibio responded with a direct appeal to EY’s 13,000 partners, telling them in an email they had “the right to vote on whether to proceed with a transaction,” according to a copy of his message reviewed by The Wall Street Journal.
The power struggle between the duo reflects the unusual structure of EY and other big accounting firms. Mr. Di Sibio runs EY’s global network, but needs approval from dozens of independent firms for the breakup.
Ms. Boland, as the head of the most powerful of those member firms, effectively holds sway over some 40% of EY’s global revenues.
There is also no guarantee the warring factions of EY can agree to a compromise deal. The U.S. demands to strengthen the audit-focused firm, at the expense of the new consulting company, could affect the amount raised by the split.
That in turn could reduce the windfalls for partners, making the deal less attractive to the U.K. and other overseas EY firms that lined up behind the original blueprint.
U.S. opposition to the deal, and criticism of Mr. Di Sibio, has also come from scores of retired EY partners, including former leaders of the firm.
Retired EY partners don’t get to vote on the deal. But they are an influential contingent. Many retain connections to the firm via friends or family, such as retired partner Jim Boland, who is Ms. Boland’s father.
Some retired partners serve as executives or board members at major companies, making them valuable as clients or potential clients.
Their central concern involves money. EY has around $7 billion of promised payouts to its retired U.S. partners that aren’t backed by a specific pot of money.
Retired partners worry the audit-focused firm, weakened by the sale of the consulting arm, may not generate sufficient earnings to meet these pension-style commitments in future, according to memos reviewed by the Journal.
“We are the largest creditors of the company and want to make sure our rights are protected,” one retired U.S. partner said.
EY’s leadership has pledged to use some of the estimated $30 billion that would be raised by the deal to increase the funding for retired partners, according to people familiar with the matter.
The firm has set up a committee to represent the retired partners, and agreed to pay for lawyers and actuaries to advise them, the memos reviewed by the Journal show.
But that may not be enough to quell the retirees’s revolt, which has morphed from concerns about pension obligations to questioning the benefits of doing a deal at all.
Four former EY leaders this month said there remained “significant questions…around the necessary strength EY must have” after any spinoff, according to a copy of their joint statement seen by the Journal.
Even if EY’s leaders succeed in overcoming the current impasse, retired partners could prove a continuing roadblock to getting a deal done. One group, who are organizing opposition to the deal online via Facebook and emails, recently appointed a law firm to advise on their rights, according to a memo reviewed by the Journal.
The start of that legal work has been delayed, while work on the deal itself is paused, the memo said.
EY Fails To Reach Deal On Split
Opposition to breakup plan is being led by two longtime U.S. auditors.
The unexpected revolt that has upended the planned breakup of accounting firm Ernst & Young is being driven by two longtime U.S. auditors who believe their part of the firm could end up weakened by a deal.
John King and Frank Mahoney, senior U.S. EY executives, have emerged as key opponents to the firm’s plan for a worldwide split of its auditing and consulting arms, according to people familiar with the matter.
After a year of planning and tens of millions of dollars in costs, the split of the 390,000-person accounting firm was put on hold earlier this month. A meeting in Silicon Valley this week failed to reach a deal.
Carmine Di Sibio, EY’s global leader, and Julie Boland, head of the firm’s U.S. arm, said in a joint statement Friday they were “continuing to work toward a transaction.” The deal is “very complicated, and we agree it is critical that we get the key elements right,” the statement added.
The stalemate dates back to earlier this month. Mr. King, EY’s U.S. head of auditing, and his predecessor, Mr. Mahoney, used a meeting of EY’s U.S. leadership to push back on the planned breakup, the people familiar with the matter said.
The two executives convinced EY U.S. chief Ms. Boland that the auditors should get a greater share of EY’s multibillion-dollar tax practice, according to people familiar with the matter.
Ms. Boland would lead the global audit firm, should the split go ahead. Mr. Di Sibio is expected to lead the new consulting firm.
As U.S. leader, Ms. Boland could have forced through the blueprint with the support of two-thirds of the U.S. executive committee, the people familiar with the matter said. But she was reluctant to ignore the concerns of the two senior auditor representatives and their supporters, the people added.
A group of powerful retired U.S. EY partners, including former leaders of the firm, is also fighting the split, people familiar with the matter said. They are concerned about the future of the auditing firm, which is on the hook for the firm’s pension payments.
An official committee representing U.S. retired partners has had discussions with Ms. Boland, according to emails viewed by The Wall Street Journal.
Ms. Boland this month appeared to support the need to rethink the deal, telling the Journal that “people are asking the right questions, and we’re making sure we’re getting those questions answered.” She demanded changes to the template for the breakup.
The U.S. is the most powerful of the scores of member firms that make up EY’s global network. A deal would be extremely difficult without U.S. participation.
Mr. King and Mr. Mahoney, who now leads the firm’s U.S. West region, didn’t respond to requests for comment. A spokesman for EY’s U.S. firm said “it would be impossible for a handful of people to derail the process under the U.S. firm’s governance rules.”
The surprise upending of the carefully orchestrated deal preparations has caused disruption and infighting at the firm.
Mr. Di Sibio, EY’s global chairman and chief executive, said in a recent internal email the firm’s 13,000 partners are “overwhelmingly in favor” of doing a deal, according to a copy viewed by the Journal.
Even if that is the case, there appears little that he or any of EY’s overseas firm leaders can do to push through a global deal should the U.S. firm’s leadership remain opposed.
This week’s meeting of EY’s global executives included Mr. Di Sibio and U.S. leader Ms. Boland, but not the U.S. auditors who balked at the original proposal, according to one of the people familiar with the matter.
The mood was broadly positive, but progress was limited because the U.S. firm is still working on an alternative template for the split, the person added.
EY’s leaders are looking at getting an agreement done in the next few weeks, according to one of the people familiar with the matter. The longer the uncertainty drags on, the greater the damage to the firm, industry watchers said.
One central concern is the impact on clients. Mr. Di Sibio in his recent email to partners said media coverage of the troubled transaction had led to “a larger volume of client questions being received and discussions being held.”
Rohit Deshpande, a marketing professor at Harvard Business School, said the delays to carrying out the split risked causing confusion about what the EY brand now represents.
“Clients are getting mixed messages as to whether strategically this was a good idea or not,” Mr. Deshpande said. “Speed is absolutely of the essence.”
The uncertain fate of the deal is also affecting staff morale, according to people familiar with the matter and messages on employee websites.
“This is an unmitigated disaster,” one EY employee wrote recently on Fishbowl. Another said they have “never been more embarrassed of this firm.”
Responding to the tensions between global leader Mr. Di Sibio and U.S. chief Ms. Boland, another EY employee commented: “Will someone pull these two aside and say please stop! Neither of you are helping the situation right now.”
The turmoil at EY could make competing firms look more appealing for employees, who are not in line for the multimillion-dollar payouts promised to partners should the deal go ahead.
That risk is heightened by the current widespread shortage of accountants, according to Troy Janes, accounting professor at Purdue University and a former EY auditor.
“If your firm seems like it’s not a fun place to be anymore, there’s other firms out there who would be more than happy to hire you away because they need people,” Mr. Janes said.
Ernst & Young Halts Breakup Plan After Revolt By U.S. Leaders
EY spent more than $100 million on split between auditing, consulting business.
Ernst & Young has axed its plan for a split of its auditing and consulting arms, marking a dramatic and costly retreat from a proposal that was meant to reshape the accounting profession but ended amid bitter infighting at the firm.
Global leaders of the Big Four firm said Tuesday they were “stopping work on the project” because the heads of EY’s U.S. arm, the biggest member of the global network, had decided not to move forward, according to a note sent to EY’s 13,000 partners.
Rather than creating two dynamic firms, EY is now left with a potential leadership vacuum, thousands of angry partners, a split between its U.S. and overseas partnerships and confused clients.
EY spent more than a year and over $100 million on the effort only to see it upended by a small group of senior U.S. executives.
“This is the beginning of a real period of nastiness,” said an EY U.S. partner who favored the deal.
EY’s global leaders said in the note to partners that they remained committed to the principle of splitting the auditing and consulting businesses.
But it isn’t clear how a split could be redesigned in a way that achieves consensus, given the failure of intense negotiations over recent weeks to rescue the deal.
“We thought we had something everyone would sign up to,” one person close to the deal said. “This means going back to the drawing board.”
The failure of the project marks a humiliating rebuff for Carmine Di Sibio, EY’s global chairman and chief executive, who championed the planned split.
Mr. Di Sibio had originally been scheduled to retire in June but was granted a two-year extension to see the proposal through and was nominated to lead the newly created consulting firm.
His plans were undone by a revolt among U.S. audit leaders who complained that the consulting business was getting the bulk of the firm’s lucrative tax business.
The auditors, joined by an influential group of retired partners, were concerned that the split would leave the audit business too weak to compete.
EY now faces a potential leadership crisis at the top of the 390,000-person firm. Mr. Di Sibio and EY’s overseas leaders who supported the breakup have lost credibility for failing to deliver on it.
Staff members are angry about the uncertainty the plan created and cost cuts imposed on them to boost profitability.
Julie Boland, the chief of EY’s U.S. arm and a potential leader of the firm, may struggle to command global support. She was due to head the new audit-focused partnership, but was unable to unite her executives behind the breakup plan.
The split entailed getting approval from partners in dozens of countries and hinged on a complicated plan to raise cash to pay millions of dollars to the audit partners for giving up the consulting business.
That plan faced headwinds from rising interest rates and volatile markets. EY had planned for the consulting business to borrow billions of dollars and raise billions more from an IPO to pay auditing partners, as well as fund pensions for retired partners.
Ms. Boland and other U.S. leaders said Tuesday that they would support a breakup at the right time, but also laid out their demands for change, according to a copy of an internal note viewed by The Wall Street Journal.
The firm needs to simplify its structure, invest in its most strategic businesses and modernize its governance, the note said. “These actions will also better prepare us to execute on transaction options in the future,” it said.
EY’s effort was closely watched in the accounting industry, which has moved aggressively into consulting operations despite potential conflicts of interest. EY hoped to create a template that other leading firms would be forced to follow.
Mr. Di Sibio said in December that the firm’s “competitors are jealous in terms of what we’re doing,” according to a copy of a webcast viewed by the Journal.
Instead of creating a model for the future of the profession, EY appears instead to have proved its doubters right. Joe Ucuzoglu, the global chief executive of rival Big Four firm Deloitte, last month said history was littered with examples of proposed transactions that “sounded great [with] pretty slide decks [and] lots of big promises” that never played out as intended.
Rival firms will likely try to poach disaffected EY partners, now that multimillion-dollar bonuses promised under the split appear to have evaporated, according to people familiar with the matter.
Cost-cutting to boost profit margins in the U.S. firm, including a suspension of the midyear bonus employees hoped to receive earlier this year, has added to staff frustration, the people said.
Differences over the planned split have riven EY’s U.S. firm, which contributes some 40% of the firm’s $45 billion in annual global revenue, according to people familiar with the matter.
Most of the executive committee backed the proposed deal, the people said, but U.S. managing partner Ms. Boland refused to override the objections of a handful of senior audit leaders.
The apparent ability of a few U.S. executives to wreck a deal affecting thousands of partners, in scores of countries, frustrated the global leadership.
Mr. Di Sibio told partners this month that the “overwhelming majority” backed the deal and that they had the right to vote on whether to go ahead.
The U.S. leaders in their note also focused on the growing financial challenges to the deal. Tougher economic and market conditions mean the “transaction economics have become challenged,” the leaders added, according to their note.
Mr. Di Sibio launched the plan, known as Project Everest, to address a longstanding limitation on the growth of the firm’s consulting business. Many countries prevent firms from doing consulting work for companies they audit.
That limited the pool of prospective consulting clients and companies the consulting firm could work with. This was a big issue for EY, which audits most of the large tech companies, meaning they couldn’t join with them on tech consulting contracts.
“The fact that this deal, as constructed, now seems unlikely to go ahead, doesn’t mean that the thinking that underpinned it was wrong,” said Fiona Czerniawska, chief executive of research firm Source.
“Clients are still looking for different delivery models, and EY’s specific constraint—the extent to which the firm can partner with big technology firms—remains just as urgent an issue to resolve.”
The breakup plan created uncertainty among the thousands of new graduates that EY needs to recruit every year. Jeffrey Johanns, accounting professor at the University of Texas at Austin, said some of his students graduating with master’s degrees in accounting and job offers from EY have been concerned about the implications of the split and its related turmoil.
The students hadn’t received start dates at EY, unlike their peers at the other Big Four firms, he said.
Deloitte Integrates Blockchain For Digital Credentials
The credentials will “have multiple use cases,” including regulatory compliance for banking and decentralized finance, age verification for e-commerce, private logins and fundraising.
Big Four accounting firm Deloitte has integrated blockchain technology to allow customers to store verification credentials in a single digital wallet to streamline the “typically inefficient” verification processes.
In a May 4 statement, Deloitte announced it has integrated KILT Protocol technology — a Polkadot parachain — to enable the issuance of reusable digital credentials to its customers.
The integration aims to improve the efficiency of Deloitte’s Know Your Customer (KYC) and Know Your Business (KYB) verification processes.
In the statement, Deloitte said the standard and “typically inefficient” processes, including KYC and KYB certificates being issued on paper, and identity verification requests requiring multiple data points when only one is needed, often create “extra work in the process.“
Additionally, these traditional verification procedures store data and personal information across multiple platforms and databases, placing consumer data privacy at risk.
Establish a digital identity with Deloitte and keep control of your data, sharing only the data you want to share. We are launching a credential verifier, in partnership with @Kiltprotocol and @Polkadot. Applications opening soon. #KYC #Blockchain #Web3
— Deloitte Switzerland (@DeloitteCH) May 4, 2023
The credentials will serve various use cases, including regulatory compliance for banking and decentralized finance (DeFi), age verification for e-commerce, private logins and fundraising.
While the wallet will be stored on the customer’s device and remain under their control at all times, Deloitte retains the ability to modify if circumstances change, as noted in the statement:
“Credentials are digitally signed by Deloitte. Deloitte can revoke credentials using blockchain technology if conditions of the customer have changed after the credential was issued.”
The company added that no prior knowledge of blockchain is required from customers to set up the credential wallet.
KILT Protocol founder Ingo Rübe said that the streamlined identity solutions built on KILT allow customers to use verifiable digital credentials across multiple services while maintaining control “over when and where to share personal information.”
As a Polkadot parachain, it also provides the “scale and security needed by enterprise partners,” he added.
Polkadot tweeted shortly after the announcement on May 4, saying that Deloitte leveraging KILT’s solutions to support its KYC and KYB processes is vital for safeguarding itself against illegal activity.
2/ Deloitte will leverage KILT’s reusable digital identity credentials to support its Know Your Customer / Know Your Business processes (KYC/KYB) – vital for protecting financial institutions against fraud, corruption, money laundering and terrorist financing.
— Polkadot (@Polkadot) May 4, 2023
This comes after reports on April 26 that there were over 300 crypto-related job opportunities available at Deloitte, with almost all of them being posted in the same week.
Meanwhile, searching for crypto-related job openings at the other Big Four accounting firms, Ernst & Young, KPMG and PricewaterhouseCoopers, showed no results.
Auditors Didn’t Flag Risks Building Up In Banks
Bond losses such as those at Silicon Valley Bank could have been raised as ‘critical audit matters’.
When KPMG LLP gave Silicon Valley Bank a clean bill of health just 14 days before the lender collapsed, the Big Four audit firm flagged potential losses on loans as a so-called critical audit matter.
But the audit opinion was silent on what actually brought down the bank—its unrealized bond losses and ability to hold them given a reliance on potentially flighty deposits.
“The auditors failed to mention the fire in the basement or the box of dynamite on the first floor, but they did point out the peeling paint on the flower box,” said Erik Gordon, a University of Michigan business professor. “How could they miss the interest-rate risk?”
The current banking crisis is the first big test of critical audit matters, a measure designed to help investors decode risks and uncertainties buried in financial statements.
Audit regulator Public Company Accounting Oversight Board introduced critical audit matters in 2017 to “breathe life into the audit report.” Described as the biggest shake-up in audits in 70 years, the new standard was meant to make audit opinions more useful to investors.
So far, though, critical audit matters have failed to shed light on issues that have caused a collapse of confidence among depositors and investors in many small and midsize banks.
Auditors are required to record any critical audit matters when they sign off on a public company’s books. Regulators define these as matters that have a significant impact on the financial statements and involve “especially challenging, subjective or complex” judgments by the auditors.
Silicon Valley Bank’s unrealized losses in its bond portfolio appear to “meet every definition of a possible critical audit matter,” said Martin Baumann, a former chief auditor at the PCAOB who had a leading role in designing the new measure.
The latest banking crisis has exposed the gamble some banks took in betting heavily on long-term government bonds, which last year plunged in value as the Federal Reserve raised interest rates.
Banks can keep these losses off their books by classifying their bondholdings as “held to maturity,” or intended never to be sold, allowing them to be held at cost rather than fair value.
The banking industry last year relied more heavily on this accounting maneuver, as rising rates pummeled balance sheets.
Accounting rules say banks can classify bonds as held to maturity only if they have both the intent and ability to hold on to them, rather than having to sell them to meet demands for withdrawals. For well-capitalized banks, that likely isn’t a tough judgment call to make.
But it is a much more nuanced issue for many of the lenders at the center of the latest banking crisis. Unlike the biggest banks, smaller banks are largely reliant on deposits for funding, which can prove flighty in stressed times, calling into question a bank’s ability to indefinitely hold long-term assets.
The parent of Silicon Valley Bank, SVB Financial Group, had $91 billion of held-to-maturity bonds on its Dec. 31 balance sheet, which a footnote said had a fair value of just $76 billion. That $15 billion loss was big enough to wipe out most of the bank’s total equity of $16 billion at year-end.
The lender’s total deposits had shrunk from the previous year, its financial statements showed. What’s more, its reported cash was only around 8% of total deposits, heightening the risk it would need to sell long-term assets if significant numbers of its depositors left.
That appears to tick all the boxes for the auditor to highlight this issue as a critical audit matter. “The judgment as to whether or not Silicon Valley Bank had the ability to hold these securities to maturity was certainly a complex question, it was material to investors, and it is hard to see how liquidity was not a matter for discussion with the audit committee,” said Mr. Baumann, who is also a former senior partner at Big Four audit firm PricewaterhouseCoopers.
“I’m not the auditor of the bank and I don’t know if this [bonds issue] should have been included in the auditor’s report,” he added. “But as the lead author of the standard, this certainly is the kind of item that we had in mind for critical audit matters.”
Representatives of the accounting industry pushed back on suggestions auditors should have sounded the alarm ahead of the crisis. Dennis McGowan, vice president of professional practice at the Center for Audit Quality, said accounting standards don’t require companies to anticipate “extremely remote” scenarios in deciding whether they can classify bonds as held to maturity.
“Some of what’s happened could not have been anticipated. Social media fueled the withdrawals from one bank, for example,” Mr. McGowan said. “Auditors don’t have a crystal ball to anticipate that kind of thing.”
KPMG’s audit of Silicon Valley Bank could be tested in court if shareholders decide to include the firm in the likely lawsuits.
“The lack of a relevant critical audit matter and of a going concern are going to come up if it comes to litigation,” said Jack Castonguay, an accounting professor at Hofstra University.
He added that it was difficult to judge KPMG’s audit without seeing the firm’s work papers or knowing what risks it discussed with SVB’s audit committee.
A KPMG spokesman declined to comment. In response to a request for comment to SVB’s successor bank, a spokeswoman for the Federal Reserve cited the regulator’s description of the bank’s failure as a “textbook case of mismanagement.” She declined to comment on KPMG’s audit of the lender.
Auditors’ apparent blind spot on the interplay of interest-rate and liquidity risks isn’t confined to Silicon Valley Bank.
Auditors for nine other U.S. banks most exposed to bond losses also didn’t flag this as an issue when they signed off on the financial statements for 2022, according to an analysis by The Wall Street Journal.
The Journal reviewed the audit opinions for the 10 small to midsize U.S. banks that last year reported the highest losses on held-to-maturity securities as a proportion of their shareholder equity, based on data from research-firm Calcbench. Silicon Valley Bank ranked second on the list.
None of the auditors included a critical audit matter related to the bank’s treatment of the bonds. Instead, nine of the 10 reported a critical audit matter for estimated losses from loans or other bad debts.
That is the risk that brought down banks in the 2008 financial crisis. Auditors didn’t report any critical audit matter for one of the banks, the analysis found.
A PCAOB spokeswoman declined to comment on whether the lack of critical audit matters related to the latest crisis was a reflection of the effectiveness of the measure.
“Unfortunately CAMS have not been used as fully as we had hoped for,” the former regulator Mr. Baumann said.
PwC Australia Tax Scandal Fuels Global Implications: Explained
* Leak Of Tax Info May Involve US Companies, Hurt PwC Reputation
* Treasury Has Referred Matter For Potential Criminal Probe
As PricewaterhouseCoopers’ Australia tax scandal moves into a new phase, the ramifications are likely to stretch far beyond Australia’s borders.
The scandal deals with an Australia-specific matter: PwC Australia’s misuse of confidential government tax information. But any investigation, like the one that Australia’s Treasury asked for on Wednesday, could extend into the US, in part because PwC’s Australia partners are believed to have shared the information with clients in the US. PwC’s US and UK affiliates have already expressed concerns.
While it isn’t yet clear whether other parts of PwC could be held liable for PwC Australia’s actions, the scandal also could deal a big hit to PwC’s global reputation, especially in the wake of a series of scandals at Big Four accounting firms in recent years that have called their ethics and performance into question.
PwC Australia says it “will continue to cooperate fully with any investigations into this matter.” The firm’s global governing body and the US and UK affiliates declined further comment.
Here’s a closer look at the fallout from the scandal.
What Did PwC Australia Do?
PwC partners took confidential information that a PwC executive had obtained while he was on a government advisory board—information detailing the government’s plans to crack down on corporate tax avoidance—and used it to solicit corporate clients to use the firm’s tax-planning advice, according to emails that were released after demands from Australia’s Parliament.
“This leak breaks every ethical rule in accounting,” said Richard Murphy, an accounting professor at Sheffield University in the UK. “There’s a fundamental conflict between governments’ reliance on big accounting firms for tax advice when these same firms are advising companies on how to avoid these taxes.”
As a result, PwC Australia CEO Tom Seymour and two other top executives have stepped down, and PwC has brought in an outside executive to conduct an independent review of the firm.
The Treasury has referred the matter to the Australian Federal Police and asked them to consider launching a criminal investigation.
What Are The Implications Outside Australia?
Like the other Big Four firms, PwC is structured globally as a network of individual, freestanding affiliates in each country where it does business.
That allows a firm in one country to avoid liability for the actions of the same network’s affiliate in another country, so it isn’t yet known whether PwC might bear any liability globally or in the US or UK for the actions of its Australian affiliate.
According to the emails, however, PwC Australia partners shared the proprietary information with clients that are believed to have included big US technology companies. And whether or not liability is established, the scandal is expected to impact PwC’s reputation worldwide.
Australian Sen. Deborah O’Neill, head of the Australian Parliament’s powerful Financial Services Committee, said earlier this month that the PwC emails contain references to Singapore, the UK, Ireland, the US and the EU, and “it’s clear this is an issue with global implications.”
Has This Type of Concern Arisen Before?
PwC and two other Big Four firms, KPMG and EY, all settled with the US government over their promotion and disclosure of tax shelters in the late 1990s and early 2000s.
In the most prominent such case, KPMG admitted to criminal conduct and paid $456 million in 2005 as part of a settlement to avoid criminal prosecution.
U.S. Regulator Proposes More Active Role For Auditors In Detecting Companies’ Law Violations
Audit watchdog PCAOB wants to require auditors to focus on any noncompliance that could have a material effect on corporate financial statements.
The Public Company Accounting Oversight Board wants auditors to take a more proactive role in flagging potential fraud at clients, requiring them to identify areas of noncompliance that could have a material impact on companies’ financial statements.
Under the current rule, auditors of public companies need to identify laws that they believe have a direct and material impact on the financial statements of their clients and detect illegal acts that fit that criteria.
Auditors don’t need to follow any plans or procedures to detect noncompliance by clients that have an indirect effect on their financials. Auditors also must communicate to the company’s audit committee about any illegal acts as soon as feasible before they issue their annual audit report.
The PCAOB now wants auditors to adopt a more active role in these situations.
A proposal floated Tuesday, by a 3-2 vote, would require auditors to perform procedures to identify the laws and regulations with which noncompliance could reasonably have a material effect on companies’ financial statements during their initial risk assessment, regardless of whether those effects are direct or indirect.
That could involve auditors asking executives about any correspondence they have had with regulators over suspected or actual instances of fraud.
Auditors would have to know every law or regulation relevant to companies’ operations—but not necessarily every law to which they are subject—for example, environmental laws for a chemical company. Other audit standards already require auditors to have a basic grasp of their clients’ regulatory environment.
The existing standard could be interpreted to allow auditors to have limited responsibilities with respect to noncompliance with certain laws and regulations unless they happen to stumble across the information, PCAOB Chair Erica Williams said Tuesday.
“The new standard makes clear what investors already expect—that it is the auditor’s responsibility to proactively be on guard for all noncompliance that may have a material impact on the financial statements,” Williams said.
Under the proposal, auditors also would have to assess whether they need outside experts, such as lawyers or engineers, in evaluating information once they have become aware a client violated or may have violated the law.
Auditors currently need to consult with specialists only if executives don’t sufficiently show the company didn’t commit an illegal act.
The proposal also strengthens requirements around how auditors convey their findings to others. Auditors would have to notify the company’s audit committee once they become aware of potential noncompliance and then again after they have evaluated such information.
Board members Duane DesParte and Christina Ho opposed the proposal, saying it could pose a significant cost to auditors and expand the scope of their duties beyond their core abilities. Ho said the proposed requirements aren’t fully transparent about the extensive new responsibilities to be imposed on auditors.
DesParte said he is “increasingly concerned” that the proposal and other items on the PCAOB’s standard-setting agenda will fundamentally alter the role of auditors without a full, transparent vetting of the implications, including a comprehensive understanding of the overall cost-benefit ramifications.
The current rule on illegal acts has gone largely unchanged since the PCAOB adopted it in 2003, shortly after the board was formed.
The standard is among many that the U.S. audit watchdog was allowed to copy on an interim basis from the American Institute of Certified Public Accountants, a professional association. The AICPA standard itself hasn’t undergone major revisions since 1988.
There have been several changes to U.S. laws and auditing standards in the 35-year window, particularly the 2002 Sarbanes-Oxley Act, which set up whistleblower programs and required certain businesses and their auditors to report on the adequacy of internal controls over financial reporting.
Tuesday’s move followed another recent proposal by the PCAOB aimed at preventing fraud. In December, the watchdog suggested tightening the requirements around how audit firms obtain and verify outside evidence about their clients, such as from customers and lenders.
Marcum To Settle SEC, PCAOB Claims Over Widespread Failures In SPAC Audits
The New York-based accounting firm known for its work with blank-check companies agreed to pay $13 million in fines as well as add an audit committee and a ‘chief quality officer’.
The Securities and Exchange Commission and its audit watchdog charged accounting firm Marcum with systemic failures in its quality controls and violations of auditing standards tied to work for hundreds of special-purpose acquisition companies and other clients.
New York-based Marcum agreed on Wednesday to pay a combined $13 million to settle the investigations, $10 million to the SEC and $3 million to the Public Company Accounting Oversight Board, without admitting or denying the claims, the regulators said.
One of the most prolific auditors of SPAC clients, Marcum failed to comply with standards related to areas such as audit documentation, engagement quality reviews, risk assessments, audit committee communications and engagement partner supervision across hundreds of SPAC audits, the SEC said.
The securities regulator said it found violations in 25% to 50% of the audits it reviewed.
Nor did Marcum design or implement an adequate system of quality control tied to certain audit standards or other key parts of these controls, including researching prospective clients’ business practices before accepting them, the SEC said.
The deficiencies occurred as Marcum more than tripled its number of public-company clients, the majority of which were SPACs, over a three-year period, according to the SEC.
The firm served as auditor on more than 400 SPAC initial public offerings in 2020 and 2021, the SEC said.
During the SPAC boom, Marcum “prioritized increased revenue over audit quality,” Gurbir Grewal, director of the SEC’s enforcement division, said in a statement.
“From 2020 through 2021, the market saw more than 860 SPACs complete IPOs and Marcum audited nearly half of them, without adequate consideration for its ability to serve as gatekeepers.”
By June 2021, Marcum had 882 SPAC clients, the SEC said, up from 113 the previous September. Those figures, though, included “clients to whom Marcum had only sent out a draft engagement letter,” but were never subsequently turned away, the SEC said.
The 2020 and 2021 boom of SPAC mergers, in which a privately held firm combines with a public blank-check company to allow the private company’s shares to trade publicly, dwindled amid the broader market downturn.
The SEC reviewed SPAC accounting and disclosures more closely during the sudden rise in these transactions, for example, saying in 2021 that some SPACs had improperly accounted for warrants sold or given to investors.
The SEC warnings led to a surge in companies restating their financials, which has since dropped off.
The PCAOB, in addition to fining Marcum and requiring certain training for all audit staff, said the accounting firm must make functional changes to its supervisory structure related to the firm’s system of quality control—a first for the watchdog.
Marcum will have to create the role of and hire a “chief quality officer” to oversee its quality control system as well as form an audit committee to provide oversight on the auditing business. The PCAOB said it closely coordinated with the SEC on its investigation.
A Marcum spokesman said the firm is working closely with an independent consultant to ensure that it fully meets PCAOB audit standards. “This process with the SEC and PCAOB identified critical areas for improvement in the firm’s internal quality control and documentation processes,” he said.
“We remain committed to maintaining the full confidence of our clients, regulators and investors,” the spokesman added.
Big Four Accounting Firms Pare Their Consultant Ranks In Postpandemic Reversal
Professional-services giants are facing the consequences of aggressive hiring over the past two years, coupled with less attrition than they expected.
The Big Four accounting firms are trimming their consulting ranks—sometimes months after a promotion—after forecasting slower growth as more businesses scale back on third-party help in certain areas.
The firms—Deloitte, Ernst & Young, KPMG and PricewaterhouseCoopers—are facing the consequences of aggressive hiring over the past two years as the pandemic spurred higher demand for consulting in areas such as corporate strategy, coupled with lower attrition than they expected during the first half of the year.
The recent rounds of layoffs have been heavily focused on the advisory sides of the firms. KPMG laid off about 5% of its U.S. staff in June—including advisory, tax and back-office people—four months after cutting some advisory personnel, nearly 2% of U.S. staff.
In April in the U.S., Deloitte cut 1.5% of its staff and EY 5%. PwC said its U.S. unit hasn’t had layoffs and isn’t planning any.
Outside the Big Four, Grant Thornton let go 3% of its U.S. staff in May.
While hiring soared in the wake of the pandemic, other data sets show exits were also rising. In the U.S. at the four firms, exits—both voluntary and not—have generally climbed each year since at least 2019, according to a review of online professional profiles by Revelio Labs, a provider of workplace data. In 2022, roughly 56,600 people collectively left the firms, up 8.3% from a year earlier in the Revelio data.
But that scenario flipped this year, even amid layoffs. Exits at the four big firms have dropped, falling 11.6% through June from the year-earlier period, to about 21,400 in the U.S., according to Revelio.
“Life became more flexible and folks have found reasons to stay where they might have been ground to a fine powder prior years,” said Michael Shaub, an accounting professor at Texas A&M University, referring to remote work and salary increases that might have kept some from resigning this year. “Now the firms are saying we can’t keep all these people.”
EY and KPMG declined to comment for this article, and Deloitte didn’t respond to a request for comment.
PwC said it expects to report an increase this year in its global workforce from the nearly 328,000 it reported last year, adding individual staffing decisions are based on local circumstances.
Consulting work exposes firms to more fluctuation in revenues, which can be particularly damaging in a slower economy, compared with auditing, which is a mandatory expense for public companies.
Clients are still working with consultants to pour more investment into building out their tech capabilities, for example, further applying artificial intelligence throughout the business.
But they also have slowed their mergers-and-acquisitions activity and need for related support such as due diligence.
“Client demand isn’t shrinking, but it’s certainly changing shape, so they need more experts in one field and need fewer in another,” said Fiona Czerniawska, chief executive of consulting-industry analyst Source Global Research.
U.S. and global consulting is expected to experience much lower growth through 2025 than in the boom times of 2021 and early 2022, Czerniawska said.
The global consulting market is projected to expand by 6% to 10% this year, putting its size between $245 billion and $252 billion, building on a 10.7% increase in 2022, according to a Source report from February.
In the U.S., consulting is expected to grow by 10.6% to $97.31 billion this year, rising at roughly the same 10.5% pace as last year but down from an 11.1% rate in 2021, Source said.
The Big Four firms’ global advisory revenue collectively has more than doubled since 2010, to $94 billion in 2022 from $39 billion a decade earlier, as the audit business comprised an increasingly smaller portion of total revenue, a review of annual reports show.
The firms also square off with consulting giants such as Accenture and Bain & Co. Accenture reported $61.59 billion in revenue for the year ended in August 2022, up roughly 22% from the prior-year period, a filing showed.
Consulting in the U.S. has been generally more recession-resilient than in other countries, but there are signs that businesses are putting more projects on the back burner.
Seventy-seven percent of U.S. consulting clients said they have canceled at least some existing projects, according to a Source survey released in June.
The loss of consulting revenue from key corporations is also raising concerns. Large companies across industries account for most of the falloff in global consulting demand, because they are reallocating their spending as a way to boost efficiencies, according to a report released last week by Kennedy Research Reports, which tracks the consulting industry.
But Czerniawska said smaller, less strategic projects remain more likely to be cut back, suggesting that, on average, the large firms are doing better than small and midsize ones.
The uncertainty around future consulting demand is occasionally visible in the timing of dismissals and recruitment, for instance, the laying off workers in sporadic bursts, cutting people within six months of promoting them or delaying the start dates of new hires.
Balancing supply and demand in consulting firms is particularly difficult when clients’ needs are changing quickly and unpredictably, Czerniawska said.
But the firms, some of which focus on individual performance as the basis for cuts, risk losing stature if they slash a sizable chunk of jobs at once.
“If you promote and then you realize you need to make people redundant, that doesn’t sound like a great way of doing it, but some firms are clearly taking that approach,” Czerniawska said. “Everybody tries to manage this in a low-key way, because of the reputational damage of taking out too many people too publicly.”
Consulting is also particularly prone to layoffs because clients increasingly expect specialized skills and experience with certain tools and data, unlike 20 years ago when consultants more freely moved from one area to another, Czerniawska said.
“Firms don’t have much choice except to lay people off from one area when they might be recruiting in another because the services they’re delivering are becoming more specialized,” she said.
Consulting firms’ net head count growth will likely be lower this year than it has been in recent years, though it varies widely by practice, said Andrew Nicholas, a research analyst at investment bank William Blair & Co.
If demand hasn’t fallen off a cliff and attrition is lower, firms will have fewer open roles to fill, reducing the number of job postings, he said. “You would anticipate that to help bridge that gap,” he said.
U.S. job postings at KPMG, Deloitte and EY across all business lines dropped 76% in July compared with a year earlier, said William Blair, which doesn’t track PwC due to an inability to determine the number of positions on its internal job postings board.
Accounting Watchdog Expects Deficiencies In 40% Of Public-Company Audits In 2022
Audit firms point to staff turnover and reliance on less-experienced workers for PCAOB’s findings. Chair Erica Williams calls findings ‘completely unacceptable.’
The Public Company Accounting Oversight Board found greater auditing deficiencies in its inspections of accounting firms last year as the firms faced staff turnover and generally used less experienced workers.
Inspectors expect that roughly 40% of the audits they reviewed in 2022 will have had at least one deficiency, meaning the audit firm failed to obtain sufficient evidence to back up its opinion, according to a report released Monday by the U.S. auditing watchdog.
That is up from 34% in 2021 and 29% in 2020. The PCAOB said it expects to finish firm-inspection reports later this year.
The PCAOB not only inspects audit firms and sets audit standards but also disciplines the firms for violations, not necessarily related to inspections.
The regulator, which is overseen by the Securities and Exchange Commission, said it inspected 157 audit firms and reviewed portions of 710 audits in 2022, up from 141 firms and 690 audits a year earlier.
Several firms attributed lower audit quality to higher levels of staff turnover, reliance on less experienced staff and adoption of remote work, which accelerated due to the Covid-19 pandemic, the PCAOB said, adding that it doesn’t analyze the root causes of audit deficiencies.
Audit firms have been grappling with a deepening shortage of auditors and accountants as more professionals retire without a robust pipeline of replacements.
The firms should have a strategy to address recurring challenges, some that arose after the start of the pandemic, Chair Erica Williams said.
“That war for talent is something that has been around and is no longer a new phenomenon and so firms again really do have to meet this responsibility and turn this troubling trend around,” she said. Williams called the 40% deficiency rate “completely unacceptable.”
The PCAOB under Williams has been stepping up its enforcement efforts, in contrast with the previous leadership, which faced accusations of being too cozy with the audit profession.
It imposed $10.5 million in total fines against accounting firms and individual auditors in 2022, up from an average of $2.1 million over the previous five years, according to a February report from Cornerstone Research, a financial consulting firm.
The penalty total reached the highest level since the PCAOB’s formation in 2003.
“Where we find wrongdoing, we will not hesitate to pursue it where appropriate,” Williams said. “Ultimately though, the responsibility to correct [audit deficiencies] falls on the audit firms.”
In May, the PCAOB said it found significant auditing deficiencies in its first-ever set of inspections in China and Hong Kong. It issued inspection reports showing that KPMG and PricewaterhouseCoopers had deficiency rates of 100% and 75%, respectively, in those two areas, based on a review of eight audits across the two firms.
SEC Chief Accountant Warns Accountants About Liabilities When Auditing Crypto Firms
Paul Munter says making or allowing misleading statements can have serious consequences for accounting firms and individual accountants.
Paul Munter, chief accountant of the United States Securities and Exchange Commission (SEC), has released a statement warning accounting firms of their obligations to the agency when working with crypto firms.
Allowing their finding to be misrepresented could have serious consequences, he said.
Crypto firms may engage accountants to “perform some sort of review of certain parts of their business, often presented as a purported ‘audit’” and falsely present the work as being comparable to a financial statement audit, Munter wrote. Doing so is not only misleading, but it can have legal liability.
Accounting firms have a legal obligation under the Securities Exchange Act of 1934 to look for illegal activities and report them to the SEC, Munter continued.
“Material misstatement” by accountants or their clients could violate both the Securities Exchange Act and the Securities Act of 1933, resulting in censure or suspension of the firm. Those provisions can also be applied to individuals.
Munter advised accounting firms to consider these issues during client onboarding and to consider contractual prohibitions on certain language. In response to misleading statements, the position of the SEC Office of the Chief Accountant is:
“As best practice, the accounting firm should consider making a noisy withdrawal, disassociating itself from the client, including by way of its own public statements, or, if that is not sufficient, informing the Commission.”
The accounting firm’s independence is vital, Munter continued, and even the appearance of a mutual interest or conflict of interest in its public statements could be enough to have the firm suspended from “the privilege of appearing or practicing before the Commission.”
Want to hear perspectives from the SEC Office of the Chief Accountant? Listen to our latest podcast with guest speaker SEC Chief Accountant Paul Munter for insights on accounting and audit hot topics. #KPMGFRV #SEC #audit https://t.co/a2MsEjOvbR
— Joe Bailitz (@JoeBailitz) July 25, 2023
The SEC does not have the resources to scrutinize every financial statement, and it “relies heavily on accountants to assure corporate compliance with federal securities law requirements,” Munter wrote.
In 2022, his office issued the SEC’s Staff Accounting Bulletin 121, which also concerned third-party disclosures and was widely criticized as regulation by enforcement.
How A Common Accounting Rule Leads To More Layoffs And Less Job Training
Because employees don’t have value in accounting terms, they can’t be considered assets. They can only be costs.
Financial accounting isn’t always the easiest topic to get fired up about. But that’s a mistake, especially these days.
Accounting rules increasingly are driving companies to make bad decisions about how they hire, fire and develop their workforce. And it is time to rethink those rules.
The problem stems from the assumption in financial accounting that only things that can be owned have value—like machines and real estate. Obviously, you can’t own employees—so, under this logic, they can’t have value.
That is true even if all the value in a company lies in the abilities of its key employees, and those employees are locked in with contracts, noncompete agreements, long-term incentives and so forth.
As somebody who has studied the workplace for four decades, I have seen this assumption wreak havoc on companies and employees alike.
That’s because if employees don’t have value in accounting terms, it means they can’t be assets—in other words, things that have value for the company.
They can only be costs that a company must pay.
If that is the case, laying off employees saves money; companies are just getting rid of costs, after all, not anything of real value. To carry the logic even further:
Because it is only possible to invest in assets, and employees aren’t assets, the money spent to train and develop them can’t be an investment. Those are current and administrative expenses lumped in with coffee and office supplies.
This flawed picture of workers is set down in Generally Accepted Accounting Principles created by the Financial Accounting Standards Board.
The rules, no doubt, made much more sense when they were formulated more than half a century ago, when manufacturing was a much bigger part of the economy, and holdings like factories played a much bigger role in a company’s financials.
But now human capital looms much larger for many businesses. Think of how much of the tech industry is built on the skills of its employees—programmers and other professionals—rather than its physical holdings.
Accounting rules don’t recognize that value. Employees are still costs, not assets, and that leads to a number of disastrous problems.
(When asked about the rules, and the damage they may potentially do, the FASB and SEC declined to comment.)
The Human Factor
The most visible problem the current standards cause is layoffs. If employees were treated as assets, layoffs would be the last—rather than one of the first—things to think about in difficult times.
Dumping assets would seem crazy, especially knowing that companies might soon have to replace them. But, as we’ve seen, dumping employees in practice just means dumping costs.
Consider the layoffs going on now in businesses that only months ago struggled to hire people and likely will need to hire again soon.
This view leads companies to skimp on employee development, as well. Consider a choice between buying a piece of equipment to perform a task—such as robots or AI—or retraining an employee to do it.
If a company buys the equipment, it counts as an asset that offsets liabilities. Companies can amortize it and pay it off over time as the value from it comes in.
If companies retrain an employee, though, there is no asset value. If a company can’t cover the training cost in that year, then the training appears to be a losing proposition. So, companies systematically underinvest in training versus other spending.
They do this even though employees obviously become more valuable with time—unlike software or equipment—as they gain skill and experience.
From there, it is a short step to other problems, such as skimping on accrued benefits that are earned over time, such as vacation and sick leave or pensions. Accrued benefits are perfectly sensible for encouraging employee commitment and retention.
But they are terrible for financial accounting because they are treated as liabilities that must be offset by an equivalent amount of assets.
All of that hurts employees who are already part of a company, not to mention the companies themselves. But the current rules also distort how companies hire people in the first place.
Financial accounting requires that companies report their total number of employees, and important measures of performance are calculated on a per employee basis, such as profit per employee.
So, companies finesse the employee problem by using leased employees, who may work in the company’s offices but are employed by a third-party vendor. More important, these employees aren’t counted as liabilities for accounting purposes.
Beyond that, the investor community doesn’t view these workers as fixed costs—the worst kind of costs, because it is believed they can’t be cut if the business goes down. Regular employees’ salaries, on the other hand, are seen as fixed costs.
By some measures, leased employees now constitute 11% of the workforce. In many tech companies, nonemployees are over half the labor being used.
There are countless downsides to this arrangement. Leased employees have few obligations to their client. Their contracts aren’t especially flexible. And they are typically more expensive per hour than regular employees, especially when considering the vendor fees.
A related and arguably more common practice than leasing is simply to leave jobs vacant under the guise of saving money. This practice cuts employment costs—but doesn’t measure the lost value of work not getting done.
Investors have known about the distortions involved in financial-accounting rules for a long time. But they have become much more vocal about changing the rules in recent years, to get more transparency about what companies are really spending.
In 2021, the SEC required companies to report whatever they thought would be material human-capital issues—but companies can choose to report whatever they want, or nothing.
So far, businesses largely don’t disclose much of anything voluntarily because they know that they then will have to keep reporting it, even when the news is bad. Otherwise, investors will assume that the news must be really bad, or they would be reporting it.
There are now proposals before the SEC that would require companies to report simple human-capital measures, such as total spending on labor, not just employees, and spending on training.
In theory, companies would no longer have strong incentives to use leased employees, drop accrued benefits and skimp on worker development. Those costs would no longer look like spending on coffee.
It is rare to think of policies that are better for investors, employees and economic efficiency all at once, but improving the transparency around human capital is one of those.
Hester Pierce Strikes Back Against Sec Crypto Warning To Accounting Firms
Hester Pierce, a United States Securities and Exchange Commission commissioner, argued that full transparency should not come at the cost of compromising good-faith efforts.
Commissioner Hester Pierce of the United States Securities and Exchange Commission (SEC) has raised concerns about the agency’s recent statement advising accounting firms against taking on non-audit work for crypto firms.
In a July 28 tweet, Pierce challenged the recent statement by the SEC’s chief accountant Paul Munter, proposing that accounting firms adopt an all-or-nothing approach in their dealings with crypto firms.
Pierce believes this might cause crypto firms to shy away from making good-faith efforts to be transparent.
Crypto platforms & their accountants should be clear about what proof of reserves is and isn’t & customers should understand the limitations, but why would we want to discourage good-faith efforts to provide more transparency? https://t.co/fsuxUGPrrb
— Hester Peirce (@HesterPeirce) July 27, 2023
While Pierce noted that crypto firms and accountants should ensure transparency regarding proof of reserves, specifying what is and isn’t acceptable, she questioned why accounting firms should be cautious of providing assurance work to crypto firms.
“Why would we want to discourage good-faith efforts to provide more transparency?” Pierce asked in a tweet.
Munter argued that partial engagements might result in crypto firms selectively choosing only certain aspects of the business to show accounting firms and then presenting that information as a full audit to clients.
He believes that work beyond a full audit’s scope will lack transparency for investors, stating:
“Certain crypto asset trading platforms, with others in the crypto industry, have marketed to investors their retention of third parties, sometimes accounting firms, to perform some sort of review of certain parts of their business, often presented as a purported “audit.“
According to Munter, if an accounting firm discovers that a client is making misleading statements about its non-audit work to the public, it should consider making a “noisy withdrawal, disassociating itself from the client” by making a public statement or reporting the crypto firm to the SEC.
Mike Shaub, an auditing and accounting ethics professor at Texas A&M University, responded to the statement in a July 29 tweet, mentioning that auditors are obligated by confidentiality, making it challenging to make public statements like Munter suggested.
The recent trend has been to take credit as being cutting edge (e.g., specializing in SPACs or crypto or whatever) to raise the profile, then to be low profile when things go south. That may have triggered SEC interest as well. If the auditor is silent in these cases, beware. 2/2
— Mike Shaub (@mikeshaub) July 28, 2023
Shaub also highlighted the issue of some accounting firms aligning themselves with cryptocurrency expertise to boost their reputation but becoming unresponsive when problems arise.
U.S. Auditing Watchdog Tries To Remake Itself, But It Isn’t Easy
Chair Erica Williams has tried to set the troubled PCAOB on a new course. The ambitious shift has been marked by policy divisions and onerous work demands, but also a bounce in morale.
When Erica Williams took over the Public Company Accounting Oversight Board, she had her work cut out for her: mend a fractured culture, put some teeth into enforcement and bring outdated auditing rules into the present.
In January 2022, when she became chair of the PCAOB, the audit regulator had recently suffered a major blow. The Securities and Exchange Commission, overseer of the PCAOB, had dismissed former Chair William Duhnke the previous year and replaced most of the five-member board amid what was described as a culture of fear under Duhnke.
Appointed by SEC Chair Gary Gensler, Williams soon signaled a tougher enforcement approach to send a message to the audit profession, vowing to conduct more sweeps to root out wrongdoing by audit firms, strengthen and update standards and make inspections more efficient and transparent.
“This board is approaching enforcement with a renewed vigilance,” she said at a conference in September. “We intend to use every tool in our enforcement toolbox and impose significant sanctions, where appropriate, to ensure there are consequences for putting investors at risk and that bad actors are removed.”
Last year, the regulator fined accounting firms and individual auditors a total $10.5 million, a fivefold leap from an average of $1.9 million in each of the previous five years, according to Cornerstone Research, a financial consulting firm.
The 2022 penalty total was the highest since 2003, when the PCAOB was created as part of the 2002 Sarbanes-Oxley Act after the Enron accounting scandal.
But that ambitious agenda is also straining staff and bringing to the surface previously rare board dissent.
Williams’ goals place significant expectations on employees to carry the new policies out, with requests, for example, to generate a big number of enforcement cases, people familiar with the matter said.
Enforcement staff feel pressure to get significantly larger fines from accounting firms and auditors than in the past, the people said. Williams has said the PCAOB wants to increase the quality and types of cases it is pursuing, along with higher penalties.
The PCAOB brought 42 enforcement cases in 2022, up from 22 on average from 2018 to 2020 under Duhnke, but down from a 51 average the prior three years, during which James Doty served as chair, the PCAOB said.
“The PCAOB is mending. Under the prior board, I think there was a big morale problem, but I think that morale problem is easing.”
— J. Robert Brown, former PCAOB board member
The increased regulatory activity generally has been in line with that of the SEC under Gensler, who spearheaded the PCAOB overhaul. And Gensler, who has been SEC chair since April 2021, has faced similar criticism of work demands.
In a report last October, the SEC’s internal watchdog said the Gensler-led agency’s more aggressive agenda had stretched staff resources and increased risk of litigation. The SEC declined to comment for this article.
Morale, however, is generally higher at the roughly 900-person watchdog under Williams, according to current and former employees.
“The PCAOB is mending,” said J. Robert Brown, who served as a board member from 2018 to 2021. “Under the prior board, I think there was a big morale problem, but I think that morale problem is easing.”
In a statement, Williams commented, “Protecting investors on U.S. markets drives everything we do at the PCAOB,” adding, “The Board and I will continue working together alongside the dedicated staff to improve audit quality for investors while making the PCAOB an even better place to work.”
The PCAOB, which regulates the accounting firms that audit U.S.-listed companies, sets audit standards, inspects audits and disciplines firms for violations.
Currently, it has nine active proposals for new and updated standards, at least two of which it plans to adopt this year, and four additional rules it plans to propose by year-end, including a standard on auditors’ assessment of a company’s ability to continue operating.
And that ramped-up rule-making has laid bare some policy fissures. The board had a rare split vote on policy, when Duane DesParte and Christina Ho—the only two board members who are certified public accountants—in June opposed a PCAOB proposal requiring auditors to take a more proactive role in flagging possible fraud at their clients.
DesParte, the board’s sole holdover from the Duhnke era, at the time expressed dismay at the PCAOB’s broadening agenda.
“As we proceed one by one, I am increasingly concerned that we are establishing new auditor obligations and incrementally imposing new auditor responsibilities in ways that will significantly expand the scope and cost of audit and fundamentally alter the role of auditors,” he said.
The divided vote underscored a longstanding divergence between the PCAOB’s audit professionals and staff more focused on investors, typically over how much to require from auditors.
The Center for Audit Quality, an industry group, also criticized the proposal, echoing some of DesParte’s concerns. The Council of Institutional Investors, however, said the proposal benefits investors, but also suggested it could go further in expanding auditors’ responsibilities.
“For two decades, the PCAOB failed miserably to update and revise all the standards it inherited, but they still have a long way to go.”
— Lynn Turner, PCAOB advisory group
The PCAOB is in the process of updating nearly 40 audit rules related to 13 of its standard-setting projects, many of which refer to outdated technology.
Since its inception, the group has used much of the rulebook of the American Institute of Certified Public Accountants on what was supposed to be an interim basis.
Many investors, however, say the PCAOB has never gone far enough to strengthen standards and enforcement, and it has yet to adopt any standards proposed under Williams.
“For two decades, the PCAOB failed miserably to update and revise all the standards it inherited, but they still have a long way to go,” said Lynn Turner, a member of the PCAOB’s investor advisory group and former SEC chief accountant.
In a statement, Williams said she is “proud of the accomplishments the Board is achieving” working together on behalf of investors.
Williams has also made some efforts to improve working conditions following a turbulent stretch at the watchdog. In 2017, the SEC replaced the board after a scandal involving the leak of confidential inspections data.
In 2019, a whistleblower alleged that Duhnke, who became chair in 2018, was pushing out career personnel, in some cases in retaliation for disparaging the organization, and engaged in a politicized attempt to run down the PCAOB.
A January 2021 report by former SEC Chairman Harvey Pitt said there was an “environment of fear and distrust” among the staff under Duhnke that led to the allegations.
Speaking of the 2017 aftermath, Duhnke said: “In the wake of the cheating scandal, the PCAOB needed a comprehensive reset … As one might expect, some were unhappy with the changes. Instead of rising to the challenge, they resorted to filing numerous false anonymous complaints.”
Under Williams, the PCAOB takes regular employee surveys, has extended paid parental leave to 16 weeks from four, and holds group discussions to improve the culture.
In an internal survey, 84% of staff said they would recommend the PCAOB “as a great place to work,” well up from 55% a year earlier. The PCAOB declined to provide the full results of the survey, which was conducted between March and May.
In recent weeks, the PCAOB has had a series of high-level departures, among them Ken Lench, general counsel; Eric Hagopian, information and data chief, and Raymond Hamm, the deputy director of enforcement and investigations.
Williams has elevated veteran staffers Karen Dietrich and Barbara Vanich to director of the office of international affairs and chief auditor, respectively, while also appointing outsiders to key roles including enforcement and investigations director and the organization’s first chief operating officer.
Still, observers see Williams’ ambitions as a tough climb.
“Chair Williams probably has some really good intentions to change the culture, but culture is very hard to change and will likely take years to achieve,” said Kim Westermann, an associate professor of accounting at California Polytechnic State University who has conducted research on PCAOB inspections.