How the auditors keep dodging the fraud bullet

A new report by Open Secrets puts them back in the crosshairs.
Scrutinising the scrutinisers … the problem is that audit and accounting regulations are heavily influenced by auditors and accountants. Image: Supplied

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

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

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

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

Read: Big four auditors face investor calls for tougher climate scrutiny

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

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

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

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

Here’s a sampling:

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

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

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

Read: Eight suspects arrested in SA’s ‘biggest bank robbery’ VBS fraud case

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

Lack of independence

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

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

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

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

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

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

Slap on the wrist

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

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

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

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

What to do

Open Secrets recommends several steps to reform the profession:

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

The report is available here.

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Accountants and Auditors are essential to the smooth functioning of commercial and other ventures, despite the reprehensible behavior of a few bad applies (which is unacceptable, given the ethics to which CAs(SA) subscribe).

CHARLES ARNESTAD CA(SA), CFA

charlesarnestad, if they are so good then they should not fight the new legislation with uncapepd fines tooth and nail… but yet they are?

Charles, read the report please. This is a systemic issue not “a few bad apples” – your comment is not justified by the facts.

@CHARLES forgive me if I have the wrong end of the stick here but in the following paragraph “One of the Open Secrets authors, Michael Marchant, said at the launch of the report on Thursday that audit firms are faced with a clear conflict of interest when allowed to conduct both audits and consulting for the same client.”
Wasn’t this supposed to be have been stopped, I thought the whole Arthur Anderson and Anderson Consulting was exactly what this was about? I would really love to hear your opinion.
I for one don’t believe that the whole profession is bad although this behavior is painting the industry and rotten.

Absolutely Charles : What is wrong though in my opinion ,as a very pre 94 CA(SA) (does that make me an Emeritus CA(SA)!!)is that the Auditing profession has morphed into Consulting more than Auditing : At least if firms want both then use 2 Audit/Consulting firms:
We also now have all sorts of other “accountants” CPA,s , CFA,s etc etc so in my opinion the entire accounting profession has been degraded.
Put a CA(SA) into every Municipality and you would clean up this countries Finances within a year : Trouble is you would have a plague of Dead CA(SA,s) in the same period.
An Audit report is there to state the fairness of Financial Statements : An Auditor (unless specifically forensic)is not there to establish if the Coy overpaid for Stationery etc etc.
I am indeed saddened to see some well known Auditing Coys bringing the profession into disrepute :

I agree. But the system to find the bad apples must be quick and effective. As an aged Attorney a report to the Law Society and a disciplinary hearing was treated with trepidation. I fear that this is no longer the case with the professions. So principles go out the window.

I agree but they are continually doing the opposite and object to being sanctioned effectively. My guess if you look at Eskom, SAA, Transnet, municipalities then VBS, Steinhoff, Tongaat etc is that “auditors” have “signed off” on around 10% to 25% of SA’s GDP being stolen or mismanaged.

The examples, and the ongoing malfeasance, show that sanctions are ineffectual. Rather demonstrate honesty, courage and integrity, not “smooth functioning” (this could mean lubricating money into Gupta pockets). Then support jail time for the “bad apples”.

Otherwise yours is just more accountant waffle speak.

We all know math’s is a problem for South Africa

No. Ethical behaviour has long been a problem for South Africa’s ruling elites, regardless of race. It’s a class thing.

Careful not to throw out the baby with the bath water. We do not know how many disasters have been saved by the auditors.
I blame IFRS for the audit failures. An inordinate amount of time is spent on justifying accounting treatments as opposed to auditing the business.
Scrap IFRS. So few understand it and even less make decisions based on the IFRS accounts.

All this shows one thing and that is that IRBA is basically a useless watchdog.

The big auditor firms are culpable by the complicity in a lot of corruption and state capture.

They are part of the symbiotic ‘feeding at the trough’ and aiding and abetting corruption in the public and private sector.

Personal Trainers who constantly push their clients to overexert themselves, struggle to retain their clients and to get new clients. A GP who tells his obese patient that he is fat and lazy, and that he is killing himself with his bad diet, will lose patients. The CA who threatens his client that he will report all immaterial issues to the regulator will not have any clients. The system incentivises entrepreneurs to look the other way sometimes if they want to build their business.

It is not the responsibility of the personal trainer to ensure the fitness of the athlete. That responsibility lies with the athlete. The doctor is not responsible for the lifestyle choices of his patients, he merely helps them to recover from the results. The CA is not the Hawks or the prosecuting authority. Overregulation will not stop criminality but it will destroy the development of small businesses. The prosecuting authorities are incompetent, so they force the CA to do their job without paying him for that job. This is the new form of slavery through legislation.

When the government plunders property rights through the legislature, law and order give way to institutionalised criminality. When plunder becomes a way of life for a group of men in society, eventually they find a cause to justify it and a moral code to glorify it. Now we have reached the stage where we blame honest, hardworking professionals for the mistakes and crimes of their clients.

I know, the auditing company should protect those parties who depend on the financial statements. The financial statements should be a true reflection of the business. This is what 99% of auditors deliver. Should we increase the costs for everybody because 1% of businesses misrepresent their affairs? More importantly, will those extra costs solve the problem?

As usual Sensei : entirely objective : as opposed to the Chop and his followers above .

While I would not go as far as CHOP YOU DOLLAR, my view is that the CA (SA) qualification is overrated in South Africa compared to other countries. The qualification does not make for good business leaders in the main. Overpaid, overrated and generally no people skills and poor understanding of marketing and HR.

In Australia, I was surpised to learn that financial statements for private companies are not required to be audited. I dont think this had led to an inferior business environment in comparison with SA and businesses dont have to pay audit fees.

Do we need these men in grey suits who have failed at critical times or been complicit in corporate fraud…?

My accountants first brief is for me to pay as little tax as possible.

I may modify that if????? the cadres stop stealing.

Integrity and honor are the 2 key elements needed in any form of management,

For long auditors have tried to separate themselves from cases of this nature,

If the Job is done right, there wouldn’t be such corruption, corruption doesn’t only exist in government, but wherever integrity and honor is neglected,

For long people have cared for their pockets instead of doing the right thing, it up to us the new business leaders to bring about a paradigm shift in a broken society.

Boards of directors lost it and corporate management lost it in the drive to grow wealth for self and shareholders – integrity took a back seat.Complexity of business grew out of proportion across borders and was replaced with legal agreements (interpreted and justified to fit the cause).How can you possibly expect an auditor, even with the back up of the best alternative legal brains, to keep pace with rampant non standard business dealings with multiple interpretations.Its not only the auditors that need to continually re assess what they are doing but boards and management are equally as culpable in Global Inc.
IRBA tries hard, but has its limitations, and perhaps if it had a re think about its over sight strategy then maybe the audit profession would function more appropriately in serving a very dysfunctional business environment. This takes me back to my point – integrity. Need to find it again, in business.

Audit partners must rotate annually , keep everyone on their toes by marking each other’s homework. Even if within the same firm , it will greatly enhance the independence.

On the CA debate.

When you start studying accounting at university then everyone is on the CA stream. By CTA , then 90% decided “auditing isn’t for them”.

That’s all crap and excuses. The fact is most people don’t pass and when you are a CA , then you’ve made it where others have failed and if you can’t do the job as a CA , then nobody can .

The problem is the bad people, that give CAs a bad name. It’s not the qualification, it’s the individual.

At this stage I am not fearful that we’ll throw the baby out with the bath water if we do so; the baby is long dead anyway. The profession in total is fraught with corruption, falsifications misstatements and omissions, even the one-man auditing firms suffer from this. How do I know it? I do quite a lot of forensic work for the Hawks and believe me although the values are lower, the problem is as rife irrespective if one refers to the Big 4 or the Small 5 000. But, I have a solution to the problem. The challenge is to strip the current structure of the audit profession. here I refer to statutory audits and nothing else. First of all, all future auditors need to be very well qualified in law as well as in accountancy subjects. Therefore, create a type of super auditor. Then structure the profession in the same vein as the advocates. If an advocate can prepare a 2 000 page highly technical submission to a court, then one properly qualified auditor will be able to execute and report on his audit findings pertaining to a major bank. The trick lies in the audit plan and the use of other professionals. I can write quite a umber of pages on this lot, but think about it for one moment: you’ll have a completely independent individual and at the same time also an individual qualified sufficiently to assist his client with the legal ramifications of any decision. Cost savings will be considerable and no more big brother games. This constitutes only the first set of my recommendations. To make it work will require a few more changes but suffice to say that if we can start here, we’ll save our economy and the profession. Lastly create something along the lines of the IRBA, but this time to include all accountants that serve clients and not only those few that execute statutory audits

Dodgy auditors can take consolation from the fact a certain Mr. Zuma sank the ‘rainbow nation’ and still walks around a free man!! Remember no lock-down transgressions – unless part of the untouchable taxi industry – otherwise justice is swift.

Please remember that the onus always rests on the tax payer, therefore the auditors can do whatever they want( within reason) and the responsibility will still be the taxpayer!

Another factor that very few in the profession will bring up, is the massive pressure on the big 4 to “transform” their partnership and senior management structure.
The result is that you have you black CAs fast tracked to partner at the tender age of 28 or 30, not only are they out of their depth, but they just don’t have the backbone to stand up against seasoned boards putting pressure on then to just sign.

End of comments.

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