Can’t KPMG Just Do Better Audits?

Jonathan Weil joined Bloomberg News as a columnist in 2007, and his columns on finance and accounting won Best in the Business awards from the Society of American Business Editors and Writers in 2009 and 2010.
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KPMG is getting into venture-capital investing, according to an article today in the Times of London. It's one moresign that the Big Four audit firms are moving beyond traditional accounting services and getting themselves into other more far-flung endeavors.

The newspaper said the fund, called KPMG Capital, will be based in London and "will invest predominantly in small British and American data and analytics businesses." We can presume that KPMG would be smart enough to avoid auditing the books at places where it invests, although you never know.

Even if KPMG doesn't audit the companies it owns, an obvious problem is that KPMG inevitably will be in the position of funding companies that compete against its own audit clients. That may not be a violation of any rules, but it can create conflicting interests nonetheless. (Then again, so can audit fees themselves, because the client is paying the auditor.)

Adversarial relationships can be as damaging to the notion of auditor independence as overly cozy ones. Plus, you have to wonder if this even makes good business sense. If I were on the board at a KPMG audit client and saw a KPMG-owned startup trying to take away my company's market share, I would want to drop KPMG and hire a different firm.

This line from the Times article, quoting a senior KPMG partner named Simon Collins, caught my attention in particular: "Mr. Collins said that it would be `very difficult' to provide audit services to the companies it invested in -- `but we can incubate them, we can advise them.'"

Let's get this much straight: "Very difficult" is the wrong answer here. The correct response is that it should be impossible. Any first-year accounting student can tell you that auditors aren't supposed to audit companies in which they have ownership stakes.

But maybe we shouldn't be surprised. In February 2011 the Securities and Exchange Commissioncensured KPMG's Australia affiliate over independence violations at two audit clients with U.S.-registered securities. The SEC found the firm sent staff members to work at an audit client under the client's supervision and direction. In another situation the firm was paid commissions for promoting an audit client's products and was retained by the client to provide legal services.

In another case, the SEC in 2005 settled with KPMG's Canadian affiliate and two of its partners over audit-independence violationsat a Colorado company, Southwestern Water Exploration Co. The firm prepared some of the company's basic accounting records and financial statements and then audited its own work, the SEC said.

In 2002, the SEC censured KPMG because it purported to serve as the independent auditor for a mutual fund at the same time it had invested $25 million in the same fund. At one point KPMG accounted for 15 percent of the fund's assets, the SEC said. That was a black-and-white violation of the auditor-independence rules.

If there is any accounting firm that should be uniquely sensitive to auditor-independence matters, it is KPMG. In April, KPMG had to resign as the auditor of Herbalife Ltd. after Scott London, the partner in charge of the company's audits, was caught by federal agents taking bags of cash in exchange for inside information about the nutritional-supplements distributor.

The U.S. and other countries long ago gave the accounting profession a valuable franchise by requiring independent audits of publicly held companies. Before it gets into new businesses as far afield as venture-capital investing, KPMG should focus on making its audits better.

This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.

To contact the author on this story:
Jonathan Weil at jweil16@bloomberg.net