Three US banks that went bankrupt had KPMG in common – 5/3/2023 – Market

The trio of bank failures since March has cast a shadow over KPMG’s lucrative business as America’s largest banking accountant.

Doubts about the quality of its work and its independence have grown in recent days, after the release of a report by the Federal Reserve (Fed), the central bank of the United States, on the collapse of Silicon Valley Bank and the forced sale of First Republic. The audit firm, one of the so-called “Big Four” in the industry, audited both banks as well as Signature, whose control was taken over by regulators in March.

In all three cases, KPMG provided the banks’ financial reports with a clean bill of health by the end of February.

“It’s a triple whammy,” said Francine McKenna, a former KPMG consultant and now a professor at the Wharton School, University of Pennsylvania. “It’s a mixed performance … and we need tough action to give weight to tough rhetoric from regulators.”

“You can’t expect an audit to know that a bank run is about to begin,” said Kecia Williams Smith, a former auditor and regulator who is now an assistant professor of accounting at North Carolina A&T State University. “What is fair is to ask about an audit’s risk assessment, and whether it adopted the correct procedures.”

The scrutiny of KPMG’s work is likely to revolve around determining whether its employees were sufficiently independent of the banks they audited, whether they paid due attention to warning signs and whether they were qualified to assess the quality of financial reporting in an environment that changed significantly due to rising interest rates, accounting experts say.

Questions may also arise about KPMG’s expanded role in the financial system.

The firm has a unique role as the auditor of more banks than any other Big Four in the United States, and it audits a greater proportion of the nation’s banking system, on an asset basis, than any other firm, according to data from Audit Analytics. In addition to auditing Wells Fargo, Citigroup, Bank of New York Mellon and three dozen other publicly traded banks, the firm also audits the Fed.

“This is something that resonates across the entire banking industry,” said Williams Smith. “Given the public interest surrounding this issue, it is to be expected that there will be stronger enforcement.”

Banking clients are particularly important to KPMG. Public banks paid the company more than $325 million in fees in 2021, the latest year for which complete data is available, and the industry accounts for about 14% of fees KPMG receives from publicly traded clients, compared to 8% at PwC, 3% at EY and 2% at Deloitte.

Professionals who graduated from KPMG also played important roles in the banking sector, including in companies that were clients of the audit group. The CEOs of Signature and First Republic were both former KPMG partners.

Accounting professors said regulators would likely pay close attention to Signature’s nomination of Keisha Hutchinson, who was the senior partner on KPMG’s audit team at the bank, to the post of chief risk officer at the firm in 2021, less than two months after she signed the bank’s 2020 audit report.

Rules from the Securities and Exchange Commission (SEC), the federal agency that regulates the securities markets in the United States, require a 12-month break period before an accounting firm partner can be hired by a firm for a role that control the production of financial reports, although the rule is usually interpreted as applying to CFO or CFO functions.

KPMG has previously stated that it confirms its audits of Silicon Valley Bank and Signature. The company declined to comment further, citing customer confidentiality.

“KPMG has long maintained a substantial and dynamic audit practice in the financial services industry,” said a spokesperson. “We conduct our audits in accordance with professional standards.”

The Fed’s report released last week revealed the extent of deficiencies in Silicon Valley Bank’s risk management and internal audit functions, which are subject to review by the company’s external auditors.

Jeffrey Johanns, a former partner at PwC and professor of auditing at the University of Texas at Austin, said this could raise questions about whether KPMG should have highlighted these shortcomings to investors as substantive weaknesses capable of affecting bottom lines.

“If there are significant deficiencies in the risk function, how can the bank claim that there is not a deficiency in its internal controls?” Johanns said.

Depositors fled Silicon Valley Bank over concerns that the bank would have to sell assets previously designated as “hold-to-maturity,” which could result in losses of up to $15 billion as rising interest rates had reduced the market value of those assets. Banks are allowed to value these assets at cost price, as long as they have the “intent and ability” to hold them until maturity, and KPMG’s agreement on this designation has been the target of criticism, for example in a class-action lawsuit filed by Silicon Valley Bank investors against the audit firm.

The question brings to mind the consequences of the bankruptcy of Thornburg Mortgage, which revealed financial difficulties shortly after KPMG published an opinion that did not express any reservations about the results of the mortgage credit institution, in 2007. The Public Company Accounting Oversight Board ( PCAOB), which regulates the auditing profession, ruled that KPMG’s lead auditor had been negligent in considering whether Thornburg continued to be a operating company and its ability to hold its assets to maturity, but the decision was reversed by the higher regulatory authorities.

The PCAOB plans to further tighten enforcement in the financial services sector. Last month, it said its review of the 2022 audits would focus on whether banks should have been required to disclose more information about liquidity risks and events between the end of the financial year and the publication of the audit report. .

The body also stated that it would examine whether auditors had the necessary knowledge to oversee complex institutions.

Williams Smith said rising interest rates had changed the environment for banks and there were questions about whether KPMG correctly assessed this and other risks when planning its audit.

“This is a wake-up call for all auditors to make sure they understand that the customer environment is changing, and that they need to think ahead.”

Translated by Paulo Migliacci