One factor unified three bankrupt US banks: KPMG

The three bank collapses that have occurred since March have dimmed KPMG's lucrative business as the main auditor of the US banking industry.

Following the publication of a Federal Reserve report into the failure of Silicon Valley Bank and the forced sale of First Republic, concerns about the organization's independence and work quality have grown recently. The Big Four accounting company served as both banks' and Signature's auditors before it was taken over by authorities in March.

As recently as the end of February, KPMG gave the banks' financial statements in all three cases a perfect score.

"It's a three-fer," declared Francine McKenna, a former KPMG consultant who currently teaches at the University of Pennsylvania's Wharton School. "It’s a dubious achievement . . . and we need tough action to back up tough talk from regulators."

"You can't expect auditors to know a bank run is coming," 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 auditor’s risk assessment and whether they had the right audit procedures."

Accounting experts said that the quality of KPMG's work would likely be scrutinized based on whether its employees were sufficiently disinterested in the banks they audited, were alert to warning signs, and were qualified to assess financial statements in a context that had been significantly altered by rising interest rates.

Additionally, there might be issues with KPMG's extensive involvement in the financial system.

According to data from Audit Analytics, the company enjoys a unique position as auditor of more US banks than any of the other Big Four, and it audits a bigger percentage of the nation's banking system by assets than any other firm. In addition to auditing the Federal Reserve, it also serves as auditor to Wells Fargo, Citigroup, Bank of New York Mellon, and thirty other listed institutions.

"This is something that reverberates across the banking industry. Given the public interest around this you can expect there will be more oversight," according to Williams Smith.

For KPMG, banking clients are particularly important. In 2021, the last year for which complete data is available, publicly traded banks paid the company more than $325 million in fees, making up almost 14% of KPMG's fees from public customers. Comparatively, such figures were 8% at PwC, 3% at EY, and 2% at Deloitte.

Alumni from KPMG have gone on to hold important positions in the banking industry, notably at former clients. First Republic and Signature's respective CEOs were once partners at KPMG.

Professors of accounting predicted that regulators would pay particular attention to Signature's hiring of Keisha Hutchinson as its chief risk officer in 2021, less than two months after she had signed the bank's 2020 audit report. Hutchinson was the senior partner on the KPMG audit team.

Before an audit partner is hired by a company into a position that oversees financial reporting, as defined by Securities and Exchange Commission rules, there must be a 12-month cooling-off period. However, this is typically interpreted to mean chief financial officer or financial controller roles.

KPMG has already stated that it stands by the audits it performed on SVB and Signature. In order to protect customer privacy, it refuses to comment further.

According to a spokesperson, "KPMG has long had a substantial and dynamic audit practice in the financial services industry. We conduct our audits in accordance with professional standards."

The Fed's report from last week highlighted the depth of SVB's internal audit and risk management shortcomings, both of which need to be evaluated by a company's external auditors.

It may be questioned if KPMG ought to have disclosed these shortcomings to investors as material deficiencies that could have an impact on the financial performance, according to Jeffrey Johanns, a former PwC partner and auditing professor at the University of Texas at Austin.

How can the bank claim that there is no weakness in its internal controls if there are severe flaws in the risk function?

Concerned that SVB would have to sell assets previously marked as "hold to maturity," which could result in a $15 billion loss because higher interest rates had decreased their market worth, depositors withdrew their money. KPMG's acceptance of that designation has come under fire, including in a class-action lawsuit brought by SVB investors against the auditor. Banks are permitted to mark such assets at cost as long as they have the "intent and ability" to keep them until maturity.

The PCAOB intends to increase inspections in the financial services industry once more. It announced last month that it will focus on whether banks should have been required to disclose more about liquidity issues and events that occurred between the end of the financial year and the release of the audit report when it looked at 2022 audits.

Additionally, it stated that it would look into whether auditors had the necessary skills to manage intricate institutions.

Higher interest rates, according to Williams Smith, had altered the climate for banks, raising concerns about whether KPMG had accurately assessed this and other risks when planning its audit.

"This is a clarion call to all auditors to make sure they understand that the client’s environment is changing, and they have got to be thinking ahead."

By fLEXI tEAM