/ 4 January 2019

Idle watchdogs take a beating

Accountable: KPMG has come in for a lashing in South Africa for its entanglement in state capture
Accountable: KPMG has come in for a lashing in South Africa for its entanglement in state capture, such as its assistance to the notorious Gupta family. (Delwyn Verasamy/M&G)

Assume a corrupt politician somehow managed to get himself into the highest office in the land, holding sway with heavy hitters in the ruling party also benefiting from the largesse over which he presided. He could appoint cronies to key positions, such as in state-owned enterprises, the criminal prosecution authority and tax collection, and his supporters would applaud.

There is a strong argument that governments are inept at best and corrupt at worst, so those holding this view would not be surprised that the scenario sketched above rolled out under the stewardship of former president Jacob Zuma.

But what then is the role of the private sector and, in particular, that of private-sector watchdogs, such as auditors, which are meant to keep corruption in check?

As the full horror of the extent of state capture during the Zuma years has unfolded, starting with the findings of former public protector Thuli Madonsela’s ‘State of Capture‘ report, released in November 2016, the list of implicated private companies has continue to grow.

Giant management consultancy firm McKinsey, which had global revenues of $10-billion last year, leads this list both in terms of the quantum (R1-billion) it took from the state- capture trough and the brazenness with which it shook down its client Eskom.

After news of the R1-billion payment surfaced, McKinsey agreed to pay back the money, suggesting it could not begin to justify the payment. It has done so, but nonetheless it, McKinsey Africa and Gupta-linked Tegeta and Optimum face charges of fraud, corruption and theft laid by Eskom with the Special Investigative Unit (SIU). Eskom boss Phakamani Hadebe said the SIU had confirmed in November that it is investigating these charges.

More important is the role of scandal-ridden KPMG, which, at least ostensibly, is supposed to be a watchdog. One of the big four auditors, the embattled company appears to have been more or less permanently in the news for all the wrong reasons. This included lending its name to a South African Revenue Service (Sars) report that had manufactured the existence of a “rogue unit” at Sars. The report was used as a pretext for firing key staff members and incapacitating what had been a proud institution.

Along the way a unit that investigated high-value tax evasion such as by the illicit cigarette industry was shut down. The result was that a hollowed-out Sars collected billions less in taxes, one reason for the unpopular one percentage point value-added tax hike in this year’s budget.

Early in 2017, KPMG was accused of helping the infamous Gupta family to evade tax and its own internal investigation showed that it was slow to respond to red flags in audit work done for Gupta-owned entities, Business Day reported.

And, not too miss out on another scandal, KPMG was also the auditor for VBS Mutual Bank, which collapsed in March, owing nearly R2-billion, mostly to municipalities, which had made deposits with an institution that turned out to be an ATM for the politically connected.

KPMG has lost a string of key clients, including the government, since news of its links to state capture broke. It has lost R1-billion in annual revenues and 1 000 of its staff have left as the headcount fell to 2 000.

Executive chairperson Wiseman Nkuhlu, in an open letter published in December, asked South Africans for forgiveness. “In society, you are forced to take ownership to show that you are wrong; once you have done that you are forced to undergo rehabilitation and ask for forgiveness [from] the people you have wronged.”

Although state capture by definition is concerned with the looting of public resources, the auditing profession is also in the spotlight for its failures in auditing private companies, the R200-billion implosion of smoke-and-mirrors furniture retailer Steinhoff, which has Deloitte as its big-name auditor, is a spectacular case in point.

When the regulator, the Independent Regulatory Board for Auditors (IRBA), does get involved, the process can be slow. Deloitte, the auditors of African Bank, which failed in 2014, is the subject of a disciplinary process by the IRBA that is yet to be concluded.

Alex Cobham, the chief executive of the Tax Justice Network (TJN), says the “problem is really one of the underlying narrative that has become embedded, which equates international private-sector actors with transparency, accountability and integrity, and national political actors with corruption”.

“This is especially ingrained in public and media discourse when the case involves private actors from high-income countries and public officials from lower-income countries.”

The TJN was formed in 2003 by, among others, economists, lawyers and accountants, united by a sense that the technical processes in which they are engaged simply do not give sufficient priority to social justice concerns.

Cobham says society gives far too much responsibility for designing policies and for ensuring financial integrity to private-sector actors that are inevitably driven by profit. “This in turn creates a systemic series of conflicts of interest so that governments pay consultancy firms, law firms, audit firms and other professional services providers to give them a stamp of approval.

“That opens up all sorts of issues but two stand out. First, as South Africa has experienced all too directly in recent years, firms may be willing to accept payments not to deliver meaningful services but simply to deliver what government wants, which can include justification for gutting a high-performing tax authority, for example, or, say, cover for potentially corrupt contracts for cronies.

“Second, the same firms involved in policy design or auditing government integrity will typically have (or seek) clients that can benefit from inside knowledge and/or influence over the outcome, and so having the big four accounting firms, for example, advise on tax policies can very easily open up bespoke loopholes for avoidance, even without any overt corruption.”

Cobham says academic research, including that by the TJN, has shown that the big four auditing firms are disproportionately present in all the most secretive tax havens.

“Having a big four firm as an auditor, never mind a tax adviser, is associated with multinational companies expanding their networks of tax haven subsidiaries, which in turn is associated with lower tax payments to governments.

“It beggars belief that those same governments or the public should be expected to treat the big four’s advice on tax policy as in any way neutral or objective. Clearly the role of KPMG in South Africa is a somewhat extreme case, in terms of their direct role in undermining the tax authority, but the issue is a systemic one.

“If the South African government is serious about challenging state capture, an important step will be to distance itself from the big four and consulting firms that face similar conflicts, and to rebuild the tax authority, with resources and a mandate to challenge tax abuse and associated corruption with complete independence.”

Auditing the auditors

KPMG may have made headlines in South Africa for all the wrong reasons, but in the United Kingdom last month it eclipsed fellow big-four auditor PwC for the number of FTSE 100 companies it audits — 28 compared with PwC’s 27.

Data from Adviser Rankings shows this is the first time PwC has lost its top spot as a blue-chip auditor, online trade publication Accountancy Age reported.

The shift in clients between top accountancy firms is likely because of 2016 European Union legislation intended to break too-close ties between large companies and their auditors and to tackle the issue of too much power in the hands of the big four. Companies must now swap auditors after 20 years.Some EU countries have gone further:Italy insists on change every nine years and the Netherlands every 10 years, Sky News reported.

In November, the Lloyds Banking Group announced that Deloitte would take over as its auditor in 2021, severing a 153-year tie with PwC.

But, instead of making way for new players, the new regime has apparently led to a battle between the big four to win clients from each other. Sky News’s Ian King says the debate on the role of auditors took on greater urgency following a series of high-profile corporate collapses, including construction giant Carillion and retailer BHS.

AFP reported last month that KPMG faces a Financial Reporting Council (FRC) investigation because of its audit work for Carillion, which went bust in January, amid concerns it may have breached ethical and technical standards.

Britain’s Competition and Markets Authority is investigating competition in the sector, and the function of the FRC is also under review.

There is also pressure on auditors to split auditing and advisory work. KPMG said it will stop providing non-audit services to big listed companies in the UK whose books it audits, The Guardian reported in November.

Pan-African Resource’s Iraj Abedian told the Mail & Guardian in April last year that audit and advisory services should be separated as “an urgent national imperative”. Countries such as the UK were investigating this and, for South Africa, “the cost of not doing so is becoming excessive”, he said.

The IRBA’s Bernard Agulhas said in April this year there was a “need to consider the benefits of moving to a model of audit-only firms to more clearly delineate the function of external audit, enhance independence and improve audit-firm focus on audit quality”. — Kevin Davie