KPMG settles $1-mn penalty case with US regulator

KPMG India settled a proceeding before the US Public Company Accounting Oversight Board (PCAOB) on December 6.

PCAOB, which audits public companies, censured KPMG Assurance and Consulting Services LLP (KPMG India) and the engagement partner (EP) Sagar P Lakhani for quality control failures, supervisory failures and documentation failures while working with a public company in 2017. It led to a monetary penalty of $1 million on KPMG India and $75,000 on Lakhani, who is also suspended from associating with a registered public accounting firm for one year and requires the audit firm to 'undertake and certify the completion of certain improvements to its system of quality control' systems. This is the second such sanction in connection with an Indian listed entity. The last time was when the infamous Satyam Computers imploded.

Talking to Bizz Buzz, Sucheta Dalal of Moneylife Foundation says, "It is astonishing that our regulators have been silent on this. What about their fiduciary duty to protect Indian consumer investors? It is not difficult to guess the bank involved and my guess is it is large enough to warrant an explanation to us about the fairness to the audit." Maybe there wasn't a compromise in India. But we need to know especially when the finding says the partner signed off on blank documents, she said. In May 2011, PCOAB settled an investigation imposing a penalty of $1.5 million in addition to $6 million imposed by the Securities Exchange Commission (SEC) of the US on five firms of PricewaterhouseCoopers International (PWC) in India. The five PWC entities who participated in the settlement were: Price Waterhouse and Price Waterhouse & Co in Bengaluru, Lovelock & Lewes, Price Waterhouse and Price Waterhouse & Co, Kolkata.

At that time, PCAOB's order said: "The reliability of global capital markets depends on auditors fulfilling their obligation to investors to perform robust audits, resulting in well-founded audit reports." That is why it is surprising that the latest order against KPMG has made no ripples, and there isn't a peep out of India's market regulator or audit regulators – the rather tame self-regulatory body Institute of Chartered Accountants of India (ICAI) or the more aggressive national financial reporting authority (NFRA). India's investor population had doubled in the past three years and, while our regulators have indeed been more active in recent years in response to huge corporate blowouts, one expects some public indication of a follow-up on the KPMG India matter. There are several good reasons for this. First, since it is a settlement, the order does not identify the listed company in which these lapses occurred in 2017. All it says is that the 'issuer' is into wholesale and retail banking and treasury services, headquartered in Mumbai.

Among other things, Lakhani and his colleagues were found signing off on blank work papers that were later "replaced with completed work papers, in many cases after the issuance of the audit report, but the sign off dates were not updated." Shockingly, completed versions of the work papers were replaced in 2017 after KPMG India had released its audit report and before the documentation completion date. The detailed order documents how eAudIT, a proprietary software of KPMG, was misused—the organisation was aware of it but did not stop the misuse. Did the sign-off on blank documents only happen with 'Issuer A', the bank referred to in the PCAOB order? Was Lakhani the only engagement partner who did this, or was he just unfortunate to be caught? ICAI, NFRA and the Securities & Exchange Board of India (SEBI) ought to investigate how extensive was the practice and what impact it had on the final audit reports.

PCAOB's order does not even go into the impact of these lapses, if any, on the accounts of the unnamed bank, whose identity should matter to Indian investors and regulators. Since KPMG India and Lakhani are, together, coughing up $1,075,000, one assumes that the lapses are serious enough to warrant further investigation and Indian investors have the right to demand more information.

The spotlight in this case would be on a Mumbai-based private bank with US listing.

So brazen was the industry's attitude that, in January 2020, when NFRA issued its first set of show-cause notices to auditors of IL&FS Financial Services (IFIN), the two chartered accountants (CAs) rushed to the Delhi High Court with a writ petition, instead of responding to the new regulator. Senior CAs wrote columns to say how the profession and captains of industry were upset at NFRA's action since the firm was superior to most others in the field. Media articles suggested that only individual partners ought to be held responsible and the audit firm let off because debarring a firm causes a lot of disruption.

This view is ironic, as compromise and collusion is usually institutionalised because the rewards and incentives of partners are tied to the business generated by them. While partners guilty of professional misconduct who permit the fudging of accounts must, indeed, be penalised, sparing the firm will allow large audit firms to make scapegoats out of partners who get caught.

Fortunately, NFRA wasn't intimidated by the noise created by the accounting industry. Between 22 and 28 July 2020, NFRA issued three detailed orders against the engagement partners for IFIN. CA Rukshan Daruvala was debarred for five years and slapped a Rs5 lakh penalty; CA Shrenik Baid was also debarred for five years but was penalised Rs15 lakh, while CA Udayan Sen was penalised Rs25 lakh and debarred for seven years.

The findings in all cases were similar—professional misconduct, collusive behaviour in going along with management in agreeing to misstatements/omissions leading to fraud on the users of the financial statements. NFRA also indicted SRBC & Co, of the Ernst & Young (EY) group for deficiencies in auditing Infrastructure Leasing & Financial Services (IL&FS) for FY17-18.

There are only three other orders since then on the NFRA website, all in 2022. On June 21, CA Gulshan Jagdish Jham was debarred for a year and slapped with a penalty of Rs1 lakh for professional misconduct, failure to report material misstatements, and exercise due diligence in the audit of Prabhu Steel Industries. On September 12, CA Som Prakash Aggarwal (of S Prakash Aggarwal & Co) was debarred for three years and slapped with a penalty of Rs3 lakh as EP of Vikas WSP Ltd. He was also asked to undertake training on accounting and audit standards and submit proof thereof within 180 days. On 19 September, CA Rajiv Bengali (of Subramaniam Bengali & Associates) was barred for five years and a penalty of Rs5 lakh. As EP for Trilogic Digital Media, he was charged with false reporting in the independent auditor's report and failure to comply with auditing standards.

Given the number of forensic audits ordered by SEBI and the falsification of accounts or diversion of funds brought out during the bankruptcy resolution process of corporate defaulters, regulatory action seems too little and too slow. Some favour the US-style settlement process adopted by PCAOB and KPMG India to our slow and tortuous process. But we have seen how the settlement provision has been vitiated by arbitrary settlement amounts at SEBI. Often, the penalties are trivial, and there is little information on the wrongdoing or its impact that could help or warn investors. Also, there seems to be no shame in 'settling' wrongdoing, which defeats its very purpose.

Compromised, collusive or even negligent auditors are a serious worry for any lender or investment professional. Apart from a few good orders from NFRA, some in the audit industry, especially after the IL&FS debacle, have tried to separate audit and non-audit business. Others are sticking to the claim that there is no conflict of interest.