Trust Me – KPMG UK Strains Credibility
Why does it take so long for these cases to wind through the regulatory process? Do they always have to wait until the external legal proceedings are completed and criminal guilt found before finding that accountants were involved and deserving of sanction?
A tribunal has fined KPMG and its partner Andrew Sayers £500,000 plus costs of £1.15m.
KPMG and Sayers were reprimanded by an Accountants’ Joint Disciplinary Tribunal for their work on the 2000 audit of Independent Insurance Group, when they accepted that loss could be turned to profit by using stop loss insurance which was too good to be true. KPMG was also ordered to pay costs of £1.15 million.
Independent was a publicly quoted general insurance company. By its nature, insurance involves the acceptance of risks and the receipt of premiums in year one, with the claims arising from the risks not likely to be paid until future years.
In computing the amount of provision which needs to be made against such claims (the provision reduces the amount of profit), insurance companies look at both historical and current data.
During 1999, claims from insurance written by Independent in 1997 and earlier years increased in value. In order to protect itself from further deterioration in its position, Independent purchased “stop loss” insurance. One of the effects of stop loss is to enable the amount of provision to be smaller. It therefore has a beneficial effect on profit.
During 2000, claims for past years continued to increase. In January 2001, KPMG, the auditor of Independent, was informed that further stop loss was being sought to extend the cover put in place in 1999.
The effect of this was that for a premium of £77 million, Independent would be able to turn a LOSS of £105 million into a PROFIT of £22 million.
The Tribunal pointed out that this was too good to be true. The company underwriting the stop loss insurance appeared certain to lose money. It gave rise to an obvious suspicion that there may be more to the stop loss insurance than KPMG was being told.
Sayers, the KPMG audit engagement partner, was advised by the KPMG concurring partner to confirm the stop loss terms directly with the reinsurers.
For some reason – no record of his thinking was made by him – Sayers decided not to do this. Independent’s reporting actuaries Watson Wyatt told Sayers that they “did not understand why the reinsurers were writing these contracts when they appeared to be obviously loss making”.
The nature and validity of the stop loss insurance were fundamental to the audit. It subsequently turned out that Independent had agreed to pledge £141 million as a condition of obtaining the stop loss. There were other agreements which limited the liability of the reinsurers and sought to pass on the risk from the reinsurer to a subsidiary of Independent.
In addition, a different stop loss contract required the payment of a premium of £1.6 billion over four years. This completely changed the situation: the chief executive resigned and Independent went into liquidation.
And some additional information from the Guardian UK:
As to the fate of its lead auditor Andrew Sayers – found to have failed to make proper validity checks on Independent contracts he knew at the time to be both vital and highly suspicious – KPMG is tight lipped.
Far from being sacked, he has been transferred out of auditing and remains a partner in “a non-client-facing role”. (Blogger Note: Maybe they sentenced him to a two year term in their Risk and Quality Assurance group!) KPMG admits he ignored suggestions from his concurring partner on the audit (a second pair of eyes) that the validity of controversial contracts be checked. They also accept Sayer had a conversation with Independent’s actuaries Watson Wyatt in which he said the apparent loss making nature of the controversial contracts raised the possibility there might be other arrangements between Bright and the counterparties.
Amazingly the only check Sayer sought in relation to this was a letter of representation from the board signed by Bright.
Just staggering. If that’s not a sackable offence, then what is?
Did you read a 17 June WSJ article about Citigroup settling with the SEC over some 2002 Argentina debt which was in default? Scott Friestad of the SEC said Citi failed to do proper impairment analysis. If so, why did Citi get a pass? What did KPMG look at? Will the PCAOB kick KPMG in the shins over this? SEC enforcement is a joke. The SEC alleged that Citi failed to maintain proper books and records. Is that an FCPA problem? How can anyone take the SEC seriously?
Partnership structure is obviously a problem for the firms. How do you enforce “suggestions” to other owners. Sure, everyone wants to make partner, but I think there needs to be another level of management or at least some kind of authoritative structure besides the crude threat of discharge for not following advice (a threat that probably doesn’t mean much after this case when they just transfer you to “non-client” roles.
As a former senior manager with one of the other firms and a former technical director for a fortune 100 company who had KPMG as its auditor, this doesn’t surprise me. As a firm, I think KPMG has a real problems with client partners ignoring the guidance of the national (technical) partners to please their clients; despite even obious departures from the rules.