September 20, 2019

Which KPMG Scandal Is Worse: PCAOB ‘Steal the Exam’ or CPE Training Exam Cheating?

Since Monday when the SEC announced it had fined KPMG $50 million for not one but two scandals involving auditor misconduct at the firm, I’ve been thinking about which scandal is worse. Is it KPMG audit partners stealing confidential information from rogue PCAOB employees in order to better the firm’s audit inspection scores OR is it auditors at all levels cheating on internal online training exams by illegally sharing answers with colleagues and manipulating test results?

Both are equal parts ridiculously stupid and disturbing. On one hand, five KPMG officials and one PCAOB inspector were indicted in early 2018 in the inspection list leak scandal: two were convicted by a jury, three have admitted guilt, and one is scheduled to go to trial later this year—and all of whom could be facing jail time. On the other hand … well, we don’t know what the outcome is going to be in that whole training exam cheating mess.

But from an ethics standpoint, which of the two is more damaging to the firm and to the profession? That question was debated by Tom Fox, an attorney and compliance expert, and Matt Kelly, founder of the blog Radical Compliance and a longtime observer of corporate compliance issues, on the most recent episode of the Compliance into the Weeds podcast, which is worth 25 minutes of your time.

I wanted to get the viewpoints of people whose job it is to educate the CPAs of tomorrow on how not to get into the kinds of trouble that presumably current and former KPMG auditors and partners are in right now. So I reached out to several accounting professors who teach or who have taught ethics and asked them which scandal they thought was worse.

And here’s what they told me:

Jillian Alderman, PhD
Assistant Professor of Accounting, Graziadio Business School
Pepperdine University, Malibu, CA

I see two primary ways in which the auditing profession could be impacted negatively by these scandals: public perception and actual audit quality.

Jillian Alderman

The PCAOB scandal results in a more severe impact on both, since the PCAOB provides independent oversight for all firms registered to perform audits of U.S. public companies. PCAOB inspection reports can lead to improvements in audit quality profession-wide, as they set precedent for what constitutes violations of the professional standards. Therefore, undermining the independence of the PCAOB could jeopardize both public confidence and actual audit quality at a much broader scale in the profession.

The current information released on the internal employee ethics training cheating does not imply collusion with any external members of regulatory agencies. Therefore, the independent oversight of audit quality is not jeopardized by the ethics training scandal, minimizing the impact on the profession as a whole. The SEC report appears to have made note of the ethics training cheating to provide additional evidence of organization-wide ethical culture issues at KPMG, and to support the $50 million penalty and the order to hire an independent ethics and integrity controls consultant.

Paul Clikeman, PhD, CFE, CIA
Associate Professor of Accounting, Robins School of Business
University of Richmond, Richmond, VA

Both are very serious violations of professional standards.

Paul Clikeman

The most troubling aspect of the first violation is that it involved partners near the very top of KPMG’s audit practice. It cannot be blamed on one or two “rogue” auditors operating on the fringes of the organization. When a firm’s leaders are corrupt, it casts doubt on the quality of all the firm’s services.

The second violation is perhaps even more troubling because it involved more people. The fact that dozens of auditors apparently cheated on CPE exams without one person reporting the improper behavior reveals serious deficiencies in the firm’s internal quality control procedures. Partners pressured subordinates to perform improper acts and the subordinates complied. This suggests a firm culture in which obedience to superiors is valued above integrity and service to the public.

Denise Dickins, PhD, CPA, CIA
Professor of Accounting, College of Business
East Carolina University, Greenville, NC

In combination, the incidents are problematic as they suggest a tone at the top that demands high ethical behavior and has a zero tolerance for violations may not be in place.

Denise Dickins

As a former Big 5 audit partner, when I first heard of KPMG hiring a former PCAOB employee who provided intelligence about which KPMG engagements were likely to be targeted for inspection, I thought this akin to the similar practice of accounting firms hiring former IRS employees to learn about transactions/deductions likely to be targeted for audit. In terms of ethics, more gray than black and white.

Learning about the second incident—multiple employees collaborating on CPE/ethics tests—is worse because it suggests at least some KPMG employees outside of the national office perceive this is acceptable practice. It begs the question, what other assignments do employees perceive can be short-cut? Time reports, expense reports, audit tests performed on clients’ financial statements? Because trust in the results of independent audits is critical to the efficient operation of financial markets. If not isolated, this incident has the potential to undermine KPMG’s entire business.

Lawrence Kalbers, PhD, CPA
R. Chad Dreier Chair in Accounting Ethics
Chair, Department of Accounting
Professor of Accounting, College of Business Administration
Loyola Marymount University, Los Angeles

The question about which KPMG scandal is worse is an interesting one. But I think a better question is, what do these scandals tell us about KPMG as an organization? The two scandals taken together strongly suggest a challenged ethical culture that allows—and perhaps encourages or even rewards—unethical behavior.

Lawrence Kalbers

The PCAOB scandal implicated leaders at high levels within KPMG, while, according to the SEC release, the training scandal was widespread, with “KPMG audit professionals—at all levels of seniority—engaged in misconduct.” Adding to this sad state of affairs is the training exams included content required by a 2017 SEC order as part of an agreement in which the SEC found that KPMG had “engaged in improper professional conduct” on a previous audit. These two recent scandals appear to be a continuation of unethical and/or negligent behavior.

Given the disclosures provided in the SEC’s report, one must wonder if investors can rely on audit reports issued by KPMG. It can be argued whether the $50 million penalty is sufficiently large enough. However, the SEC has provided a path for KPMG to work toward the competence and credibility required of public accountants through a host of remedial actions the order imposes on the firm.

It remains to be seen whether KPMG can provide the leadership and perseverance that it will take to sufficiently improve its audit effectiveness and to develop the necessary ethical culture to gain back the trust of the public.

J. Edward Ketz, PhD
Associate Professor of Accounting, Smeal College of Business
Pennsylvania State University, University Park
Author of “Confessions of an Accounting Critic”

J. Edward Ketz

I think the CPE scandal is worse than the firm inspection cheating primarily because the inspection cheating could be blamed on a few rogues who tried to get a leg up, but the CPE scandal has much greater scope, indicating a poor ethical culture in the firm or at least a significant subset of the firm.

It also shows low regard for proper authorities who regulate the accounting industry. And it shows low regard for the ethical principle of competence, wishing to allow colleague Joe Schmuck an ability to get CPE credit while not deserving it.

Linda A. Kidwell, PhD
Associate Professor of Accounting, H. Wayne Huizenga College of Business
Nova Southeastern University, Davie, FL

It is hard to rank the failures of KPMG. They are part and parcel of a failure of ethical leadership, which naturally leads to more of a cultural problem in the organization.

In the case of the PCAOB hires, the knowledge of the act was far more limited and focused, but its intention was clearly corrupt. The SEC order states that the former PCAOB hires understood that the inside information was a condition of their employment, so the KPMG partners involved must have been fairly clear about that. Such openness suggests that the colluding partners involved felt no need to hide this from each other or their targets, a situation that can only involve mutual trust to develop an unethical, illegal plan. In other words, they must have felt comfortable enough to discuss it and pursue it, no small thing in a profession that demands the utmost integrity.

Linda Kidwell

As you know, the CPE cheating scandal was more pervasive. Is cheating on CPE that has already been internally developed as serious? That’s very hard to say. CPAs take high-stakes exams to get licensed, but the stakes for CPE are lower. If one fails to get enough answers right, one usually has the option to take the test again or to take other CPE. The stakes are not as high, so perhaps the participants did not see the cheating as being as serious as, say, cheating on the CPA exam. My research has found that people are more likely to cheat on things they don’t perceive as serious cheating and less likely on the bigger things. But this is where we get into a slippery slope.

I’d be less concerned if it were staff or seniors passing answers to each other, but the involvement of partners is very troubling. Did they not think CPE was relevant to them because they were above that by this career stage? This multi-level sharing of answers is troubling for multiple reasons. It may be that partners set the tone that CPE is not serious and their subordinates should not take it seriously. This undermines the entire purpose of CPE, which is to ensure CPAs maintain currency in their field and uphold the public trust. Or it may be that the culture leads junior staff to feel intimidated into participating, subordinating their own judgment. If that were the case though, I’d have expected at least someone to call the hotline. Either way, it’s a pervasive cultural problem. I hope KPMG will be forthcoming about some of the details, such as whether it is confined to a certain office or a certain industry group, because if it isn’t, there’s a major cultural crisis at KPMG.

Some of that CPE was required under order from the SEC, so I’d certainly call that very serious. If I were a member of an audit committee of a KPMG client company in the oil and gas sector, since that was the sector for which the SEC made the order, I’d be suggesting we ought to look for another firm (not because it was ordered, but because they cheated on what had been ordered). And the SEC may want to consider requiring externally developed CPE to meet their requirements when CPE is the result of a sanction, as this O&G CPE was.

Finally, in the first case involving the PCAOB hires, I consider it an unreported regulatory failure of the PCAOB not to have realized their inspections were compromised and therefore make a different selection for review. That has no bearing on KPMG’s status, but I think it worth noting. They should have realized that even if KPMG hired these individuals solely for their expertise and not for nefarious purposes, their work on KPMG’s behalf would at least be subconsciously biased regarding the known audit review targets. And if course since it was for that inside information, it makes the failure worse.

Joyce Lambert, PhD, CPA, CIA
Arthur Andersen Professor of Accounting
University of New Orleans

Cheating is cheating. Each one is an act discreditable to the profession under the AICPA Code of Professional Conduct.

Joyce Lambert

If I had to rank them, I would say that hiring someone from the PCAOB to get inside information to revise their audit workpapers would be greater. The reason is that this action implies that their audits of their clients’ financial statements were deficient and would have a more serious impact on whether they would have rendered the proper audit opinions.

At the same time, cheating on KPMG internal training exams by sharing answers, manipulating test results, and no one reporting these activities within the firm is extremely troubling.

Note: Under the AICPA’s Code, soliciting or disclosing CPA exam questions and answers is specifically listed as an act discreditable. Sharing answers on a firm’s training exams would be seen in a similar light.

3.400.001 Acts Discreditable Rule

.01 A member shall not commit an act discreditable to the profession. [Prior reference: paragraph .01 of ET section 501]

Interpretations Under the Acts Discreditable Rule

3.400.020 Solicitation or Disclosure of CPA Examination Questions and Answers

.01 A member who solicits or knowingly discloses the Uniform CPA Examination question(s) or answer(s), or both, without the AICPA’s written authorization shall be considered to have committed an act discreditable to the profession, in violation of the “Acts Discreditable Rule” [3.400.001]. [Prior reference: paragraph .07 of ET section 501]

James McKinney, PhD, CPA
Clinical Professor of Accounting, Robert H. Smith School of Business
University of Maryland, College Park

Both scandals are awful. I have so many former students who work at KPMG, and I know and have known various partners at KPMG who are decent people trying to do the right thing. I have enormous respect for them. However, both scandals are examples of people taking shortcuts to get their desired end instead of putting forth the necessary work to get there. Both scandals to my understanding were ultimately self-reported. Though the ethical lapses went on too long, at least some people at KPMG are doing the right thing.

James McKinney

To me, the PCAOB intelligence might be considered to have larger implications because it involved tampering with completed audits and ultimately may have impacted PCAOB inspection findings. However, as a firm, I would be more troubled by the CPE cheating scandal. The CPE cheating was a blatant disregard of ethical norms. Clearly, these partners and staff had no respect for the necessity of passing such an ethics exam. The concern would be that this disregard of ethics with respect to the exam might bleed into other areas of audit behavior.

Certainly, KPMG should be scrutinizing the work product of the cheaters to a greater extent. There should be a lot of soul searching on how to improve the ethical culture at KPMG to prevent future ethical lapses and to encourage more rapid self-reporting.

Steven Mintz, PhD
Professor Emeritus of Accounting, Orfalea College of Business
California Polytechnic State University, San Luis Obispo

Both acts are terrible and raise questions about the culture at KPMG and whether the firm has lost its moral compass.

Steven Mintz

Cheating on training exams raises ethical questions about what else KPMG might have manipulated. It also brings into question the firm’s own quality control system that was circumvented. If the quality controls don’t work in one area, it’s reasonable to ask whether we can and should expect them to work in other areas.

That said, I think the PCAOB audit inspection situation is worse.

Imagine if every audit firm did this. The inspection system would be meaningless. The result is the public’s interest in high-quality audits that ensure financial statements are fair and accurate would be compromised.

What was the motivation for KPMG in obtaining inside information from a PCAOB official who joined the firm?

If KPMG felt it had to change audit workpapers in anticipation of PCAOB inspections, it implies that the firm may have thought its audits failed to comply with professional auditing standards, which means a violation of AICPA Code of Professional Conduct Rule 1.310 (Compliance with Standards). These audits may have failed to identify material misstatements in the financial statements of clients because the audits may have been deficient (or at least KPMG was concerned about it). This could be a violation of AICPA Rule 1.320 (Accounting Principles). This also means the firm may have violated the “due care” standard – Rule 1.300 (General Standards). Finally, the actions of KPMG audit professionals could be deemed an “act discreditable” to the profession thereby violating Rule 1.400.

Another reason why obtaining confidential information from the PCAOB on audits to be inspected is a worse ethical violation is it involved the firm’s Audit Quality and Professional Practice Group. Also, five officials from the firm’s national office who had responsibility for the firm’s overall quality controls were involved in the decision to change audit workpapers. The firm also actively sought to cheat the audit inspection system by hiring former PCAOB officials and then pressure them to provide confidential information about potential audits that would be inspected by the PCAOB.

The bottom line is the culture at KPMG was not an ethical one. The tone at the top was that the firm would do whatever it could to gain an advantage over the inspection process and game the system. Absent an ethical firm culture, all other actions and decisions can be questioned from an ethical perspective.

David Middendorf’s pressuring of Brian Sweet is an egregious violation of what it means to be an audit professional and be part of the profession that values high ethics and the trust of the public.

Ethics and integrity are the bedrock of financial reporting and the independent audit. The independence of an audit can and should be questioned when audit workpapers are changed after audit reports are issued. The public interest is not protected when audit workpapers are changed after the fact and the reason for doing so is not what would normally be the case (i.e., subsequent information that brings into question the accuracy of financial report information).

Here, KPMG changed the reports because they were concerned that the PCAOB would inspect them and the firm’s audit deficiency would be high. The fact that they were motivated by a high level of audit deficiency in the past shows motive and intent, two elements of a fraudulent act.

Michael Pakaluk, PhD
Acting Dean and Professor of Ethics and Social Philosophy, Busch School of Business
The Catholic University of America, Washington, DC

“Worse” is always relative to a dimension. Call the two scandals the “inspection scandal” and the “CPE scandal.” On the dimension of pervasiveness, and what it says about firm culture, the CPE scandal looks worse. The inspection scandal was carried out by a small number of persons who—KPMG argued plausibly then—were quickly censured, separated, and isolated. The CPE scandal was much more widespread and longstanding too.

Michael Pakaluk

Another dimension is something like internal control—whether mechanisms for finding wrongdoing have been tampered with. The inspection scandal was uncovered pretty quickly by a partner who went to the firm’s general counsel. The CPE scandal involved manipulation, even of the server, as regards to what percentage correct answers counted as a pass. This is a high level of basically undiscoverable mendacity. So the CPE scandal again looks worse.

Then there’s the dimension of the substantive seriousness of the matter. For a KPMG partner to be concerned about the number of deficiencies in an inspection report, well, everyone knows and the PCAOB explicitly says that because of the risk-based, drill-down method of inspections, it’s not possible to draw any conclusion about audit quality in general from the number of deficiencies in an inspection report. The samples are not random. So KPMG wanted to get its hands on the inspection schedules basically as a matter of PR and marketing to audit committees—not in the end a substantive matter (as important as it might be for their business). But the CPE scandal involved cheating on matters involving genuine professional competence related to carrying out audit engagements well. So on this dimension too, the CPE scandal looks worse.

Finally, there’s the dimension of how the scandal affects the trustworthiness of the firm. PCAOB inspections are discrete; gaming the inspection system is unlawful in regards to this one particular authority. But a firm’s commitment to professional education and competence is a standing commitment; gaming this system is implicitly an attack on the very notion of a profession, as based in knowledge and expertise. On this dimension too, then, the CPE scandal is worse.

So my conclusion is that although the inspection scandal got all the headlines because it was so flagrant and looked like “stealing the exam,” the CPE scandal on all the dimensions I can think of was worse.

But three questions:

  1. Are we sure that CPE is not treated in a similar way by other firms?
  2. Is the reason that CPE is “gamed” or “cheated” in this way because the CPE offerings (mostly online?) are so poor that busy professionals can’t take them seriously?
  3. Why does the SEC believe that three hours of ethics training every month (no matter what the nature or the character of the ethics course, apparently) is an important part of the solution?

Matthew Reidenbach, PhD, CPA (inactive)
Assistant Professor of Accounting, Lubin School of Business
Pace University, New York City

Both of these incidents are particularly bad for KPMG since they illustrate efforts to “game the test” and show an utter lack of professionalism on behalf of the individuals involved. Both incidents demonstrate poor “tone at the top” as the actions of these partners show those who report to them that firm and industry rules are a nuisance and unimportant.

Matthew Reidenbach

That said, from my time as a former Big 4 auditor, I believe that unethical actions on CPE compliance likely occur on a smaller scale in most public accounting firms. I also believe the PCAOB inspection scandal is far greater as external stakeholders associate the PCAOB inspection process with true audit quality (whether fairly or not).

Senior leadership in KPMG actively using information about which audit engagements may be selected for PCAOB inspection provides a significant advantage ensuring that audit working papers correctly document performed work and comply with PCAOB standards. This conduct around the PCAOB inspection reflects poorly on KPMG’s entire audit practice, while the CPE scandal can arguably be dismissed as the extremely poor judgment of several bad actors (and not all of KPMG’s audit practice).

Tying back to ethics, since the AICPA Code of Professional Ethics is largely rules-based (in contrast with the new principles-based IESBA Code of Ethics), having such a high-profile publicized ethical lapse (“acts discreditable” in the code) demonstrates a problem that KPMG must fix quickly to protect its market position.

Michael Shaub, PhD, CPA
Clinical Professor of Accounting
Deloitte Professional Program Director, Mays Business School
Texas A&M University, College Station

It’s actually a great opportunity for the profession to take stock about where we are. This is not just a KPMG problem, in my opinion, but a culture problem in our profession. 

Michael Shaub

Which event is worse? Well, stealing the inspections list was actually corporate espionage for competitive advantage that involved corruption at both a regulator and an accounting firm. It’s hard to top that, and I can’t recall an event in my 40 years in the profession that was worse. But the CPE cheating event is of the same nature. Both are events where people sacrifice their integrity to project a false level of competence. It is a violation of both halves of accounting ethics—competence and integrity.

It is easier to sanction the inspections list theft, to fire those involved, and to characterize them as rogue employees, even if they were at the highest level. I can’t imagine how much time will be spent figuring out how to sanction the CPE cheaters within the firm, because they appear to be pervasive in number, a reflection of the culture. And, in the end, all those fired will get jobs elsewhere. What is the SEC’s solution? Three times as much of the CPE they ignored the first time, only it’s all ethics CPE. That ought to go well.

Lawrence Murphy Smith, D.B.A., CPA
Professor of Accounting, College of Business, RELLIS Campus
Texas A&M University, Corpus Christi

Any ethical scandal is damaging to the reputation of the accounting profession. I think all should be taken equally seriously.

Lawrence Murphy Smith

How should recent accounting scandals be evaluated? A good answer to that question requires a historical context. In world history, there has never been a country like the United States of America. Relative to other countries, America has more freedom, more wealth (more evenly distributed), and more opportunity. The accounting profession has compiled a lengthy record of vital contributions to the efficient functioning of business operations, the capital market system, and the economy in general. To carry out its role, the profession must consistently maintain its most priceless asset—its reputation.

Accounting professionals must be exemplars of ethics. Ethical values are the base on which a civilized society is established. Lacking that solid base, a civilization falls apart. I’ve often said, “On a personal level, everyone must answer the following question: What is my highest aspiration? The answer might be wealth, fame, knowledge, popularity, or integrity. Be on guard, if integrity is secondary to any of the alternatives, it will be sacrificed in situations in which a choice must be made. Such situations inevitably occur in every person’s life.”

The role of ethics in accounting and business is to guide business men and women to live by a code of conduct that builds public confidence in their products and services. Accounting leaders and educators must stress the importance of high ethical standards. Adherence to high ethical standards will enable the accounting profession to continue its historic role in the ongoing success of the country and its economy.

John Thornton, PhD, CPA
LP and Bobbi Leung Chair of Accounting Ethics
Professor, School of Accounting
Azusa Pacific University, Azusa, CA

Both issues involved very egregious behavior and are a huge black eye for KPMG. The only small consolation is that both were uncovered by internal whistleblowers.

John Thornton

In my opinion, by far the worst issue is one with former and current PCAOB employees colluding with KPMG to avoid oversight in audits. It is not enough to fine KPMG; there should be criminal convictions as well. Moreover where does the culpability of the PCAOB fit into this? Did they fine themselves? How is it legal to jump straight from their organization to a partner in a Big 4 firm? It is their own internal control problems to not have processes in place to protect the public from this public institution. This is a huge issue.

Cheating on tests? Especially ethics ones! How ironic.

Both incidents suggest the tone at the top and throughout this firm is simply unacceptable for the auditing profession.

Extremely disappointing!

Related article:

SEC Says $50 Million Fine For KPMG Is ‘Significant’ and ‘Appropriate’ For All That Cheating Going On

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