KPMG Braces For Litigation Battles By Bolstering Balance Sheet

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KPMG Braces For Litigation Battles By Bolstering Balance Sheet

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Anglo-Dutch auditing giant KPMG is strengthening its balance sheet by asking the firm’s equity partners to chip in significantly more capital. While the auditor is casting the change as a positive development that “offers more opportunities for people to get onto the partnership ladder”, a more cynical view is that KPMG is shoring up its financial position as it faces a barrage of lawsuits and complaints.

The £1 billion complaint which KPMG is facing over the collapse of British construction firm Carillion is likely a key motivation behind the capital injection, but serious problems abound elsewhere as well. A notable case in point is the ongoing fallout over the implosion of Dubai-based equity firm Abraaj, the financial world’s one-time darling which turned out to be little more than a Ponzi scheme.

KPMG has come under increasing scrutiny—both in the media and the courtroom—for its role in the Abraaj debacle, while other smaller complaints have only added to KPMG’s plight. Expanding its cash reserves might ward off KPMG’s imminent litigation liabilities, but more sustainable solutions are needed to fix a sector in desperate need of reform.

Tapping partners

KPMG has dressed its new partnership structure as “a fairer pay model”, though it’s undeniable that it demands a significant increase on previous payments.

The prior setup required partners to pay in between £70,000 and £80,000 when joining KPMG’s partnership. The new plan features five bands based on partners’ seniority, with the lowest demanding an injection of £150,000 and the highest an eye-popping £500,000.

Some spectators have commented that KPMG has always trailed the other Big Four auditing firms in terms of capitalisation, meaning that a restructuring was always on the cards. It’s noteworthy, however, that the move comes just weeks after the Official Receiver advanced a claim against KPMG, related to the insolvency of Carillion, which could exceed some £1 billion.

KPMG is also facing a fine of up to £25 million from the Financial Reporting Council (FRC) for its sloppy work on Carillion, with the British industry watchdog branding its bank auditing “unacceptable” for the third consecutive year.

The Cabinet Office, meanwhile, recently advised KPMG that it risks a ban on bidding for UK government contracts if there is further misconduct at the firm—the surest sign yet that patience has run out with KPMG’s string of scandals.

Abraaj adds to KPMG’s woes

The pending Carillion complaint might be the most immediate impetus for the KPMG cash injection, but it’s far from the only cloud on the horizon. Indeed, KPMG Lower Gulf—the auditor’s Middle Eastern subsidiary – was recently sued in Dubai for at least $600 million in connection with the Abraaj scandal.

At the peak of its powers, the UAE-based investment fund managed $14 billion in assets, but Abraaj executives were apparently shifting monies between different parts of the fund to hide its true insolvency, while founder Arif Naqvi stands accused of pocketing as much as $780 million.

The activity was not uncovered by KPMG auditors, but by investors concerned that their funds were being misappropriated. The fact that KPMG repeatedly gave Abraaj a clean bill of health despite numerous red flags is troubling—particularly given the fact that the two companies share uncomfortably close ties.

The son of KPMG LG’s chief executive worked at Abraaj, while executive Ashish Dave repeatedly bounced between roles at KPMG and at Abraaj. Nor was this unusual—several other Abraaj employees had come over from KPMG. Complicating the matter still further, KPMG also audited some of the companies Abraaj invested in, such as Air Arabia—calling its independence as an auditor into severe doubt.

Concerningly par for the course

Perhaps most worryingly of all, cases like Abraaj and Carillion are not isolated incidents. KPMG was forced to fire several American employees over a data-stealing investigation and has faced strong criticism for becoming too cosy with South Africa’s Gupta family.

Meanwhile, the firm have already been hit with a £3.2 million fine by the FRC for their incompetence in auditing insurance outsourcer Quindell and their coffers could be further drained by a £15 million lawsuit that the company, now known as Watchstone, are lining up against them.

Coincidentally, Watchstone previously launched a £63 million claim against PwC over alleged misconduct, signalling that potential auditing malpractice spreads far further than KPMG—a hypothesis backed up by the avalanched of court cases that have befallen the Big Four in recent years.

Both PwC and EY are being scrutinised by the FRC over the failure of holidaymaker Thomas Cook, while the latter are fending off a substantial legal claim over their involvement with the FTSE 100 hospital operator NMC Health. Despite this storm of controversy, the profit margins of the Big Four seem completely unaffected, with Deloitte, PwC and EY all posting record profits this year. KMPG is expected to follow suit when it publishes its financial records this month.

Reform ahead?

Understandably concerned by the auditing sector’s increasingly commonplace scandals and conflicts of interest, the UK government last year mandated that all four firms must fence off their auditing arms by the end of 2024.

Steps have already been taken in this direction; PwC made headlines with a $2.2 billion deal for its staff mobility and migration consultancy in October, while Deloitte and KPMG offloaded restructuring divisions earlier this year. KPMG raised further funds via the sale of its pensions department and the proceeds from the arrangement will apparently not be carved up between partners.

Instead, the auditors claim that the revenue will join the newly leveraged funds from its partner programme to allow for greater agility in investment and expansion. However, sceptics believe that the hoarding of capital is merely a failsafe in the face of a tidal wave of litigation battles.

One thing is for sure: sloppy auditing practices won’t just expose KPMG and its counterparts to costly complaints, but will also add fuel to the fire for those who believe that far greater oversight is necessary to reform the scandal-ridden auditing industry.

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KPMG Braces For Litigation Battles By Bolstering Balance Sheet

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