KPMG faces embarrassing questions over its role with the Co-operative Bank

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KPMG is one of the ‘Big Four’ accountancy firms and is growing again after a blip during the recession. Its global revenues last year were $23.42bn (about £14bn).

In the mutual sector, though, KPMG is having some difficulties. For the last 30 years it has been auditor to the Co-operative Group and the Co-operative Bank, leading to questions being asked about the quality of its audits. Meanwhile in Ireland, it is dealing with hostile questions regarding its relationship with the former Irish Nationwide Building Society. The society collapsed in 2010, costing the Irish state €5.4bn (£4.5bn), after a quarter of the value of the society’s loan book was written-off because of terrible lending practices.

These issues are significant, as KPMG has a reputation for being the leading accountancy and consultancy firm for mutuals. It provides a respected annual report on the state of the building society sector and is auditor for many building and co-operative societies.

Richard Gabbertas, financial services partner at KPMG, was happy to confirm this. “KPMG prides itself on having an integrated mutual practice – covering building societies, co-operatives and mutuals – which has supported the sector on a wide range of issues for over 25 years,” he says.

“We audit about half the UK’s building societies, provide internal audit services to almost a quarter of them and we have advised most of the sector at one time or another on a variety of business issues. We have advised over 10 co-operatives in the UK and are recognised as the leading advisory firm in this sector.”

KPMG has unquestionably built-up significant expertise on mutuality over the years. In its annual reports on building societies, the firm has spoken strongly in support of the sector and its strengths. However, this has not prevented it from working with building societies to support their demutualisation. In one of those instances, KPMG advised the former Irish Nationwide Building Society. Subsequently, it imploded in one of the most disgraceful episodes in the Irish banking sector. KPMG remained the auditor during its collapse.

KPMG says there is no reason why it should not support a mutual client that wants to demutualise. Gabbertas explains: “We have remained the leading provider of assurance and wider advisory services to the mutual sector for many years. In that role we have provided advice to mutual organisations across a range of strategic paths decided on by their boards. While we are supportive of mutuality, our role is to provide support to our clients on their individual business needs rather than to make decisions – including whether to demutualise – for them. In our advisory capacity, it would be strange for us to refuse to act for mutual clients if they decided to demutualise for what they believe are genuinely valid strategic reasons.”

It is this willingness to ‘run with the foxes and then run with the hounds’ that has generated much of the hostility within the mutual sector towards KPMG. Bob Cannell – personnel officer for Suma, a director of Co-operative Business Consultants and Co-operatives UK and a board member at CECOP, the European Federation of Worker Cooperatives – takes a critical view of the approach taken by KPMG.  

“I said at the ICA [International Co-operative Alliance] AGM in Cape Town that a co-op using KPMG or any of the other Big Four as its auditor is like a chicken farmer asking a fox to count the chickens in the farmyard, find the holes in the fence and then trusting the fox when he promises not to tell his mates outside,” says Bob.

“It got a big round of applause from delegates from all over the world and I was being hand-shook all down the corridor afterwards by delegates thanking me for raising the point. Clearly many co-operators are uneasy at the close relationship between KPMG and senior co-op managers all over the world. The ICA board agreed to review its auditors.”

But it is not merely ideological issues that are damaging KPMG’s relationship with the mutual sector. The quality of its audits is also under review. There is general astonishment that the Co-operative Bank could have got its financial reports so wrong, for so many years. It is surprising that the Bank’s reporting failures were not spotted by its auditor, KPMG.

There is currently a review being undertaken by the Financial Reporting Council (FRC) – which regulates these matters – into the Co-operative Bank’s financial reporting and the audits of the reports by KPMG.  My guess is that this investigation could be extended into the financial reporting by the Co-operative Group. The FRC was unable to comment on the likelihood of this, or the expected timetable for the conclusion of its investigations.

Parallel investigations into the Bank’s reporting are taking place by the other City regulators, the Financial Conduct Authority and the Prudential Regulation Authority. The Treasury select committee is also taking a close interest.

Gabberetas plays a straight bat to the issue. “Given the issues the bank has experienced in recent months, and in light of the high media profile and public interest associated with these issues, it is understandable that there should be appropriate regulatory scrutiny,” he says.

He adds that “it is to be expected that this scrutiny should extend to the audit, while recognising that the auditor is independent of the events which gave rise to the issues experienced by the Bank. As auditor to the Bank we believe that we have provided, and continue to provide, robust audits which provide rigorous challenge to the judgements and disclosures proposed by the bank’s management. We look forward to co-operating fully with the FRC (and other regulatory authorities) in their investigations.”

KPMG has also been questioned about its role in providing due diligence to the Co-operative Group and Bank over the acquisition of the Britannia Building Society. But, as the auditors are keen to stress, the Bank itself conducted the due diligence on the bits of the building society where the substantial losses subsequently emerged. And the Group has previously told me it attaches no blame to KPMG for any failures in due diligence. The issue of why it was the Bank that conducted that due diligence – and why that was the bit that went so wrong – has been the subject of searching questions at the Treasury select committee and will surely be examined far more in the coming months.

What is perhaps most extraordinary has been some recently published remarks made back in July 2012 by the former Britannia chair and then Co-operative Bank deputy chair Rodney Baker-Bates in a memo to Group director Ursula Lidbetter. He suggested that if the acquisition of the Lloyds branches under Project Verde went ahead, the Bank’s “capital ratio is very stretched and will need accounting engineering by KPMG”. Those remarks are bizarre in the extreme given the supposedly arms length and objective role of an auditor.

KPMG says it was unaware of the comments at the time. “We have not previously seen the correspondence posted on the Treasury committee web pages,” says KPMG’s Gabbertas. “We are therefore unclear as to what the intention of the author was in making the comment. However, if the assertion is that we would be prepared to countenance the presentation of financial information in a manner which does not present that information fairly then we strongly refute that we did, or would ever, agree to this.”  He adds that as auditor it provided “robust audits” and “rigorous challenge” to the the bank’s management.

Let us not overlook, though, another outstanding issue facing KPMG. Having been auditor to the Irish Nationwide Building Society and consultant to it in the society’s demutualisation, KPMG was subsequently appointed as liquidator in the run-down of the business, which is now merged with the Anglo-Irish Bank into the Irish Bank Resolution Corporation.

KPMG was not the auditor to the Anglo-Irish Bank – that was Ernst & Young (now called EY). As liquidator, KPMG is suing EY over its audits. (EY denies its audits were inadequate.) So far, KPMG has declined to sue itself over its own audits of Irish Nationwide. Under intense political pressure, KPMG has agreed to have the decision on possible legal action against itself being taken in a way that is not affected by a conflict of interest. (KPMG did not respond to a request for a comment on the issues related to Irish Nationwide.)

This must, one would think, be embarrassing for KPMG. Whether, though, it is more embarrassing than the investigations into its audits of the Co-operative Bank is difficult to say. Taken together it does present a severe reputational problem for the audit firm that achieved market dominance in the mutual sector.

This comes at a bad time, too. The FRC, the Competition Commission and the European Commission are all trying to break the stranglehold of the Big Four audit firms – KPMG, PwC, Deloitte and EY – and encourage more large companies to switch to mid-size firms, such as Grant Thornton and BDO.

The FRC’s Corporate Governance Code specifies that large listed companies should put external audits out to tender at least once every 10 years. The European Union is going further, preventing auditors from holding contracts for more than ten years where there is a public interest. This is not merely to keep down costs, but also to ensure auditor objectivity.

Auditors’ responsibilities are to shareholders, or members in the case of a mutual. If auditors get too close to directors or management the necessary objectivity may be lost. Let us hope these principles are remembered during the forthcoming season of annual society meetings.

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  • http://www.ianfraser.org Ian Fraser

    You forgot to mention KPMG’s lamentable auditing of HBOS in 2001-09, and its acceptance of a brief from the HBOS board to produce an “independent” report into the circumstances surrounding the departure of the bank’s former head of group regulatory risk, Paul Moore. The report that KPMG eventually produced fell far short of being independent. http://www.ianfraser.org/kpmg-and-the-hbos-whisteblower/ Thjere are also some serious issues of “regulatory capture” given the presence of former KPMG senior partner John Griffith Jones as chairman of the FCA and the preponderance of ex KPMG-ers at the Financial Reporting Council. http://www.ianfraser.org/paul-moore-why-john-griffith-jones-must-go/