South African Audit Scandal Ethical Violations

Ethical Violations - South African Audit Scandal

Introduction

Browning, Levin, & Wolod is interested in expanding accounting and auditing services to Luxembourg, Malta, Monaco, and south Africa. The introduction of international operations into the organization creates new opportunities that can be leveraged by the organization to generate revenue and new risks that can be mitigated by training the recruits accordingly (Minh Duc et al., 2019). The KPMG case is recognized internationally for the egregious violation of accounting and auditing professional codes of conduct. The training process of the auditors and accountants who will be involved in the international operations will focus on the American Institute of Certified Public Accountants (AICPA) Code of Professional Conduct, South African Institute of Chartered Accountants (SAICA) Code of Professional Conduct, and International Federation of Accountants (IFAC) Code of Ethics for Professional Accountants (Schilder, 2017). The KPMG SA was selected since it encompasses comprehensive auditing and accounting professional ethics and codes of conduct that were not observed, resulting in an international financial scandal.

Money Laundry

KMPG SA, a financial institution, was contracted by the Gupta family to conduct audits of their estate but liaised with the family to launder money obtained illegally from the South African government. Money laundering is the use of deceitful, complex transfers and transactions obtained illegally through a series of businesses to appear as legitimate revenue or profits. The Free State government initiated a dairy farming project at Verde and established it intended to empower the impoverished residents and boost provincial agriculture (Holtzblatt et al., 2020). Afterward, a company named Estina was established to enable the construction of a dairy project. However, Estina was linked to the Gupta companies since it shared addresses with some of the Gupta companies. The Free State Provincial Government allocated Estina a 99-year lease to construct the dairy company. Notably, the only director of Estina was one individual who only had a background in I.T. sales, and the dairy farm was not open for public bidding despite initial statements that it would be open to private investors.

In a series of transactions, the Free State Government allocated $8 million to Estina which was diverted to a Gupta-controlled U.S. dollar account at Standard Chartered Bank in Dubai. Three-quarters of this amount was redirected to 2 Gupta-owned companies in South Africa. The remainder of this money was used to pay for a Gupta family wedding which was invoiced to Accurate Investments Ltd, a Gupta controlled company in the UAE, listing items used for the four-day wedding by Linkway Trading, which was also owned by the Gupta’s in South Africa. since there Accurate’s Bank balance at Standard Chartered was d U.S. 15,811, Estina deposited $1,999,975 from the amount initially deposited to its account by the Free State Government to Guptas’ Gateway Limited in Dubai (Holtzblatt et al., 2020). On the same day this transfer was made, the money was moved to Gupta UAE shell, Global Corporation LLC.

On the following day, Global Corporation LLC transferred the U.S. $1,590,000 into Accurate’s Standard Chartered that had been invoiced by Linkway trading company invoiced for the Sun City wedding. The $400,000 balance was transferred to Accurate’s Standard Chartered account. Accurate transferred the U.S. $1,986,000 to Linkway Trading’s State Bank of India account (Holtzblatt et al., 2020). The transfer notes of the transfer were the invoice number issued by Linkway initially to Accurate. However, this amount was not enough to settle the initial invoice, thus resulting in another cycle of laundry where $2,999,975 from Estina arrived in Gateway’s Dubai account. U.S. $1,400,000 was deposited into Accurate’s account and was used to settle the U.S. $1,347,400 of the wedding invoice balance.

Linkway was a client of KPMG SA and overlooked the listing of the Sun City wedding, a personal expense, as a cost of sales. Some of the violations that led to the scrutiny of KMPG SA was the listing of the wedding as a business celebration, and no income tax was paid as well (Holtzblatt et al., 2020). KMPG international acknowledged that accounting and auditing malpractices had been overlooked in the course of an audit. The Independent Regulatory Board of Auditors (IRBA) began an investigation of KPMG following allegations held in the public domain. The investigations discovered even more “grossly negligent” practices for the year ending 28 February 2014.

For example, Wessels, an employee at KMPG SA, was compromised after attending the Sun City wedding and enabled Linkway Trading to avoid the payment of over 2 million Rands in taxes to the South African Revenue Service (SARS). In addition, the IRBA found that KMPG SA had facilitated the diversion of 30 million Rand for the Vrede Dairy Farm Project located in the Free State to finance the 2013 Gupta family. Wessels’ audit had changed the books of Linkway to record the 6.9 million Rand used to pay for the wedding guests’ accommodation from expenses to cost of sales in the financial statement (Holtzblatt et al., 2020). Consequently, Linkway only paid 55,000 Rands instead of 55,000 Rands in tax to SARS. Besides tax evasion and professional negligence, the IRBA found KMPG SA guilty of lack of independence, failure to conduct procedures accordingly, and dishonesty.

Importance of Reputation for an Accounting Firm

The reputation of an accounting firm is the perception of its reputation among its stakeholders, such as suppliers, employees, investors, customers, regulators, non-governmental organizations, and politicians (Abdullah, Almsafir, and Al-Smadi, 2015). The perception of internal stakeholders greatly determines the external perception of an organization. A strong reputation of an organization attracts prospective external investors into the firm. Conversely, a bad reputation results in the avoidance of the organization by potential and suitable investors owing to the trust deficit in the financial reports published by an accounting organization. The role of accounting firms to their clients is a valuable addition to business operations by communicating the organization’s financial performance.

Contracting an organization that does not have a good reputation results in publishing reports that are not trusted by internal and external stakeholders (Abdullah et al., 2015). Further, this may prompt scrutiny by the relevant regulators, resulting in even more damage to the organization’s reputations and business activities with clients and other businesses. Consequently, building trust in an accounting organization creates trustworthiness among internal and external stakeholders attracting customers and complementary business partnerships with other firms. This also avoids the loss of resources, time, and efforts made by stakeholders towards the growth of the business that the negative reputation of an organization could limit.

KMPG SA measures towards rebuilding trust and redefining professionalism in the organization began in September 2017 with the restructuring of the leadership and governance structure in the organization. The efforts began by appointing an independent non-executive member of the board of directors to scrutinize the organization’s internal operations. In addition to the non-executive members of the board of directors, a new committee was formed to ensure the operations at KMPG SA were above the required standards. In October 2017, the organization allocated a permanent executive position to the Head of Risk to accept and retain clients by the firm (Writer, 2019). In January 2018, a new chairman of the board of directors, Wiseman Nkuhlu, was appointed to rehabilitate the operations and reputation of KMPG SA. In April 2018, Ansie Ramalho was appointed as the independent director of KMPG’s board of directors. In June 2018, the organization began re-evaluating its client portfolio and selecting only clients who were aligned to its risk assessment criteria.

These measures were directly related to the responses to the allegations leveled against the organization. For example, the organization was charged with the lack of independence of its employees and dishonesty due to doctoring of books to avoid tax. Consequently, the appointment of a non-executive director and a committee to examine organizational operations were intended to help avoid compromise of the ethics and codes of professional conduct, such as AICPA and SAICA. The measures taken by KMPG were necessary but still require more organizational initiative towards the public responsibility-oriented services rather than preference of the clients (KPMG report signals firm’s renewal, 2019). Since the organization initially acted in the interest of the Gupta’s, the initiation of measures towards retraining the staff to act in the public’s interest is critical. Further, the inclusion of the IRBA’s stakeholders in the restructuring process towards the re-establishment of trust in the organization and the participants from the IFAC would have been critical to establishing trust in the stakeholders and the regulators of accounting across the globe.

Professional Skepticism in Accounting

Professional skepticism is essential since it enables the professional accountant to identify and respond accordingly to circumstances that might be perceived as alarming, such as misstatements. Consequently, it serves as a critical attitude towards the approach taken from the onset of an audit to enable the professional to be alert by critically looking into the audit evidence that may contradict other sources of evidence, or that creates uncertainty about the information obtained from the management and the client’s organization’s governance. The IAASB’s International Standards on Auditing (ISAs) distinguishes that the fundamental role of professional skepticism is that adopting and applying professional skepticism is a good practice and a professional responsibility of auditors (Henderson, 2021). The ISA holds that it is the fundamental approach to developing an auditor’s skill set and the closely related concepts of autonomy and professional judgment for the performance of quality audits.

Some of the red flags that the auditors at KMPG SA should have to identify internally range from the operational, organizational structuring, and governance. For example, internally, the invitation and attendance of its employees to the Gupta’s Sun City should have been perceived as a source of a possible compromise on the autonomy of these employees. Establishing Estina to create a dairy company without the involvement of the public, like initially stated, should also have been perceived as a red flag. The allocation of Estina a 99-year lease while the company’s ownership was associated with the Gupta family should have triggered the onset of a more thorough audit (Shawver, 2020). Transfer of U.S. $8 million to Estina’s account and the subsequent transfer to Accurate’s account in Dubai twice should have been a reason enough to detect the illegal dealings within the organization. The alarm raised after the costs incurred by Linkway during the Sun City wedding had been transferred in the cost of sales account by a junior accountant should have initiated a probe internally for the funding of sources and funding of the Sun City further.

External red flags of the laundering activities by the Gupta family were the concerns raised by the landing of the guests invited to the Sun City wedding in a military base. Such circumstances are unconventional and would have been detected by a professional auditor with a skeptical attitude. The 30 cows found dead due to starvation in a pit on the land set aside for the dairy farm should have led to further investigations of the reasons explaining this scenario (Holtzblatt et al., 2020). Rumors about the president’s compromise by the Gupta family since they had contributed to his campaign and election into office should have also been perceived as a red flag and led to further probing.

KMPG SA was lacking professional skepticism resulting in the scandal that destroyed its reputation. The negligent behavior of the KMPG SA employees involved in the audits of Gupta companies in South Africa lacked the professional demeanor and skepticism required of external auditors. Notably, there were red flags recognized by the junior auditor at KMPG SA but their senior auditor’s independence had been compromised. The approach employed in the audits done by KPG SA indicates that the integrity of its operations had been compromised by the Gupta family (Holtzblatt et al., 2020). Further, the corporation must have been aware of the money laundry conduct in collaboration with government officials who approved the establishment of the dairy project and the daily company at Verde. Notably, the activities associated with Sun City should have been a red flag since it was against all military and government policies and prevented the KMPG SA employees from attending. Consequently, their integrity would not have been compromised. The audits of the Linkway expenses and taxes should have led to the involvement of the relevant authorities to launch a further investigation of the Gupta companies.

Importance of Auditor Independence

Auditors’ independence is critical to their ability to execute their mandate without being compromised by the clients or negligence of their professional conduct. An auditor’s independence is critical to upholding the fundamental principles of accountants’ professional code of ethics (IFAC), including professional competence and due care, objectivity, integrity, confidentiality, and professional behavior (Shawver, 2020). The principles are critical to overcoming the different categories of threat, such as advocacy, familiarity, self-review, self-interest, and intimidation threats but are only effective if the auditor is independent. The IRBA defines auditor independence as avoiding circumstances and facts that are significant in a manner a reasonable and informed party would a member of the audit team or the firm can foundational principles stipulated by IFAC are upheld. The management of these requirements makes it possible for the corporation to determine the changes associated with creating a common understanding of these differences. Notably, the auditor’s responsibility is not to meet the expectations of the client only but also ought to act in the public interest by complying with IFAC.

The IFAC frameworks stipulate the significant and insignificant threats that the organization to determine where safeguards should be implemented for perceived threats and when they should be reduced. Consequently, an auditor’s independence results in sound audits that give the company credibility and foster public trust in the accuracy of the published financial reports (Shawver, 2020). The immediate benefits of an independent auditor are the protection of the stakeholders from fraudulent activities in an organization, accounting aided misappropriation of funds and safeguarding the investor’s interests. Further, they might bring to light mistakes, or financial errors that the client might not have detected and foster diligent administration since the information rendered is reliable.

KMPG auditor’s independence was compromised due to the involvement in the Gupta family activities that compromised the attendant auditor’s objectivity while conducting audits of the Gupta businesses. Besides the compromise of the auditor’s objectivity, the integrity, professional competence and due care, and professional behavior at the expense of the economically disfranchised residents of Verde. The compromise of the professional behavior and integrity of KMPG auditors, such as Wessel, led to the misappropriation of U.S. $8 million that initially was intended to help in the agricultural development of Verde to help raise the living standards of the residents of Verde (Holtzblatt et al., 2020). The negligence of their professional responsibility to the public and care led to more suffering of these residents since the misappropriation of public funds worsens the country’s economic performance. The poor are affected disproportionately compared to the wealthy, such as the Gupta’s. The compromise of the KMPG auditors’ integrity resulted in the record of the Gupta wedding expenses as the cost of sales at Linkway. In contrast, these expenses did not have any value in the generation of the company’s income. Further, these failures resulted in tax avoidance, notwithstanding the laundry of public funds to benefit the Gupta family.

The impact of auditor rotation on KPMG SA auditor independence, both internal partner rotation, and external firm rotation, will have a strengthening impact on the independence of the auditors involved. The familiarity with the organizational operations and clients might result in complacency that threatens the credibility of the organization. According to KMPG (2017), there are two kinds of independence affected by the internal and external rotation of auditors. The accounting challenges witnessed in South Africa were attributed to the lack of auditor independence (Holtzblatt et al., 2020). According to the KMPG article, there is the independence of fact and independence of appearance. Compromise of the independence of appearance results from oversight of facts or circumstances that substantiate the firm or auditor’s professionalism or adherence to the IFAC professional code. Since the measurement of independence of appearance compared to the fact is harder to evaluate, auditor rotation in the KMPG operations internally and externally.

Notably, the auditor’s internal and external rotation has been implemented in some countries, such as Brazil and Nigeria, and withdrew subsequently (Erah et al., 2012). However, the E.U. auditors’ rotation was implemented through a parliamentary process instead of IRBA due to a high market concentration. The success of mandatory audit firm rotation in the E.U. was attributed to the high concentration of audit firms. The implementation of internal rotation will result in the upholding of the professional code of conduct. Similarly, the external auditors will embrace the professional skepticism and other elements of the IFAC professional conduct since the subsequent auditors will critique their professionalism.

The inconvenience of auditor rotation internationally has been associated with the cost accrued tendering process that might result in allocating resources that could have been used for methodologies, transformation, and attracting talent being redirected into the tendering process. Erah et al. (2012) hold that most Nigerian banks that sort the services of the big four, PWC, Earnest, KPMG, and Young and Akintola Williams, collapsed. The collapse of the banks was imminent, notwithstanding, rotation of the external audit firms since the organization’s management was not held accountable. Consequently, implementation of internal and external auditor rotation should also be accompanied by a letter of representation written by the auditors to the management to launch an investigation into grey areas raised by the auditor.

Legal Structure of the Global Accounting Firms

The legal structure of the global accounting firm, PWC, Earnest, KPMG, and Young and Akintola Williams, employ a horizontal structure to reinforce their global network rather than an administrative structure of the alliance. The horizontal structure facilitates the brand recognition of the four companies internationally. Still, it does not have standard operating procedures nested within the IFAC or other international professional codes of ethics. Consequently, subsidiaries of either of the companies that operate in either of the 150 countries where these companies are present that conduct substandard audits that may have adverse consequences are not held accountable by the collective companies (Rapoport, 2018). Further, the international entities are not held liable for the poor performance of their subsidiaries and shy away from claiming such responsibility.

This structure was created to facilitate a consistent global culture, accountability, values, and execution. The U.S. assent laws are aimed at bringing forth the affiliates of U.S. companies that are publicly traded. However, the fragmented big-four legal structure limits the liability of the U.S. partners for the negligent conduct of the subsidiaries (Abdullah et al., 2015). Subsidiaries operate as independent entities since each country has its legal framework for licensing and training requirements through the local affiliates. However, the legal implication is the global entity cannot be held accountable for the occasional problematic audits despite challenges suffered by investors and the local community.

KMPG international should be held accountable for auditing issues that arise from its affiliates, such as KMPG SA. KMPG International facilitates the establishment of the affiliates. The subsequent benefits associated with the affiliate are enjoyed by the international brand as a marketing strategy and benefit its stakeholders accordingly (Abedian, 2018). Consequently, the approach taken to avoid liability should be alleviated through the complete termination of affiliates whose audit issues can be considered “significant” according to the AICPA, ISA, and IRBA. Therefore, GPMG should have been held liable for the KMPG SA scandal with the Gupta family since it was also involved in the audit.

Client Acceptance and Continuance

Client acceptance and continuance refers to the measures taken to investigate the new and continuing clients to determine if the client meets the prerequisite quality standards set by the KMPG SA. Probing an organization’s financial reporting practices makes it possible to determine if the existing client portfolio and exiting relationships align with KMPG SA assessment criteria and business model (Pang, n.d.). Further, these practices evaluate the client’s competency, or prospective should have the competency and capabilities complementary to the KPMG’s organizational operation. Examining the trends of compliance with ethical requirements would help determine the clients who accepted or whose relationship is to be continued. The evaluation of the integrity management systems of clients investigates whether there have been alarming experiences, such as fraud or non-compliance (Pang, n.d.). When KMPG acquires access to the client’s books or revaluates the books of current clients can lead to a withdrawal scenario (after-the-fact) where the evaluation results in uncovering facts, such as significant new risk, change in the governance structure, or the client’s financial condition, that are contrary to the firm’s acceptance and continuance prerequisites.

KMPG SA overlooked acceptance of the Gupta business evaluation to determine if they were suitable for acceptance and continuance after that. The involvement of the Gupta’s in the presidential election and the allegations of compromising the country’s leadership violate ethical standards by the IRBA, AICPA, and SAICA (Holtzblatt et al., 2020; Shawver, 2020). Besides overlooking these initial red flags that could have limited the acceptance of the Gupta family businesses as clients, GPMG SA overlooked the core evaluations of these businesses on an annual basis to examine their governance, financial situation, integrity, organizational capability, and risk (Wolfe & Stanley Sterna, 2020). The Gupta family laundered money obtained illegally from the South African government. The Free State government initiated a dairy farming project at Verde and established it to empower impoverished residents and boost provincial agriculture.

Afterward, a company named Estina was established to enable the dairy project. However, Estina was linked to the Gupta companies since it shared an address with some of the Gupta companies. The Free State Provincial Government allocated Estina a 99-year lease to construct a dairy company (Holtzblatt et al., 2020). Further, the company was involved in the $8 million allocated to establish a dairy company. The transfer of these funds to foreign banks accounts associated with Gupta’s should have been perceived as a risk and failed to meet the continuance requirements warranting an after-the-fact termination of engagement with the Gupta estate.

Changes in the Audit profession

There is a need to implement a centralized auditing regulatory framework to hold the leading accounting firms, the big four, accountable for the auditing issues that are often downplayed. At the same time, the success is broadcast to aid the reputation of their brands globally. For example, Deloitte & Touche and BDO were fined the U.S. $50,000 for circumnavigating the Public Company Accounting Oversight Board procedures (Abedian, 2018). As established, the subsidiaries of international accounting organizations work as independent entities since each country has its ideal legal framework for licensing and training requirements through the local affiliates. However, the legal implication is the global entity cannot be held accountable for the occasional problematic audits despite challenges suffered by investors and the local community. However, these loophole in regulation leads to the exemption of the international entity from liability of the losses caused by their subsidiaries (Abdullah et al., 2015). Further, they trivialize the offenses committed by their subsidiaries despite taking actions that reflect culpability and being found by local international accounting regulation bodies such as SAICA and IRBA in the case of KMPG SA.

To uphold the auditors’ professional integrity, the regulatory frameworks should necessitate the establishment of an internal and external mechanism to vet the performance of private, public, and private-public-partnerships organizations internally and externally. To avoid unwillingly facilitating corrupt perpetrators, the IRBA should require confidential mechanisms for all stakeholders in the process of an audit to raise the alarm anonymously about possible fraudulent activities (Abedian, 2018). Externally, the financial data f an organization should make public for the inquiry by whistle-blowers, citizens, journalists, and self-reporting. Further, internal and external auditors should be guaranteed in the regulatory frameworks to perform their oversight functions effectively. For example, the Spanish General Comptroller of the State Administration (IGAE) was established to conduct financial control, monitoring, and audits of the Spanish public sector’s economic and financial activities. The establishment of such a mechanism would have prevented the misappropriation of taxpayers’ billion in South Africa.