KPMG SA Scandal: Ethics Violations in Public Accounting

Introduction: Ethics in Public Accounting

Public accounting is a field faced with ethical issues similar to any area of practice. Unethical practices in accounting are often motivated by management greed, incentive structures, bonuses, management pressure, and related factors. These practices only lead to short-term gains (Finn, Chonko & Hunt, 1988), while long-term impacts are usually negative. Ethical behavior and practices are therefore critical aspects of good accounting. Accounting regulations and rules exist to ensure that users remain objective as they make decisions by utilizing accurate financial statements at the end of business operations.

The AICPA is the primary body that guides accountants in the public sector, while the IIA and the IMA govern accountants and auditors in the private sector. This paper presents a case study of a South African firm involved in a scandal due to ethical violations, examining the detrimental impacts of the resulting negative publicity. The case study and the accompanying findings examine various ethical issues and challenges in depth.

Forms of Ethical Violations: Money Laundering

Ethical violations take various forms, including fraudulent practices, improper management of records, and violation of federal and state laws, all of which can be manifested in multiple ways. One such practice is money laundering. Money laundering is an illegal practice used by criminals to conceal their illegal income sources from the law. It is one of the most organized criminal activities in the world. With money laundering, illegally acquired funds are converted into what appears to be legal money and tender. Large organizations typically resort to money laundering when they engage in organized criminal practices that generate large quantities of cash, causing authorities to question their activities. As a result, they seek ways of concealing this money to avoid attracting legal scrutiny.

Money laundering occurs in three stages: placement, layering, and integration. Placement involves introducing dirty money into the legal financial system through activities such as blending legal and illegal funds, invoice fraud (including under-invoicing and over-invoicing), and fraudulent documentation. It can also be accomplished through smurfing — breaking large illegal sums into smaller, less suspicious transactions — as well as offshore accounts that hide dirty cash in foreign institutions to evade taxes, and aborted transactions.

The second stage, layering, generally involves transactions that move illegally earned money deeper into the legal financial system, usually through offshore techniques, making it difficult for authorities to detect. This can be done through investing in shell companies or real estate, converting funds into stocks, or moving money into offshore accounts. The final stage, integration, involves absorbing the money back into the economy as apparently legitimate tender through investments in high-end cars, artwork, property, jewelry, and other high-priced commodities.

In this case study, as documented in exhibits 3 and 4, money laundering occurred according to these three stages (Holtzblatt, Foltin & Tschakert, 2020). The government granted Estina — a subsidiary connected to the Gupta family — a contract to participate in the Verde Dairy project without opening the project to competitive bidding. The state government provided the company with 84 million rands to fund the project's first year. That money was later transferred to an offshore account in Dubai, deposited into a Gupta-controlled UAE shell company called Gateway Limited.

Approximately 75 percent of that money was then sent back to two subsidiaries of the Gupta business empire in South Africa, including funds that paid for the lavish Gupta wedding. The invoices show that a substantial amount was spent at the Sun City celebrations, totaling 30 million rands (approximately USD 3,333,400) — a figure significantly different from the amount initially reported for the wedding, which was equivalent to approximately USD 15,811. These figures provide clear evidence of foul play involving the conversion of illegally acquired public money through an offshore account in Dubai and a UAE subsidiary, then wiring it back to two further subsidiaries, including using it to pay for a private wedding. Ultimately, the family converted state funds into their own legitimate-appearing assets.

KPMG SA was also implicated in this laundering scheme by disregarding the fact that 30 million rands designated for the dairy farm had instead funded the lavish Gupta wedding. Linkway Trade — a Gupta Empire subsidiary involved in the laundering scheme and a KPMG client — managed and paid for the wedding celebrations. Foul play was evident, particularly when the celebration expenses were recorded as a business expense and the company failed to pay income tax on them, neither of which KPMG SA questioned. As a result, the KPMG SA audit fell far short of expected quality standards, as later reported by KPMG International. The auditing firm was found to have violated several ethical codes of accounting. Moreover, IRBA and SAICA concluded that KPMG SA was negligent in its oversight of the Gupta money laundering activities, and that the president of KPMG SA failed to fulfill the firm's auditing responsibilities.

Reputational Damage and Recovery Efforts

Reputation and public trust in an auditing firm's judgments are crucial in substantiating the functions of an auditor and the value-added services that lend credibility to published financial audits and reports. A strong reputation and public trust encourage and drive an auditing company to conduct transparent accounting practices, issue reports that stakeholders can readily understand, and attract potential investments and business dealings — ensuring a consistent flow of income. Any financial restatement caused by fraudulent practices, especially by a high-profile firm such as KPMG, erodes public confidence in financial reports and audit functions more broadly.

When such a scandal as the one encountered by KPMG SA occurs, restoring public confidence becomes critical. However, because the firm's dealings resulted in serious negative publicity, restoration is challenging — though not impossible. It requires significant efforts from every stakeholder, including the accounting profession, the business community, standard-setting bodies, regulators, and legislators.

After the scandal, KPMG took several responsive measures to restore its reputation and trust in its South African affiliate. The first step was a change in leadership: Nhlamu Dlomu was selected to replace the former president, Mr. Wessels. The company believed she was well qualified and experienced enough to return KPMG SA to quality auditing while upholding ethical standards. Her first priority was to build a management team committed to ethical conduct and integrity in order to ensure high-quality service and stability for clients. She also oversaw the appointment of a partner to serve as a risk management partner, improving risk management and audit quality. The firm took additional steps to enhance its corporate governance processes, including adopting key recommendations and appointing a senior, independent, non-executive director to complement the existing board and assist the leadership team in rebuilding public trust. KPMG International has also been committed to supporting KPMG SA throughout its recovery by providing global expertise and specialist resources working in unison with the local team (Holtzblatt, Foltin & Tschakert, 2020).

While a change in leadership is the first and most important strategy for restoring reputation and public trust, it is not sufficient on its own. Additional affirmative actions can enhance the restoration process. For instance, the firm's marketing team could launch periodic campaigns to win back public trust and attract new investors and clients — with each subsequent campaign highlighting key achievements since the previous one, thereby demonstrating consistent improvement. The firm could also implement a customer win-back program, designed by the marketing team with management support, which has been proven cost-effective and efficient. Other activities might include employee motivation programs and strategies to build mutual trust between management and staff, since a healthy internal working relationship generally improves service quality and speeds up the recovery process.

References

Finn, D. W., Chonko, L. B., & Hunt, S. D. (1988). Ethical problems in public accounting: The view from the top. Journal of Business Ethics, 7(8), 605–615.

Holtzblatt, M. A., Foltin, C., & Tschakert, N. (2020). Learning from ethical violations in public accounting: A South African audit scandal and a firm's transformation. Issues in Accounting Education, 35(2), 37–63.