KPMG South Africa Audit Scandal: Ethical Violations

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 to generate revenue, as well as new risks that can be mitigated by training recruits accordingly (Minh Duc et al., 2019). The KPMG case is recognized internationally for its egregious violation of accounting and auditing professional codes of conduct. The training of auditors and accountants involved in international operations will focus on the American Institute of Certified Public Accountants (AICPA) Code of Professional Conduct, the South African Institute of Chartered Accountants (SAICA) Code of Professional Conduct, and the International Federation of Accountants (IFAC) Code of Ethics for Professional Accountants (Schilder, 2017). KPMG SA was selected as the focus of this analysis because it encompasses a comprehensive set of auditing and accounting professional ethics violations that resulted in an international financial scandal.

Money Laundering and the Gupta Scheme

KPMG SA, a financial institution, was contracted by the Gupta family to conduct audits of their estate but instead 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 involving illegally obtained funds, moved through a series of businesses to make them appear as legitimate revenue or profits. The Free State government initiated a dairy farming project at Vrede, established with the intention of empowering impoverished residents and boosting provincial agriculture (Holtzblatt et al., 2020). A company named Estina was subsequently established to enable the construction of this dairy project. However, Estina was linked to Gupta companies, as it shared addresses with several of them. The Free State Provincial Government allocated Estina a 99-year lease to construct the dairy facility. Notably, the sole director of Estina had a background only in IT sales, and the dairy farm was not opened 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 then diverted to a Gupta-controlled U.S. dollar account at Standard Chartered Bank in Dubai. Three-quarters of this amount was redirected to two Gupta-owned companies in South Africa. The remainder was used to pay for a Gupta family wedding, 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 Guptas in South Africa. Since Accurate's bank balance at Standard Chartered was only U.S. $15,811, Estina deposited $1,999,975 from the amount initially deposited to its account by the Free State Government into the Guptas' Gateway Limited account in Dubai (Holtzblatt et al., 2020). On the same day, this transfer was made to Gupta UAE shell company Global Corporation LLC.

The following day, Global Corporation LLC transferred U.S. $1,590,000 into Accurate's Standard Chartered account, which had been invoiced by Linkway Trading for the Sun City wedding. The $400,000 balance was also transferred to Accurate's Standard Chartered account. Accurate then transferred U.S. $1,986,000 to Linkway Trading's State Bank of India account (Holtzblatt et al., 2020). The transfer reference cited the invoice number originally issued by Linkway to Accurate. However, this amount was insufficient to settle the initial invoice, triggering another cycle of laundering in which $2,999,975 from Estina arrived in Gateway's Dubai account. U.S. $1,400,000 was deposited into Accurate's account and used to settle U.S. $1,347,400 of the outstanding wedding invoice balance.

Linkway was a client of KPMG SA, and the auditors overlooked the listing of the Sun City wedding — a personal expense — as a cost of sales. Among the violations that brought KPMG SA under scrutiny was this reclassification of the wedding as a business expense, as well as the failure to ensure income tax was paid (Holtzblatt et al., 2020). KPMG International acknowledged that accounting and auditing malpractices had been overlooked during the course of the audit. The Independent Regulatory Board of Auditors (IRBA) began an investigation of KPMG following allegations in the public domain. The investigation uncovered even more "grossly negligent" practices for the year ending 28 February 2014.

For example, a KPMG SA employee was compromised after attending the Sun City wedding and enabled Linkway Trading to avoid paying over 2 million Rand in taxes to the South African Revenue Service (SARS). In addition, the IRBA found that KPMG SA had facilitated the diversion of 30 million Rand from the Vrede Dairy Farm Project in the Free State to finance the 2013 Gupta family wedding. The auditor had altered Linkway's books to reclassify the 6.9 million Rand spent on wedding guests' accommodation from expenses to cost of sales in the financial statements (Holtzblatt et al., 2020). As a result, Linkway paid a significantly reduced amount in tax to SARS. Beyond tax evasion and professional negligence, the IRBA found KPMG SA guilty of lack of independence, failure to conduct audit procedures correctly, and dishonesty.

Reputation and Its Importance for Accounting Firms

The reputation of an accounting firm is the perception held by its stakeholders — including suppliers, employees, investors, customers, regulators, non-governmental organizations, and politicians (Abdullah, Almsafir, & Al-Smadi, 2015). The perception of internal stakeholders greatly shapes the external perception of an organization. A strong reputation attracts prospective external investors, while a poor reputation leads potential investors to avoid the firm owing to a trust deficit in its published financial reports. The role of accounting firms is to provide a valuable service to their clients by communicating the organization's financial performance accurately.

Engaging an accounting firm with a poor reputation risks the publication of reports that are not trusted by internal or external stakeholders (Abdullah et al., 2015). This may prompt scrutiny by relevant regulators, causing further damage to the firm's reputation and its business relationships. Consequently, building trust creates trustworthiness among stakeholders, attracts clients, and fosters complementary business partnerships. It also prevents the loss of the resources, time, and effort that stakeholders have invested in the organization's growth.

KPMG SA's efforts toward rebuilding trust and redefining professionalism began in September 2017 with a restructuring of its leadership and governance. These efforts included appointing an independent non-executive member of the board of directors to scrutinize the organization's internal operations. A new committee was also formed to ensure KPMG SA's operations met the required standards. In October 2017, the organization created a permanent executive position for a Head of Risk to oversee client acceptance and retention (Writer, 2019). In January 2018, Wiseman Nkuhlu was appointed as the new chairman of the board of directors to rehabilitate the organization's operations and reputation. In April 2018, Ansie Ramalho was appointed as an independent director. In June 2018, the organization began re-evaluating its client portfolio, selecting only clients aligned to its risk assessment criteria.

These measures were directly related to the allegations leveled against the organization. For example, charges of lack of employee independence and dishonesty through the doctoring of books to avoid tax prompted the appointment of a non-executive director and an oversight committee — steps intended to prevent future compromise of professional codes of conduct such as the AICPA and SAICA. The measures taken by KPMG were necessary, but they still require a deeper organizational commitment to public-interest services rather than client preference ("KPMG report signals firm's renewal," 2019). Since the organization had acted in the interest of the Gupta family, retraining staff to act in the public interest is critical. Furthermore, including IRBA stakeholders and IFAC participants in the restructuring process would have been important for re-establishing trust with regulators and stakeholders globally.

Professional Skepticism in Auditing

Professional skepticism is essential because it enables the professional accountant to identify and respond appropriately to circumstances that may be alarming, such as financial misstatements. It represents a critical attitude that should be adopted from the outset of an audit, keeping the professional alert to evidence that may contradict other sources or create uncertainty about information obtained from management. The IAASB's International Standards on Auditing (ISAs) recognizes that adopting and applying professional skepticism is both 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, closely related to the concepts of autonomy and professional judgment necessary for quality audits.

The red flags that KPMG SA auditors should have identified ranged across operational, organizational, and governance dimensions. Internally, the invitation and attendance of employees at the Gupta's Sun City wedding should have been recognized as a potential source of compromise to their professional autonomy. The establishment of Estina to construct a dairy company without public involvement, contrary to initial statements, should also have been treated as a red flag. The allocation of a 99-year lease to Estina while the company's ownership was linked to the Gupta family should have triggered a more thorough audit (Shawver, 2020). The transfer of U.S. $8 million to Estina's account and its subsequent redirection to Accurate's account in Dubai should have been sufficient grounds to detect illegal dealings. The reclassification of costs incurred by Linkway during the Sun City wedding into the cost of sales account by a junior accountant should have prompted an internal investigation into the sources of funding for the wedding.

External red flags of the Gupta family's laundering activities included the public concern raised when wedding guests arrived at a military base — unconventional circumstances that a professionally skeptical auditor should have detected. The discovery of 30 cows dead from starvation in a pit on the dairy farm land should have led to further investigation (Holtzblatt et al., 2020). Rumors about the president's ties to the Gupta family, given their alleged contribution to his election campaign, should also have been perceived as a red flag warranting further inquiry.

KPMG SA's lack of professional skepticism contributed directly to the scandal that damaged its reputation. The negligent behavior of the employees involved in auditing Gupta companies lacked the professional demeanor required of external auditors. While some red flags were recognized by junior auditors at KPMG SA, the independence of senior auditors had been compromised. The approach taken in the audits indicates that the integrity of the firm's operations had been undermined by the Gupta family (Holtzblatt et al., 2020). The audits of Linkway's expenses and taxes should have led to the involvement of the relevant authorities and a further investigation of the Gupta companies.

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