SEC charges former KPMG and PCAOB officials with ‘stealing’ inspection exam
The Securities and Exchange Commission charged six CPAs Monday who were former senior officials at KPMG and ex-staffers at the Public Company Accounting Oversight Board with participating in a scheme to misappropriate and misuse information on the PCAOB’s planned inspection of the Big Four firm.
The SEC alleges the former PCAOB officials made unauthorized disclosures of PCAOB plans for inspections of KPMG audits, enabling the former KPMG partners to analyze and revise audit workpapers in an effort to avoid negative findings by the PCAOB. Two of the former PCAOB officials had left the PCAOB to work at KPMG. The SEC accuses a third official of leaking PCAOB data while he was looking for a job at KPMG. The three former KPMG partners were all members of the firm's national office.
“We charge that this effort to improve, or to put it another way, to get a better grade, was accomplished through unlawful conduct, in essence, stealing the exam,” Steven Peikin, co-director of the SEC's Enforcement Division, said during a conference call with reporters Monday.
The scheme started in 2015 and lasted until February 2017. KPMG said it learned from an internal source about the misconduct and immediately reported the situation to the PCAOB and the SEC. Not long afterward, the six CPAs were then either fired by the PCAOB and KPMG, or they resigned, or they were placed on leave before they were terminated.
“When KPMG first discovered the issue in early 2017, we promptly notified the authorities and have been fully cooperating with the government in its investigation,” said KPMG spokesman Manuel Goncalves. “KPMG took swift and decisive action, including the engagement of outside legal counsel to conduct a detailed investigation and the separation of involved individuals from the firm. Since then KPMG has taken remedial actions to assure that such conduct cannot happen again. Integrity and quality are paramount for KPMG, including operating with the utmost regard for the critical importance of the regulatory process to our profession.”
PCAOB Chairman William D. Duhnke said the board had also acted immediately. “The PCAOB has cooperated with and appreciates the government's actions to preserve and reinforce the integrity of the PCAOB's regulatory oversight programs that protect investors who rely on the audits of public companies,” he said in a statement Monday. “Immediately upon learning of the alleged misconduct last year, the PCAOB board and staff reviewed and reinforced the PCAOB's safeguards against the improper disclosure of confidential information. Nevertheless, as indicated by [SEC] Chairman [Jay] Clayton today, the new PCAOB board will conduct an ongoing review of the organization’s information technology and security controls, as well as its compliance and ethics protocols, to assess their effectiveness. Today’s actions should send a clear signal that the misappropriation of confidential PCAOB information or otherwise undermining the integrity of our programs will not be tolerated.”
The SEC's Enforcement Division and Office of the Chief Accountant allege that while preparing to leave a PCAOB supervisory position for a job at KPMG, Brian Sweet downloaded confidential and sensitive inspection-related materials that he thought could help him at KPMG. The firm had recruited him to join the firm at a time when it had a high rate of audit deficiencies. Indeed, nearly half of the KPMG audits that the PCAOB inspected in 2013 were found deficient.
After he left the PCAOB, Sweet allegedly continued to gain access to confidential PCAOB materials through Cynthia Holder, a PCAOB inspector. After she joined Sweet at KPMG, a third PCAOB employee, Jeffrey Wada, allegedly leaked confidential information about some of the inspections the PCAOB planned of KPMG to Holder. According to the SEC's order, Wada leaked this information while he was seeking employment at KPMG.
The SEC alleges that after Sweet started working at KPMG, he told his supervisors in KPMG's national office he had taken confidential materials from the PCAOB, including, for example, the KPMG audit clients the PCAOB planned to inspect that year. Among those allegedly encouraging Sweet to provide the stolen information to them and others at the firm were his supervisors—David Middendorf, who was then KPMG's national managing partner for audit quality and professional practice, and Thomas Whittle, who was then national partner-in-charge for inspections, along with another high-level partner at the firm, David Britt, KPMG's banking and capital markets group co-leader. The SEC's Enforcement Division and Office of the Chief Accountant allege that Middendorf, Whittle, Sweet, Holder, and Britt worked together to review the audit workpapers for at least seven banks they were told the PCAOB would inspect in an effort to minimize the risk that the PCAOB would find deficiencies in those audits. Middendorf and Whittle allegedly instructed that no one disclose that they had confidential PCAOB information.
“We allege that the hiring of former PCAOB personnel was part of a strategy to improve inspection results, and obviously this misconduct was directed at essentially cheating on the exam,” Peikin said in response to a question from Accounting Today. “I can’t really comment on post-inspection results that post-date the period alleged in our order in these proceedings.”
Asked whether any current employees were involved, Peikin replied, “Our investigation is continuing, but people who we charged today have all been terminated by KPMG and by the PCAOB.”
In a parallel action, the U.S. Attorney's Office for the Southern District of New York announced criminal charges Monday against the six CPAs.
SEC Chairman Jay Clayton issued a statement Monday about the charges. “The alleged conduct is disturbing, and I support the SEC's enforcement action,” said Clayton. “Audited financial statements are at the heart of the SEC’s disclosure-based regulatory regime: a company's financial statements provide investors with a wealth of material information, and independent audits give investors confidence that those statements can be trusted. The PCAOB is a critical part of the oversight of our local, national, and international capital markets, in that it helps to promote high-quality audits of the financial statements of issuers and broker-dealers, upon which investors rely.” The SEC said it stands ready to work with issuers to ensure that collateral effects, if any, to issuers and, in particular, their shareholders are minimized.
Sweet has agreed to settle an SEC order requiring him to cease-and-desist from violating PCAOB ethics rules, while barring him from appearing or practicing before the SEC as an accountant based on findings that he, among other things, violated PCAOB ethics rules governing confidentiality and lacks integrity. The case is scheduled for a public hearing before an administrative law judge, who will prepare an initial decision saying what remedial actions, if any, are appropriate.
According to Bloomberg News, Middendorf made a court appearance in Atlanta and was released on bail, said his attorney, Nelson Boxer.
"Dave is an experienced accounting professional," Boxer told Bloomberg. "We are reading it for the first time and we expect him to defend his good name."
Britt and Whittle pleaded not guilty during an appearance before U.S. Magistrate Judge Andrew J. Peck in Manhattan on Monday and were released on a $200,000 personal recognizance bond.
“This is an example of government overreach,” Robert Stern, an attorney for Britt, told Bloomberg. “The conduct at issue is simply not a crime and Mr. Britt looks forward to proving his innocence in court.”
Norman Bloch, an attorney for Holder, who was scheduled to appear in a Houston court, didn’t immediately respond to a telephone message seeking comment from Bloomberg.
James Glasser, an attorney for Whittle, declined to comment to Bloomberg.
Sweet has pleaded guilty to conspiracy and is cooperating with prosecutors, his lawyer, Richard Morvillo, said in an interview with Bloomberg.
"In stepping up and cooperating with the government, Mr. Sweet is taking the first steps to redress his mistakes," Morvillo said.
(Bloomberg News contributed to this report)