Re:Balance -- Jim Peterson

KPMG’s Family Planning – Good Luck!

Last week I was pleased to guest-post on The Dig, Francine McKenna's Substack. For those who missed it there:

On March 10, 2025, Stephen Foley reported in the Financial Times that “KPMG is aiming to slash the number of ‘economic units’ that make up the international network to as few as 32 by next year, from more than 100 two years ago…”

A reader’s comment quickly followed:

“Consolidating audit entities across jurisdictions? That worked brilliantly for Arthur Andersen – right up until it didn’t.”

Because little enough is known, much less understood, about the organizational genius that made Andersen the profitability leader and structural envy of the profession for the last quarter of the 20^th century, the reader’s intent was presumably sarcastic.

And wrong. From one who was there – if intended as snark, the comment is unironically correct. Each of its two parts requires scrutiny in assessing what KPMG is up to.

If Andersen could not survive Enron, despite being the most cohesive and profitable of the large firms, what are the prospects for KPMG’s aspirations?

Some background will help.

In the early 1980s I moved from private law practice to join the Andersen organization, in its newly formed in-house counsel group. It was my privilege to be a partner in the Andersen Worldwide Organization until my retirement in 2001 – fortuitously enough, just months before the pervasive misfeasance at Enron triggered Andersen’s rapid disintegration.

As Andersen was collapsing, a fellow member of Big Audit’s in-house legal fraternity gave a more nuanced version of the FT reader’s comment, in a combination of jealousy and schadenfreude:

“The Andersen global structure was brilliantly designed for success; unfortunately it was also ill-suited to manage failure.”

In the mid-1970s, as it was extending its global footprint, Andersen with the assistance of a Washington-based international lawyer (RIP 2024), had adopted its unique global structure. At its core was an obscure form of legal entity peculiar to Swiss law - a Swiss “Société Cooperative” or S.C. for short - which provided that while country-level firms retained their separate legal forms and identities to comply with local laws and regulations, they along with individual country personnel – both accountants as well as consultants and others like myself – joined and made up its partnership.   

The ownership flexibility of an entity that was not an accounting firm, supported by internal accounting and book-keeping of eye-watering complexity, made it possible to capture costs at the global level for aggregation and re-allocation, so as effectively to enable true profit sharing among the worldwide partners.

Put more simply – unlike the approaches of the other firms, then and since – the financial fortunes of every entity in the Andersen organization had a direct impact on my compensation, for better or worse. It was to my benefit as a worldwide partner, housed in the headquarters function and with a world-wide remit, if the French practice had a boom year; if Italy or Mexico slumped, I felt it; if Brazil required global support through a rough patch, it came out of my pocket.  

It can be inferred from the FT’s reporting that at least for the moment, KPMG has a lower level of ambitions:

“KPMG is also insisting that, in any mergers, the profit pools for partners be at least partially shared across the countries involved, with the aim of moving to full profit-sharing over time…”

Or not. Let it be clear – without common commitments of financial skin in the game, it’s at best only a “merger” for optics and a level of administration. Andersen not only required world-class treasury and information management, across countries with dramatically different economic business models and costs of living and working. It was required to solve the logistics and the politics of multi-national engagement referral and performance, while achieving broad and acknowledged fairness in partner compensation, employee salaries, practice opportunities and career development.

With the incentive to cooperation created by common financial interests, referred work was not begrudged, but was recognized for the common good; training and quality initiatives were for shared purposes; personnel secondments strengthened both sides of a transfer. Democratizing and leveling followed from shared information – locally maintained fiefdoms and cookie jars were exposed, and closet doors were pried open to reveal long-concealed skeletons.  

Andersen was in funds for investment, in part but not entirely with the stunning profitability of its consulting practice, which acted to blunt the edge of the other challenges. That is, by definition, half of Andersen’s practices would in any year have earnings below the global average – but with earnings booming along, time and mutual support would give room and resources to turn the fortunes of a country needing support.

And with complete information sharing about both the financial results of the country practices and the individual ownership units allocated to the partners under a plan disclosed to and voted for approval by all the global partners, potential squabbles were swept up in the celebration of shared success.               

These were all achieved not only with the stunning quality of the people at the heart of its infra-structure, but because of shared commitments in the form of trust, transparency, patience, and a level of profitability that fueled an operation like no other.

“Until it didn’t.”

It was crucial at Andersen to centralize both the costs and the culture of practice quality, ethics and independence, and compliance including related insurance, litigation and law enforcement. The Andersen/Enron debacle provided the proof – when its leadership allowed a local office to sideline and evade centrally-provided expertise, the integrity of its once-robust and complex tapestry was revealed as frayed and tattered beyond repair.    

“Until it didn’t.” The FT comment is right – and rightly fingers the skunk at KPMG’s party. Which is, even if achieved with real profit sharing (as may be but is not disclosed), the KPMG “mergers” will have embedded at least two fatal flaws.

The first is the questionable extent to which firms with dominant profitability will sacrifice to sustain their brethren. The growth orientation in the years of Andersen’s expansion lasted only to the turn of the millennium, and the recent signals are to the contrary – the trust-busted Accenture divorce, the failure of EY’s Project Everest, and the arrival of third-party equity capital with the questionable alignment of its strategic objectives for the mid-tier firms.

The second is the unsolvable weakness that was fatal to Andersen - as emerged with the corrosive and ultimately fatal consequences to its accounting practice of the divorce with the practice that became Accenture – namely that there is nothing in the strongest contractual commitments or optimistic year-on-year results that will sustain a global network under the imposition by a legal system of a multi-billion dollar litigation or law enforcement impact.

Even though uniquely cohesive and the envy of its fellows, Andersen blew apart in weeks in the tempest of Enron, as its separate national practices disavowed their contractual obligations, voted their local interests, and left the US firm alone, isolated, and financially bereft.

Lest I be charged with misleading by incompleteness, brief mention here of what I hope is the diminishing myth that Andersen was killed by the Justice Department’s indictment over the destruction of documents in its Houston office. As laid out at pages 56-60 of my book, Count Down: The Past, Present and Uncertain Future of the Big Four Accounting Firms (Emerald Books 2d ed. 2017), the large firms are not organized nor do they have the financial resources to withstand claims from misfeasance on the order of Enron’s $67 billion bankruptcy. Andersen was like a terminal patient on life support in an ICU. Its demise was inevitable – DOJ was just the nurse that pulled the plug.

This is neither a prediction nor a voice of doom. KPMG deserves credit and respect for its aspirations, and may indeed make it happen. Andersen’s run of success, after all, extended across a generation.

There is however a corollary to movie mogul Sam Goldwyn’s attributed view that an oral contract is not worth the paper it’s printed on.

Which is that under stress, neither are the written versions.    

 

Thanks for joining this dialog. Please share with friends and colleagues. Comments and feedback are invited and welcome, and subscription sign-up is easy and free - both on the Main page.   

The CPA Pipeline – How It Looks From Here

 

A drunk scrabbling on his knees under a street light tells the inquiring policeman that he lost his keys in the dark alley.

“So why are you looking here?” asks the cop.

“Because the light’s better.”

Here is why not to be concerned over the so-called “pipeline” problem with the future supply of new CPAs – what KPMG’s US head Paul Knopp recently called a “brewing crisis” that “calls for urgent reforms to halt the slide in the accounting ranks.”

Because much of the current discussion is both exaggerated and misguided in its failure to reach the core issues, its distractions pull attention away from two basic topics, usually treated separately but in fact deeply inter-twined. 

That is, the concerns hand-wrung by Knopp and his colleagues in practice and academia mistakenly treat as two issues a single problem with two related parts – both to be resolved by the market, to allay any concern over the future stock of new entrants - namely the adequacy of qualifications, training and competencies before the rookies are unleashed in a way that will do minimal harm to the capital markets, and the adequacy of the incentives in their compensation plans and career paths.  

To start, the supply issue is not profession-wide. That was made plain with EY’s postponement last fall of starting work dates for the cohort of hires for its strategy advisory practice in the US.   

EY’s six-month pushback was procured with a lagniappe of between twelve and thirty-five thousand dollars, on the heels of delays for the prior year. The newbies will appear when summoned, at salaries flat to 2023. As put by a recruiting consultant, “’there is strong enough demand for consulting roles that it is still heavily outweighing supply’… meaning big firms do not feel the need to raise pay to attract students, particularly since starting salaries remain subdued in competing professions, such as banking or technology.”

In other words, on the consulting side the hiring strategy appears validated, that “if you pay them, they will come.” Human nature being what it is, the same should hold for the entry-level ranks of the audit practices as well. Or, in any event, it would seem hard to reconcile the existence of truly fundamental resistance to the “lifestyle” demands of an audit’s busy season, in favor of the non-trivial salary gap with young lawyers and bankers. The well-known brutality of the working conditions for Big Law associates leaves no time to enjoy their fatter pay packets, and suggests that young auditors are not by comparison actually suffering all that grievously.

No - it’s the audit practice itself – not just at the cannon-fodder level, but at its very heart.

Nor is it new. I’ve been saying for years that challenges to the legitimacy of the audit model are fundamental: clients and information users are happy to welcome the optimistic support of the consultants, but nobody is eager for the arrival of the auditors – looked on with distaste and disdain, as the proctologists of the professional services sector, poking around in dark places, exposing questionable behaviors and dirty little secrets, delivering cold and limited comfort before washing their hands of another year’s annual examination.

Simply put, money for staff won’t solve that perception problem, nor will proclaiming the importance of the audit function. That’s because it’s a circular claim, that investors should value a professional’s audit because it is performed by professionals. That fails to grasp a client’s real need - not that its audit be staffed by young CPAs, but that it should be performed, at least cost, to the level necessary to comply with the regulators’ requirements.

That is, the profession has no right or entitlement to insist on the qualifications of its assurance workforce, whether 150 hours of credit to qualify for the exam, or some variable amount of work experience. So long as clients get their reports, it’s a matter of indifference. Value in the marketplace cannot be achieved or demnded as of right, but is earned and legitimized by the choices of the consumers.

That being so, the “audit pipeline problem” elevates up from one of trends and head-counting to an existential level.

That is, the capital market most emphatically will have some forms of information assurance. That role that has figured in human society since the invention of trade, and the inscription on clay tablets by Sumerian merchants of contractual obligations for measures of wheat and bolts of cloth and herds of animals. Whether the future suppliers of that service will have emerged from the “pipeline” now decried as running down to a trickle, or bearing any designation resembling today’s credential as a “profession,” however – those questions remain very much to be determined.

At which point, the sadly-neglected analysis done by Sir Donald Brydon in 2019, his Independent Review of the Quality and Effectiveness of Audit, deserves a re-visit. For if the standard audit opinion whose origins trace to the Victorian era has indeed reached beyond its useful life, to be supplanted by company reporting on the full breadth of business activities embraced by the capacious rubric of Sustainability, that will require skills and competencies beyond those of today.

Which in turn requires the public dialog to be re-written. The expanded scope of skills required to staff an assurance function fit for future purpose exposes the profession’s reticence in the opening of its ranks, and in the practice-narrowing vision of, for example, EY’s proposed consulting and audit practice separation under its aborted Project Everest. “Shrinking to success” is a failing strategy, when the demands of the market go exactly the other way.                 

Because, as Brydon put it, “it is far from clear that an accountant is best placed to opine on many of the variables involved,” and while “only some would need to have an accountancy qualification as known today,” the implications for the market are clear: salary scales offered to graduates of traditional audit curricula will be obsolete and irrelevant, for the two symmetrical reasons that the needs for such staff will be steadily diminishing, while those qualified to become the auditors of the future will both require and respond to differently-scaled inducements. 

Which means no “brewing crisis” – instead, the emergence of new pipelines.   

Thanks for joining this dialog. Please share with friends and colleagues. Comments and feedback are invited and welcome, and subscription sign-up is easy and free – both at the Main page.   

Auditor Performance Metrics: The Deal Offered by the PCAOB

 

Even as the new year will likely bring the defenestration of Erica Williams, chair of the Public Company Accounting Oversight Board, that agency has tossed up to its over-seer, the Securities and Exchange Commission, proposed rules that would – in the unlikely event of SEC approval - require registered audit firms to bring forth volumes of details on their performance metrics.

Views differ on both the wisdom of the rules themselves and the extent of the capital markets’ appetite for details on the operations of the world’s large public companies’ auditors. But pass the basic question whether any of the proposed disclosures would guide investors in handicapping a “good” or “bad” audit. There are at least three reasons why the rules are untethered from the realities of the Big Audit model.

First is the expected SEC disapproval – either entirely, or in anything like the rules’ current form. Paul Atkins, nominee to succeed Gary Gensler as SEC chair, has made well known his hostility to the PCAOB and the recent scope of its activities. Spelled out in detail by Mark Maurer in the Wall Street Journal for December 9 is the likelihood that Atkins will return the agency into the deep retreat that marked its somnolence under Williams’s predecessor.

The coming months will tell whether chair Williams might get her way, in bringing live any of the expansive reporting and data collection, but it’s a reasonable wager that with the changing of administrations in Washington in January, she will be out of a job and her proposed rules will waste like flowers in the desert air.

Second is the deep divergence on the value of the information to be required. Chair Williams had put it that the cascade of information “would provide investors, audit committees, and other stakeholders with valuable information on firms and their engagements to help them make knowledgeable decisions regarding audit firms and investment-related choices.”

The accounting firms themselves are in vigorous opposition, set out by the Center for Audit Quality, speaking for the large firms,in a series of letters (June 7, November 11 and November 22, 2024), “based on public policy concerns, lack of cost-benefit analyses and the likely negative competitive impact to the US public company audit profession.” And the AICPA, with focus on the smaller firms, wrote in its letter to the SEC of December 19, 2024 that “these rules will have unintended negative consequences, including driving small and medium-sized firms out of the public company auditing practice.”

Chiming in was Bob Conway, whose credentials span his long tenure as a KPMG partner and senior staff positions at the PCAOB. In early December he brought to YouTube and to Francine McKenna’s substack, The Dig, his view regarding the familiar, standard and amply criticized auditor’s opinion required for public companies by the SEC, about which he says that “commodity pricing is the culprit.”

With respect, Conway’s endorsement rests on flawed premises, beginning with the problem that pricing power for a commodity product is limited. The language of an audit opinion, prescribed by and acceptable to the SEC, prevents differentiation even as it confines the auditors in golden handcuffs. The form of that opinion - the core product of the firms’ assurance practices, with wording compelled by law and regulation - is expected by a generally indifferent user population, invariant across the critically small number of provider firms.

In this market, not only do the firms lack pricing power. Neither they, their clients, nor the providers of capital have any incentive to change. Typical retail investors could not identify the auditors of companies in their portfolios, much less distinguish one firm’s opinion from another, while investment professionals and audit committees alike already have access to as much information as they may deem significant.

Nor does the limited scope of available auditor choice allow for what Conway calls “informed decision making (by audit committees and prospective employees) that will fuel competition on elements other than price.” As reported by Statista, in 2022 the Big Four networks gathered up fully 99.7 % of the audit fees of the S&P 500 companies. In this environment, large public companies lack a range of auditor options under the limitations of the four-firm Big Audit model.

And the prospects for expanding that tetrapoly are nil. If anything, the mid-tier and smaller firms are shrinking or giving up their positions in the public company audit market altogether, for various strategic reasons including the combined influence of private equity and other third-party capital and their own eager appetites for expanded non-assurance revenues.  

Nor does Conway’s position gain traction by his invocation of the 2008 activities of the Advisory Committee on the Auditing Profession, convened by Treasury Secretary Paulson in the second term of the younger President Bush.

The output of that group, so riven with discord and animosity as to challenge the leadership of amiable co-chair Donald Nicolaison (RIP 2019), would have been so inconsequential as to die on the vine in any event. The over-whelming impact of the credit crisis, however - already underway although not yet much recognized - was enough to erase from the sands of time any of the Committee’s footprints, faint as they were.

Third and finally, the fine-grained rules that Williams and Conway support would be inflicted on a franchise already confronting change at a more fundamental level for its very survival.

Not that the advocates are necessarily wrong in pressing for greater auditor transparency. It’s a sympathetic argument, that the providers of assurance on the corporate information required of their clients should, for the sake of their own reputations and professional legitimacy, offer the market at least the same disclosures about their own enterprises.

Indeed I have long advocated that the profession should have followed the lead of the Arthur Andersen organization in the 1970s, when for several years it published its own global financial statements, together with the unqualified auditors’ opinion of the firm then branded as Haskins & Sells. (Disclosure/reminder – for nearly two decades I was a member of the Andersen internal legal group and a worldwide partner, retiring the summer before its Enron-driven collapse.)

It's that the value of the standard commodity auditor’s opinion has been in demonstrable decline for years:

• Going back to the crisis in the US savings & loan sector in the 1980s.
• Through the negligible impact of the post-Enron passage in 2002 of the Sarbanes/Oxley law on the credit crisis that followed in 2007-2008.
• Lately with the ever-increasing volume of activity in financial markets outside the reach of the Big Audit model:
  • Manifest in such scandals as Theranos and FTX.
  • The passion with which activity in the crypto-sphere has exploded.
  • The outbreaks of dubious corporate behavior that back-footed the regulators in the form of the reverse-IPOs of companies in China and the groundswell of registrations based on mergers with special purpose acquisition companies.

While at the same time, the degree of enthusiasm for reporting and assurance under the broad heading of Sustainability has turned the heads of strategists and commentators, occupying energy and resources elsewhere than in the profession’s traditional practices.

Even assuming that in some revised form the PCAOB’s inspection and enforcement activities may trundle inexorably onward, the structure of its legislative mandate means that its reporting of inspection results and enforcement outcomes is at best partial and opaque, while actual improvement measurement remains elusive. Inspection deficiency rates as reported by the agency itself continue to attract the rhetoric of official dissatisfaction (as put by chair Williams herself, in 2023 and again in 2024).

Informative and useful academic research is still to be delivered, with adequate sample sizes and coverage at scale of the large public companies, by which to assess and evaluate any actual impact on audit quality over the history of the PCAOB. A catalogue of issues - partner naming and opinion signing, scope of practice limitations, reporting of key or critical audit matters, and (in the UK and the EU) mandatory auditor replacement or rotation - remain to be tested.

Participants with self-interests offer each other the predictable exchanges of mutual reinforcement - claims that “things are better than they were before.” What is not asked is the more disciplined question, “are things better than they would have been if Sarbox had never been enacted” – an alternative scenario under which a market-cleansing process could have allowed legitimate concerns over audit quality, corporate reporting and investor protection to be sorted out through performance criticisms, enforcement proceedings and damage claims under the still-salient application of the antifraud provisions of the core securities laws.

Simply put, the PCAOB’s proposed metrics disclosure rules might, if put into place, satisfy some bureaucratic appetite for data-gathering, in answer to a need that nobody really feels, in a flurry of motion in the guise of progress. As expressed in the CAQ’s skeptical letter of June 7, however, “without a sufficient understanding of how – or if – investors would use the information presented in the proposed metrics (and taking into account the risk of inappropriate use), it does not seem appropriate to suggest that investors would use such information to make investment and proxy decisions.” 

Instead, under a market-oriented test of utility or good effect, the fate of the proposed rules would resemble the shipboard orchestra mournfully performing on the sinking stern of the Titanic.

Thanks for joining this dialog. Please share with friends and colleagues. Reactions and comments are invited and welcome, and subscription sign-up is easy and free, both at the Main page.