From Securities Regulation Daily, January 24, 2014

SEC charges Big Four accounting firm KPMG for violation of independence rules

By Jacquelyn Lumb

KPMG has agreed to pay $8.2 million to settle SEC charges that it violated the auditor independence rules by providing prohibited non-audit services to affiliates of the companies whose books it audited. The SEC found that KPMG provided restructuring, corporate finance and expert services to the affiliate of one audit client, and provided bookkeeping and payroll services to another. KPMG also hired an individual from the affiliate of another audit client and then loaned him back to do the same work he had done when employed by the affiliate (Rel. No. 34-71389, January 24, 2014). The SEC issued a Section 21(a) report in connection with the matter to address the scope of the independence rules (Rel. 34-71390, January 24, 2014).

In addition to disgorgement of the fees received from the three clients plus prejudgment interest, KPMG also agreed to pay a penalty, to implement internal changes directed toward educating its personnel and to monitor auditor independence requirements for non-audit services. An independent consultant will evaluate the changes.

Loan of tax professionals. During the investigation, the SEC considered whether KPMG’s independence was impaired by its loan of non-management tax professionals to assist its audit clients with their tax compliance work under the supervision of the clients’ management. The SEC determined not to bring an enforcement action based on this activity, but issued a report of investigation to make clear that loaned staff arrangements, by their very nature, appear to be inconsistent with the auditor independence rules that prohibit auditors from acting as employees of audit clients.

KPMG had internal guidance that prohibited most staff loan engagements with SEC clients, but it permitted loans for certain tax services. Between 2007 and 2011, KPMG entered into loaned staff engagements with multiple SEC audit engagements, which involved non-manager level professionals who performed junior level tasks related to tax compliance. The loaned staff was supervised by the audit clients’ managers, performed the same work as other client employees, worked exclusively and continuously at the audit clients’ places of business for extended periods of time, and used audit clients’ resources. KPMG paid the loaned staff and continued to provide benefits, while billing the audit clients for the services.

Section 21(a) report. The Section 21(a) report points out that an auditor may not provide an otherwise permissible non-audit service, such as a tax service, in a manner that is inconsistent with the other provisions of the independence rules, such as the prohibition against acting as an employee of the audit client. The auditor must consider both the nature of the proposed non-audit service as well as the manner in which it is delivered.

The report also notes that an arrangement or a relationship that results in an accountant acting as an employee of the audit client implicates Rule 2-01(c)(4)(vi), separate and apart from whether the accountant acted as a director or an officer, or performed any decision-making, supervisory or ongoing monitoring functions for the audit client. An accountant is not independent under the rule when a current professional employee of the accounting firm is employed by the audit client. Accountants may not do indirectly (act as an employee) that which they may not do directly (be an employee).

The SEC considered whether the “acting as an employee” provision of the rule provides a sufficient standard by which an accountant can assess its non-audit services. It concluded that the standard requires accountants and audit committees to carefully consider whether a relationship or service would cause the accounting firm’s professionals to resemble, in appearance and function, even on a temporary basis, the employees of the audit client. The report adds that the fact that the professional who is loaned is junior level in skill does not exempt that person from the prohibitions against acting as an employee of an audit client. The fact that loaned staff was not paid by the audit client also does not exclude the relationship from the prohibition.

The SEC’s Office of the Chief Accountant has a professional practice group dedicated to questions about auditor independence and other matters, and it encourages auditors and audit committees to consult with the staff about the about the auditor independence rules and the permissibility of contemplated services. Chief Accountant Paul Beswick said that it is better to resolve questions about the permissibility of a non-audit service before the service commences.

The SEC acknowledged the assistance of the PCAOB in its investigation.

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