The Public Company Accounting Oversight Board has fined the former vice-chair of KPMG’s audit practice $100,000 for his role in a scandal where KPMG offered jobs to PCAOB employees in exchange for confidential information about upcoming inspections of KPMG audits.
You might remember the story from several years ago. The feds indicted three KPMG partners and three former PCAOB staffers in 2018, alleging that KPMG would hire the ex-PCAOB staffers in exchange for those folks bringing along highly confidential details about which KPMG audits the PCAOB was planning to inspect. KPMG partners could then use the intel to clean up their work papers, making the audits look better and improving the firm’s inspection results.
KPMG ended up paying $50 million to the Securities and Exchange Commission in 2019 to settle the firm’s role in that mess (plus a side scandal of KPMG staffers cheating on training tests). The individuals involved in the jobs-for-intel scandal either went to trial or pleaded out, and received sentences ranging from probation and home confinement to one year in prison.
Now the PCAOB has given us one more chapter in this long saga. On Tuesday it sanctioned Scott Marcello to the tune of $100,000, the largest fine against a single person in PCAOB history. Marcello was vice-chair of KPMG’s audit practice in the mid-2010s, when the misconduct happened and supervisor of those errant KPMG employees — and as such, the PCAOB said, Marcello had a responsibility to oversee his subordinates.
“This first-of-its-kind disciplinary action demonstrates that the PCAOB is committed to sanctioning top-level personnel at the largest firms when they fail to take sufficient supervisory steps aimed at preventing violations by their subordinates,” PCAOB chairman Erica Williams said in a statement. After the enforcement actions against the perpetrators, “the board believes it is important to hold Mr. Marcello accountable as their supervisor for contributing to a culture that led to this serious misconduct.”
Marcello neither admits nor denies the findings in the PCAOB’s settlement order. He parted ways with KPMG in 2017 shortly before the indictments started rolling, and these days is head of a healthcare charity that supports relief work in Africa.
Failure to Supervise
The PCAOB settlement order does not paint a flattering picture of Marcello. As vice-chair of KPMG’s audit practice, Marcello was responsible for the firm’s Department of Professional Practice, headed by a partner named David Middendorf. Within that department was a team known as the Inspections Group, which had been tasked with improving KPMG’s performance on the PCAOB’s annual inspection of KPMG audits.
As early as March 2016, the order says, Middendorf told Marcello that the Inspections Group had obtained advance information about which audits PCAOB inspectors would examine that year. Specifically, Marcello understood that KPMG had obtained that information thanks to one of Middendorf’s subordinates, Brian Sweet. Sweet was one of the former PCAOB staffers who landed a job at KPMG in exchange for sharing that confidential information about the inspections.
Despite knowing about the origins of that intel, when Marcello should have exercised his authority to end such monkey business, he did not. Rather, the PCAOB said:
Despite knowing that Middendorf and others had received advance notice of certain inspection selections and intended to review and could enhance work papers for those audits, Marcello failed to take appropriate action in response. Marcello did not report or escalate the matter, or instruct Middendorf and other subordinates to refrain from using the PCAOB’s confidential information. In failing to take action in response to learning about the receipt and intended use of confidential information in 2016, Marcello missed an opportunity to change the tone at the top of the Firm, which could have helped prevent further violations.
That same cycle of poor judgment happened again in 2017, when Sweet had again worked his PCAOB contacts for intel on upcoming inspections. Marcello only put a stop to things when he learned that other KPMG partners had figured out the scam and were preparing to disclose it.
Will We See More of This?
The PCAOB has taken action many times before against audit firm partners for sloppy audit practices. We have not, however, seen the PCAOB take action against senior audit firm leaders for poor corporate culture and tone at the top. So the obvious question is: will we see more of this in the future?
For example, right away I wonder about the cheating scandals that have happened at both KPMG and PwC. In both cases, many hundreds of employees were sharing answers for internal training tests. In KPMG’s case specifically, employees manipulated computer servers and HTML code to lower the threshold for passing the tests. That’s an extraordinary amount of conspiracy and willful misconduct.
You can’t have such widespread misconduct without a poor culture. So will the PCAOB collect more scalps from people high up the org chart, for their poor supervision?
Eventually an enforcement push like this might trickle down to corporate clients; if senior audit firm leaders lean on engagement partners to do better, those engagement partners might then become more by-the-book sticklers for following the rules. That could lead to more, shall we say, bracing discussions about how your specific audit will work.
It’s also interesting to see that we have yet another regulator in the Biden Administration starting to take tone at the top more seriously. That’s been the watchword from the Justice Department since last year; the Securities and Exchange Commission picked up that mantra too, and now we see it at the PCAOB.
Who knows? Eventually we might start to see enforcement of tone at the top all over the place.