The red flags seemed bright.
Fake transaction documents handed to auditors. A bribe offered to convince an auditor to look the other way. A campaign by top partners to retain a client—a bank that would fail only weeks after getting a clean audit.
Those are among the allegations leveled in a lawsuit and a congressional report this year that have revived concerns about age-old problems for the audit industry: its inability, and lack of motivation, to identify and respond to headline-grabbing risks like fraud.
The whistleblower lawsuit by a former
A Senate investigative committee upbraided
The Big Four mainstays count some of the world’s largest companies as clients. EY audits tech giant
Together, the lawsuit and report offer a window into the practices, challenges and breakdowns that, despite pledges of reform, continue to plague the profession.
Investors have long pressed for auditors to dig deeper when they spot signs of fraud and to warn shareholders sooner of problems that could sink stock values. But auditors uncover just 3% of all corporate frauds, according to the Association of Certified Fraud Examiners.
“The auditors time and time again just will not take management to task,” said Lynn Turner, chief accountant of the Securities and Exchange Commission from 1998 to 2001.
The latest example might be BDO USA P.C., thrust into the spotlight in September after its client, auto supplier First Brands Group, collapsed under a web of financial transactions that masked debt totaling more than $10 billion. BDO six months earlier had issued a clean audit opinion for the supplier.
The firm has defended its audit and denied knowing about the company’s off-book financing. Auditors have a difficult time detecting fraud when corporate managers deliberately conceal their misconduct, the firm told Bloomberg Tax.
Auditors say they are doing more to spot problems and to manage risks with their clients, in the face of increasing regulatory pressure and tougher rules.
Turner, however, is among those who believe a new wave of fraud looms, as tariffs, inflation, and economic uncertainty converge to hit corporate bottom lines.
“The big question is not whether we will see more,” he said. “The big question is when.”
Client Conflicts
The latest scrutiny for EY began when Joe Howie, a former partner, filed a suit in July, claiming that he was removed from his roles and stripped of his titles in retaliation for repeatedly warning EY that it had “overlooked or deliberately ignored” fraud and other illegal conduct by clients, including some linked to organized crime. He also claimed that he was wrongfully fired in May.
Among the signs he claims EY dismissed: a client, unnamed in the lawsuit, who he said created phony documents in response to auditors’ questions about certain transactions, and a
The firm was “reluctant to implement measures that could negatively impact client relationships, hurt revenue, or reveal additional audit failures,” according to the complaint from Howie, who had spent more than three decades at EY.
The Wirecard scandal unfolded in 2020, as EY was reeling from similar failures at other clients—hospital operator NMC Health and Luckin Coffee, once China’s largest coffee chain. Together they sparked a wave of regulatory actions and legal disputes.
EY responded by adding mandatory fraud training for staff and expanded its use of third-party information to include short-seller reports. The firm also modernized its methods for confirming cash balances and assigned forensic specialists to certain audits based on their risk profile.
“Over the past several years, EY has implemented sustained and substantive enhancements to strengthen audit quality and risk assessments globally,” the firm’s global arm said in a statement. Those efforts led to EY affiliates turning down work, it said, including for certain entities “which later faced publicly documented issues.”
The firm publicly dropped Super Micro Computer Inc. and
Howie’s complaint asserts such efforts amount to a publicity campaign, not genuine reform. In addition to compensatory damages for his firing, he is seeking a judgment forcing the firm to fix flaws in its audit practice.
“That’s what Mr. Howie’s complaint is all about: trying to ensure that EY is ultimately held accountable to those promises that it made post-Wirecard,” said Michael Willemin, Howie’s lawyer and a partner with Wigdor LLP.
EY has asked a judge to dismiss the suit, arguing that Howie couldn’t pursue his claims because he didn’t fit the definition of a protected whistleblower and also contending he didn’t have any firsthand knowledge of fraud at any EY client.
Sidestepping the accuracy of his allegations, the company said Howie had been offered early retirement last year, and that he ultimately was removed as a partner in May because he had improperly disclosed privileged information.
It’s unclear when the judge will rule.
Anatomy of a Bank Audit
The quote on the cover of the 291-page Senate subcommittee report released in September didn’t mince words. “This industry is a joke,” it said.
That was allegedly captured in a text message one frustrated KPMG auditor wrote to another in 2023 while trying to parse a bank’s financial details.
Democrats on a Senate Homeland Security and Governmental Affairs subcommittee issued the report after what they said was a 28-month inquiry scrutinizing the clean audits KPMG issued before the 2023 failures of Silicon Valley Bank, Signature Bank, and First Republic Bank, as well as broader industry dynamics.
Among the details cited in the report: KPMG offered to sponsor a cycling team supported by Silicon Valley Bank at the same time the lender was debating whether to replace its auditor. The offer was made as KPMG was finishing its audit on the bank, which collapsed barely a month later.
“These powerful incumbents threaten our capital markets when longstanding relationships, which offer steady, lucrative work, incentivize auditors to prioritize their client’s satisfaction,” the report said.
Lawmakers also chastised KPMG for taking a narrow view of which threats could hit the financial statements of the failed regional banks.
They recommended legislative or regulatory action forcing US companies to rotate auditors periodically to guard against relationships that could sway an auditor’s objectivity. But the inquiry was opened when Democrats led the Senate; any such reforms are unlikely to gain traction in the GOP-controlled Congress.
KPMG declined to comment. But the Big Four firm previously defended its work, telling Senate staff it wasn’t the auditors’ job to evaluate the business strategies of its clients.
The bank failures exposed the limits of audits, which focus on whether a company’s financial performance was fairly portrayed but provide no guarantees that a company won’t face future challenges, industry watchers say.
Similarly, BDO stands by its audit of First Brands, it said in a statement to Bloomberg Tax. The professional standards it followed to vet privately held First Brands “acknowledge the high risk” that an audit won’t spot fraudulent misstatements when corporate managers intentionally mislead auditors or fail to record transactions to conceal the fraud, BDO said.
The firm said it had “no knowledge” of First Brands’ financial arrangements “that were off balance sheet” and that it didn’t audit other entities that took on such debt.
Cloudy Judgment
Despite long pushing back on the expectation that they should detect fraud, audit firms are taking steps to bolster the effectiveness of their work.
EY, KPMG, and BDO have each said they increasingly tackle more of the audit before a client’s financial year closes to give staff time to dig into thorny accounting questions or more closely examine red flags, among other steps to shore up the effectiveness of their audits.
They could do even more, starting with assigning a forensic professional to every audit, said Mary-Jo Kranacher, a fraud examination professor at York College CUNY.
Unlike forensic accountants, auditors don’t turn over every rock but instead focus on the highest-risk accounts.
Adding those fraud experts would add cost and potentially time to an audit. Firms, however, face potentially crippling liabilities when audits fail. EY’s German unit is still mired in litigation over its audits for Wirecard, considered the German Enron.
Starting in 2027, auditors will have clearer rules that direct them to look for and respond to any fraud or suspected fraud that would cause a significant hit to a company’s accounting under standards set by the International Auditing and Assurance Standards Board.
Similar standard changes in the US are in limbo amid the latest leadership overhaul at the audit regulator, the Public Company Accounting Oversight Board.
Rule changes alone won’t guarantee that auditors would catch or halt a fraud like Wirecard, said Ulrike Thuerheimer, an assistant accounting professor at the University of Amsterdam. “The standard needs to be enforced, including through internal quality control systems of audit firms,” she said.
And they don’t alter the financial incentives for auditors to sidestep questionable accounting or behavior: the significant fees they earn from their multinational clients.
“How much are you going to be willing to push back?” Kranacher, the York-CUNY professor, said of auditors. “They have a business mentality, rather than a public-service mentality.”
The challenge for auditors will be navigating those conflicting pressures from the market, which depends on their work, as well as their clients and an evolving rule book as they sift through complex corporate transactions for globe-spanning companies.
“You’re not going to be hired to exclusively look for fraud,” said Salvatore Collemi, managing member of Collemi Consulting & Advisory Services LLC, which works with accounting firms to improve audits. “But if you see the red flags, you see signs of it, it is your obligation under the standards to ask questions and continue digging to find out what is going on.”
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