Don’t Blame KPMG Audits for the Three Regional Bank Breakdowns

The collapse of three major regional banks—Signature Bank, First Republic Bank, and Silicon Valley Bank—that were all audited by KPMG, has led politicians, academics, and investors to question KPMG’s audit quality and the dominance of Big Four audit firms in the US.

While scrutiny is warranted, it’s important to focus on which issues are within the control of auditors and regulators and which are outside their control. Based on public information available to date, the issues at KPMG represent bad optics given the close and related timing of each bank failure following clean audit opinions. But that may not represent a failed audit approach or low-quality audit on behalf of KPMG.

KPMG is widely considered an industry expert in financial services audits. They audit a disproportionate number of regional banks and are best positioned to do so. Because of that expertise, if there’s a bank failure, it’s more likely that the bank will be a KPMG client, all else being equal.

SVB and Signature seemed to have both been operationally mismanaged by their executive teams, but that’s not KPMG’s job to address or comment on. Plenty of companies have poor management—a passive board of directors, questionable business models, or some combination therein—and yet appropriately receive clean audit opinions when the auditor believes they’ll survive beyond a year.

It’s not the auditor’s responsibility to grade management. It’s their job to grade the financial statements and assess their ability to survive for a year.

Outside of KPMG’s control, SVB and Signature Bank both experienced modern-day bank runs. SVB had significantly more uninsured depositors relative to its peers, creating a business risk to the bank, but also one that they disclosed. If auditors must consider the risk that every regional bank is prone to an unprecedented bank run and warrants a going concern opinion, then the opinion itself becomes useless. There would be no differentiation between banks—if one is risky, they’re all risky under those parameters.

It’s possible that if many of the depositors at SVB didn’t share a similar industry concentration (which SVB disclosed) and weren’t connected socially, SVB and Signature Bank both would have survived, and KPMG’s audits wouldn’t be under the microscope.

Bank run risk generally isn’t unique to SVB, Signature, or First Republic. The Federal Reserve’s depository data indicated customers were pulling deposits from almost all regional banks around the same time as the failures at SVB and Signature. Actions by the FDIC stopped the bank run contagion, but regional banks will always be at the mercy of depositors to some extent.

Many are big enough to cause contagion and worsen a crisis, but not big enough to be able to withstand large-scale withdrawals like Bank of America Corp. or JPMorgan Chase & Co. likely could. The auditor must consider this in their going concern assessment, but the risk appears more systemic to the industry than it does to individual banks at the time the audit report and financial statements were released.

In light of the collapse at three banks audited by KPMG, there has been some commentary that, independent of KPMG’s audit quality, the Big Four firms—which include EY, PwC, and Deloitte along with KPMG—are too big to fail. This implies that if there was more competition at the top, perceived audit failures such as these would put the accounting firms at risk of dissolution and change their behavior.

That belief is largely misguided. Research has shown that the largest accounting firms tend to be more risk averse with their oligopoly power, not less. For each of the Big Four firms, no individual client is worth the reputational effects of a failed audit. The clients need them more than they need the client.

The only large accounting firm in the last 30 years to dissolve due to malpractice was Arthur Andersen (although its obstruction of justice charge was later overturned on appeal). Andersen is too often brought up when there is a perceived audit failure such as EY over Lehman Brothers Holdings Inc. or KPMG over SVB.

But the facts don’t warrant a parallel comparison. Andersen lacked independence in appearance due to its large consulting arrangement with its auditees. Those arrangements haven’t been permissible since the Sarbanes-Oxley Act passed in 2002. Instead, the risk now is that, because the largest companies and banks are so complex and resource intensive, only the Big Four firms have the resources and capacity to audit them, and banks are left with few options.

It’s common for large banks to have one of the Big Four as its auditor and the other three employed in a consulting capacity. Because auditors can’t audit their own work, it’s difficult for the banks to switch auditors to one that isn’t already providing some other consulting services without violating independence rules. The same worry would remain if there were still the Big Five, the current Big Four, or a hypothetical Big Three.

Yes, KPMG audited SVB, Signature Bank, and First Republic. Yes, those banks went into bankruptcy less than a year after receiving a clean audit report from KPMG. But it doesn’t mean KPMG was negligent or allowed its market position to cloud its judgment. It just means KPMG is the leading bank auditor and regional banks are riskier than we believed, even if they don’t receive the systemically important financial institution classification.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Jack Castonguay, PhD, CPA, is an assistant professor of accounting in the Zarb School of Business at Hofstra University and vice president of content development at KnowFully Learning Group.

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