KPMG & Nkonki contract termination: Auditor-General briefing

Meeting report

KPMG & Nkonki contract termination: Auditor-General briefing
Auditor-General, Mr Kimi Makwetu, said the action to terminate both contracts was taken on 17 April 2018. AGSA had made a choice way back that due to the size and the timing of the audits that must be carried out post March and June, it was inescapable fact that it had to seek the assistance of private audit companies. There is no less than 90 registered audit firms that do work on the AG’s behalf and the arrangements with the firms have been in existence for over 20 years. The work ranges from assistance with the audits of  municipalities, departments and entities. Amongst others, the relationship with private firms was based on two specific fundamental principle: independence and professional competence in accordance with auditing standards. Firms are contracted in the agreements that they will stringently follow those standards. For AGSA to satisfy itself on the adherence of those principles by the firms, it super-imposes supervision to ensure that the work is not compromised.

The two fundamental principles speak to the outcome of the audit product because the audit conclusion is not a physical good that can be moved from one person to another – it is based on trust, hence those principles are the underlying features. This is the context in which AGSA operated with these firms, hence when that trust ceased to be credible, the decision was taken to terminate the working relationship.

KPMG SA
Mr Makwetu said that in September 2017, a report surfaced that outlined key findings on KPMG risk management and audit practices. It also reflected on the allegations and confirmed at that time a series of leadership changes and processes in KPMG were underway in an effort to enhance its practices. Two independent investigations were instituted. More relevant for AGSA was the IRBA (Independent Regulatory Board for Auditors), and the Ntsebeza Inquiry commissioned by SAICA (South African Institute of Charted Accountants) to investigate what came out of the report.

AGSA took steps to seek engagement with the leaders of KPMG who were new at the time, and sought to understand whether the allegations were true. He specifically asked if the matters raised in the report were a fallacy or isolated or indicative of a systematic break down in the risk management and audit practices of the firm. AGSA was given assurance that the partners continued to be independent and strived to improve on the weaknesses identified in the report. As there was no answer, the AG waited for the outcome of the two investigations. Hence, KPMG services were still secured by AG although subject to the conclusion and outcome of those investigations. Due to the lack of a sufficient or convincing answer, the AG took the decision in September 2017 to allocate a one year contract to KPMG instead of a two year contract.

When the decision was taken in April, work was not yet done for the 2017/18 financial year.

The SAICA and IRBA investigations are still on-going and both institutions are uncertain about when the investigations would be concluded because other concerning matters keep coming up during the investigations.

In April, two KPMG partners were implicated on matters of conduct in the VPS Mutual Bank matter. The bank is now under curatorship because there was no verifiable evidence with regards to certain transactions in the bank. AGSA decided that as another matter had arisen implicating KPMG - while still waiting for the September 2017 matter to be resolved that in order to minimise the risk, the solution was to withdraw its contract with the firm until those questions were answered.

Nkonki Inc
Mr Makwetu said the Nkonki Inc termination of contract had to do with independence with glaring risks that may compromise audit practices and risk management disciplines. One of the questions the AG needed answered was whether the new shareholder with a significant shareholding in the firm was a registered auditor or not – this was fundamental. AGSA tried to ascertain from the Nkonki leadership the identity of the new majority shareholder. Their response was that their shareholders were not involved in those transactions. This response became a concern about whether there was a departure from independence – which is at the heart of auditing. AGSA had wanted to ensure that no aspersions could be cast. AGSA decided that it would be reluctant to subject the audits of public entities to a firm that did not know who its shareholder is.

The firm went through a review by IRBA but a final report was not yet generated. AGSA was not successful in getting the report, so it remained in the dark about the ownership of the firm that AGSA has entrusted the responsibility of carrying out audits. Although there may be the need to investigate the circumstances, the fact of the non-identification of owner of the firm was sufficient for AGSA’s reluctance to continue contracting the firm. In April, the major risks pertaining to independence informed by the fact that its shareholder had not been identified to AGSA nor was it certain if it was a registered auditor, the decision was taken to terminate the contract with Nkonki Inc. The AG is aware of incidents reported in the media about the behaviour of auditors. Even though that is happening in the private sector, it is always under scrutiny as AGSA is also required to defend and protect the independence of the audit profession.

The April announcement to terminate both contracts were decisions about companies whose risks emerged at different times but that could have had a devastating impact on the AG. The credibility of its work and the independence of the AG would be questionable. Since the decision to terminate the contracts was taken, the AG has worked hard with both firms to ensure that that the audit processes already underway continue to be carried out until sign-off at the end of July. In order not to compromise the audit quality of the work, it is preferred, according to ISQC1, that a person who commences an audit should ideally be predominantly the same person presiding over the audit evidence right up to the audit outcome. It is not a case of handing over the work to another firm; it is not that simple in auditing. The AG had tried to minimise the impact that this decision would have on the professional staff of the firms, because there was no pronouncement or judgement on the capabilities of the professional staff in those firms.

Currently AGSA is aligning itself with the professional staff of the firms to ensure those audits will be signed off on 31 July with a level of scrutiny and reviews associated with the type of audit work they are supposed to deliver. Thus, AGSA made available some of its staff members to reinforce that scrutiny.

We have assessed the different categories of audits that have been assigned to them, and now all the AG’s partners are busy in correspondence with those firms.

One of the categories of audits is section 4(3); these are audits that the AG has opted out to audit and the auditee would appoint its preferred firm after consultation with AGSA, which has to concur with the appointment, and the audit report would be signed off in their name. As AGSA is not a direct appointer, it decided to withdraw the concurrence on the appointment of the two firms as external auditors proposing that AGSA opt-in as external auditors as per the Public Audit Act in consultation with the accounting and executive authority. This implies that the professional staff of the firms will continue to be involved in the audit as initially envisaged, whilst the necessary review, quality assurance and final responsibilities will be handled by AGSA. Examples of such auditees include Denel, National Housing Finance Corporation and Development Bank of Southern Africa. These transitional arrangements will apply only to the audits ending on 31 July 2018. The audit arrangement for any audit cycle beyond this date will be confirmed after the completion of these audits in consultation with the auditees.

Mr Makwetu noted an exception to this involved the KPMG audits of a couple of universities and TVET who financial period ended 31 December 2017. At the time the decision was taken those audits were far advanced. AGSA allowed the firm to finalise the audits – but it will ensure that the final review and quality checks will be conducted by AGSA.

On the way forward, the priority of the AG is to work with the interested stakeholders to improve the confidence of the public about the public audits. We are pulling together a round-table engagement with all the firms that conduct audit work on behalf on the AGSA. There is a need for stronger public audit orientation to ensure that everyone was on the same page.

In conclusion, independence and professional competence has been at the centre of protecting the credibility of AGSA for many years. It did not wish to partake in situations that may affect its credibility and its audit reports. We are finagling the schedules to realign and re-organise the audits – if the people in those firms resign before the end of July, there are contingency plans that have been put in place.

Discussion
The Chairperson stated that the Committee now had to take a decision on either to defend or reject the AG’s decision.

Mr N Singh (IFP) said his personal view is it was necessary for AGSA to intervene in the manner it did. Within those companies are highly trained and competent individuals. Government should not lose the expertise of those individuals because of the Nkonki and KPMG brand – so how is this going to be curbed. Secondly, the AG spoke about other firms that were being investigated. Could the Committee be told who those firms are? Are there any KPMG and Nkonki audits currently being reviewed by AG that could have an outcome that was suspect? Finally, should we not see this as an opportunity for the Committee to recommend that AGSA audit all state owned companies? Perhaps this could also be an opportunity to enhance the capacity of AGSA to carry out those audits.

Ms Z Dubazane (ANC) agreed with the decisions taken by the AG as the AG had analysed the whole situation in terms of what occurred in those two companies. However, the Committee must remember the 2008/9 recession where the main questionable entities were the regulatory bodies. They failed to identify and address conflicts of interests in companies that were grossly conflicted. She was concerned about IRBA, because she assumed that there is a prominent conflict of interest. She asked what IRBA had done up to this point, because the investigations have been ongoing for a long time. A firm is required to report the ownership of the firm, how come IRBA was not working within its own regulatory framework to ascertain this? She was convinced that there is a conflict of interest due to the manner in which IRBA was conducting itself in the Nkonki matter. Perhaps, it should be called to Parliament to account. It was critical for the Committee to call IRBA to engage with it directly on this matter.

Mr M Ntombela (ANC) was of the view that the AG took the right steps under the circumstances if one considered the reputational damage it would have bestowed upon the AG. He asked for clarity on the notice the firms were given – how much time was this. He would appreciate if the AG provided some form of correspondence between it and the firms concerned so that one could gain better insight on their stance on the decisions taken by the AG’s Office. Before taking the decision, did the AG’s Office warn the firms prior to taking the decision to terminate the contracts.

Ms N Khunou (ANC) agreed with the AGSA’s decisions. She said that there is a long way to go in promoting transformation in the country. There are very few black firms contracted by the Office of the AG. This was concerning and AGSA had assured the Committee that it would look into this. This was important.

Two weeks ago South African Airways came before the Standing Committee on Public Accounts. Throughout the years, their books were fine with unqualified audits before the AGSA took over the audit. Currently SAA is in dire financial straits because the previous contracted private audit firms continued issuing favourable audits to secure more contracts. Although she may be in favour of contracting black firms, but perhaps it was about time AGSA was capacitated to audit all SOEs. Perhaps it was about time the Committee looked at the organogram and ensured that more money was allocated to AGSA to do away with private firms because most of the SOEs that are in dire position was because of those firms.

Ms R Adams (ANC) supported the decision; AGSA was doing the right thing according to the legislation.

Ms Khunou asked about the credibility of the audit reports issued by Nkonki and KPMG for the remainder of their work. She asked how the termination of the contracts was going to impact on the AGSA budget.

Response
Mr Makwetu thanked the Members for their support. AGSA had conversations with some members of the profession to come to the party in allowing those on training contracts at the two firms to complete their training and articles elsewhere – this was the kind of damage control that is being discussed. From an ethical point of view it would have been a significant problem to abscond from those working relationships. These would compromise their ability to qualify as professional auditors, and AGSA decided to weigh in and take some responsibility to ensure that this part was saved. The reference to other firms was largely the matters that were already in the public domain and did not necessarily mean investigations.

With regards to audits done in the past by the firms in question, the AG conducts its own final assessments upon the completion of the audits and nothing was found to be suspicious.

As for AGSA to audit all SOEs, this is an opportunity but the challenge is the economics of this when put into practice. There are 3 500 auditors. If the AGSA decided to not contract some of the work; this meant AGSA would need to have another 1 500 people spread out across different places. The total value of the work contracted out by AGSA is somewhere between R450 to R500 million. The necessary tools were required to undertake the big data that comes from entities such as Eskom, Denel, Transnet, amongst others. AGSA would need a number of people trained to do the work that is contracted to external auditors. Some people would argue that the R450 million paid out to external auditors could be used to pay the additional personnel required to capacitate AGSA. The reality is that if you look at the total quantum of the audits done, there are about 380 PFMA audit reports produced and 400 reports for local government annually. It is possible, but when you employ those people you will have to finance their salaries, equipment, and infrastructure. There is one peak audit period that reports in July and once those reports are done, the system goes into quiet mode and then the provinces pick it up again with the audits of the municipalities because those are not done at the centre. You will face a situation where the bulk of the people you have created a fixed cost around will continue to exist in the environment due to labour relations legislation. The huge amount of money that will have to be carried to support their existence will probably be disproportionate to the money paid out to the external auditors. If you look at the strategy that determines the work and components of the audits that will be carried out by the external audits, there is an agreed fee – the AG does not have to worry about fixed and other related costs for the audit.

On the continuation of the professional staff of those two firms, the Denel audit is budgeted around 45 individuals, seven of which are partner level people. We do not have those people at AGSA ready to be put into an audit of Denel, even if we had then it would be extremely difficult (R12 to R14 million) to carry the audits due to the complexities of the business projects and functions. AGSA having to do an audit in the next two months of that size – that would be disastrous. AGSA ensured that it communicated clearly that there was work to be finished, and it included some of its own people. In order to achieve final audit sign-off, we need to ensure that the audit fee was not affected as well. We do not want to be a situation where, when the people have disappeared, AGSA has to answer questions about audits that it did not audit.

Ample time was given to Nkonki in our view based on fact that AGSA was raising issues of principle and wanting the answers since 2016 until a decision was taken in April 2018 without a clear answer on who the owner is. The AG did inform the firms about the decisions that it would take in light of the previous discussions that were held.

Mr Makwetu pointed out that AGSA audits many SOEs it did not previously audit. There is a gradual progress of taking these on. AGSA now audits SAFCOL, PetroSA, SAA, etc. which were not previously audited by it ten years ago.

On transformation, Mr Makwetu said the commitment is ongoing. There are a number of black auditors and firms that are in the database. Due to the level of their capacity and size as well as ensuring that the audit firms employed were not doing work within the same environment that AGSA is doing work, it becomes difficult for AGSA to contract some of them. There will now be enhanced rigour to focus on that database.

Mr T Godi (APC) fully appreciated this platform so that the AG can have the opportunity to clarify to Parliament about the steps taken on those firms. Reputation is everything and the AG must defend it with his life. The auditing profession has not covered itself in glory in recent times, and nothing has been done or action taken against the perpetrators. The Committee was pleased that the AG took some action in that regard. At the time, he was not happy with the AGSA response when the KPMG issue first came up. However, he engaged some of the AGSA staff members and began to understand its stance at the time.

AGSA is a Chapter Nine institution, as such it accounts to Parliament, but it must take its own decisions. The two elements need to be separated: with KPMG the issue was risk management and audit practices. With Nkonki, the leadership could not disclose the shareholder of the firm which he did not understand how that was possible. Two years down the line, there was still no answer, with its leadership saying it did not know who the new shareholder was. Either the firm is a crook or a clown – there is nothing it can say more to discredit itself.

On transformation, as an Africanist, the fundamental question is that people are black when they want to contract. It appears to be a trap government has fallen into of talking transformation from a liberal point of view that seeks to perpetuate the notion that transformation is about assisting incompetent black people that should not be held to the highest standards. Clearly transformation is about inferiority. When government was fighting apartheid, we said that we had higher values, but our way of doing things after 1994 should reflect that superiority. As an Africanist he found that insulting. How do we even talk about Nkonki, its contracts are stake but yet it still refuses to disclose the shareholder’s identity.

Lastly, he agreed with Ms Khunou about questionable audit outcomes of entities that have been audited by private firms. For instance, everything with SABC was fine until the AG came in to conduct the audit, then things came to the fore. The audit reports from private firms are questionable, and that will remain so. In terms of moving forward, the Committee can try to work out a number or scenarios.

The Chairperson said that IRBA is mandated to report to the Standing Committee on Finance. This Committee would have to engage with the Chairperson of the Finance Committee to look into inviting IRBA to Parliament. Until Nkonki declares who the shareholder is, it must be barred from receiving any contracts with taxpayers’ money. Until Nkonki declares, no business is to be conducted with them. He asked the AG to comment on the risks or consequences if KPMG were to withdraw from South Africa, since it appears that South Africa is a small portion of KPMG International.

He thanked the AG for his presence and work, and the Committee supports the decision taken by the Auditor-General about the two firms.

Mr Makwetu said AGSA will continue doing the work entrusted by Parliament and the Constitution. If anybody was wondering why such a step was necessary, the AG was trying to avert the prospect of a frightening possibility from becoming a horrendous reality. He thanks the AGSA staff for demonstrating their support. Inasmuch as this decision may be difficult to some, it is to ensure that trust in the audit work was not compromised. If people tamper with independence and professional competence, it does not matter how much the audit fee is.

KPMG International operates like any other brand as one of the big four audit firms. Thus, if the firm did not clean up its act or decides to flee from the South African market, their clients elsewhere might be frightened by that and that will start affecting its profits. KPMG cannot escape that reality.

The Chairperson thanked the Auditor-General once again.

The meeting was adjourned.