Bank fraud spotlight falls on KPMG

Bank fraud spotlight falls on KPMG

In the immediate aftermath of the recent scandals which have rocked blue-chip City banks Morgan Grenfell and Robert Fleming, anxious City investors are asking themselves: ‘Where were the auditors?’.

The auditors play a meaningful part in protecting the interests of investors and shareholders, but why is it they are rarely deemed culpable when a high-flying investment manager has been found consistently breaking the rules?

The issue is not so much whether the auditors spotted problems that could materially affect investors or shareholders. It centres more on the management controls and whether the auditors agreed they were clear and rigorously upheld. Increasingly, auditors are performing ‘balance-sheet auditing’, critics argue. This amounts to no more than a check that the assets of a company are valued correctly. If investors cast their minds back to the Ferranti case, they will remember KPMG asked all the right questions in its efforts to assess the assets of a US firm owned by Ferranti. But the brief given by the client and the fee paid to KPMG were restricted and did not extend to any investigatory work. In the end, Ferranti collapsed because the assets were worthless.

Morgan Grenfell’s owner, Deutsche Bank, hopes the same is not the case in its asset management arm. Again, KPMG is the external auditor and is waiting for City regulators IMRO to start asking questions.

A spokeswoman for IMRO would not confirm last week if the investigating auditors it has appointed from Deloitte & Touche will be examining the role of KPMG. It would only say they had been asked to calculate the value of the unquoted stock holdings built up by Peter Young, the high-flying fund manager at the centre of the scandal, and compare them with the value he gave them. The bigger the difference, the deeper Morgan Grenfell will need to dig into its pockets to compensate investors.

But senior figures close to the scandal said KPMG would find itself ‘in the frame’ along with the internal auditing and compliance departments at the company. ‘The recent audit (of Morgan Grenfell Asset Management) would have covered the company and its quoted funds,’ said a highly-placed source. ‘KPMG must have judged that the value of the assets was reasonable.

That may be fair. But once they looked at the amount of money Young was pumping into each of the unquoted companies, which sometimes amounted to a shareholding of 40% or more, they must have seen it was in breach of IMRO and Morgan Grenfell rules.’

KPMG refused to comment on its relationship with Morgan Grenfell and the investigation now underway. But there could be some tricky questions if it turns out that the company failed to report lapses in management control.

In the case of Jardine Fleming, the Hong Kong-based fund management company jointly owned by Robert Fleming and Jardine Matheson, Accountancy Age can reveal that the auditors of its three top-earning funds were under a tight brief. In Section 89a of its rules, the SFC only asks the external auditors, in this case, Coopers & Lybrand, Price Waterhouse and Ernst & Young, to report what amounts to criminal activity or an incident that would incur losses for investors. In other words, they must be presented with a clear case of fraud or impropriety before they need to include any reference in their submission to the SFC.

So when Jardine Fleming allowed one of its top fund managers to siphon money into his own account, the treatment of the problem was markedly different to the treatment expected in London. It was considered a minor breach in 1993 when managers discovered the problem. For this reason, KPMG, the investigating auditor at Jardine Fleming, was given a strict brief by the SFC. Tim Lewis, head of the investigation team, confirmed: ‘We did not have any reference to examine the activities of other auditors or any work they might or might not have done.’ Lewis spent five months delving into the activities of Colin Armstrong, another ‘star’ fund manager given enough rope to hang the company. He may have cleaned up the mess left behind by Armstrong, but investors should remain wary.

The excuse is that in Hong Kong the regulations are weak. Critics may say that the external audit is a cheap and cheerful exercise which fails to cover problem areas. In this atmosphere, clients and professional firms must accept that there will be more scandals. Without a belt and braces approach, where internal and external audits have some value, things could get out of control.

Alan Bray, a partner in Deloittes’ forensic accounting department, agrees that clients should begin to accept they will need to increase the amount they pay for audit services. ‘They also need to change the focus of their audits and ask how exposed they are to fraud. Very few firms we deal with have produced things like an ethics guide with an anti-fraud policy. If you tell staff where they stand, you are better equipped to prevent fraud occurring in the first place.’

Some observers take comfort in IMRO’s stringent demand that auditors report anything irregular. It doesn’t matter if there is only a suspicion that a minor breach of internal rules has occurred, IMRO wants to know.

Following the Jardine Fleming debacle, an IMRO spokeswoman said: ‘It was not for Robert Fleming to decide how important the incident was. The company should have informed us in its 1994 report. It is one of the reasons why we came down so heavily on them.’

But two cases in quick succession is embarrassing for IMRO. In the next weeks and months, IMRO will be under pressure to show that self-regulation can work. So maybe Morgan Grenfell is in for an even rougher ride than Jardine Fleming, if only because the excuses will be harder to justify.

It would certainly appear that KPMG will come in for questioning over this case. But the affair is set to raise broader questions over the regulation of fund managers and the role of auditors.

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