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Too Big To Fail Doesn’t Mean they Won’t

On March 11th, 2019, a federal court in Manhattan convicted KPMG’s former national managing partner for audit quality, David Middendorf, on conspiracy and wire fraud charges for to his role in the ‘steal the exam’ scandal which involved executives and employees from both KPMG and the Public Company Accounting Oversight Board (PCAOB).1 In January of 2018, the Southern District of New York indicted “[five] former KPMG Executives and PCAOB Employees” and charged them in connection with a scheme to improve KPMG’s PCAOB inspection results by stealing and using confidential information from the PCAOB.2 Notably, and unsurprisingly, the Department of Justice did not choose to charge KPMG as a firm for the actions of its agents because of fears that subjecting the firm to entity-liability would cause another Andersen-style collapse of a ‘Big-Four’ accounting firm.3 The loss of any one of the four remaining large auditing firms would prove disastrous for global markets and the current financial regulatory regime constructed after the collapse of Andersen in the early 2000s.4 This concern has led to speculation that the big four accounting firms are too big to fail,5 but a declaration does not make a destiny, and calling a firm too big to fail does not mean it won’t.  

Auditing Firms have strong market incentives to act ethically because their ability to win and maintain clients depends on the amount of trust the market places in their opinion. Market participants rely on auditors and CPAs to verify qualitative and quantitative elements of an issuer’s financial information.6 To gauge the trustworthiness of an individual auditing firm, issuers consider the firm’s track record of successful audits and which other companies engage it for its services. When an issuer engages with an auditing firm, it signals to the rest of the market a certain level of trust in the auditor which may depend on a variety of factors specific to any one issuer/auditor relationship. When an auditing firm is able to engage with multiple issuers, it benefits from an aggregation of the trust-signaling market participants observe when they see issuers engage with each firm on an individual basis.7

The market’s use of trust-signaling helps explain the concentration of large issuer audits almost exclusively with the ‘Big Four’ accounting firms of Deloitte, PwC, KPMG, and Ernst & Young. Market participants face significant barriers, be they informational, technical, or resource determinant, in evaluating the quality of an auditor, which increases the extent to which the market, and in turn an issuer, relies on the reputation of auditors when making this choice.8 The concentration of large issuer audits indicates these issuers do not see a suitable alternatives to a ‘Big Four’ auditor for because alternative smaller and mid-market firms cannot match the reputational capital earned by ‘Big Four’ firms through their track-record of issuing quality opinions for large, complex issuers.9 Included in this reputational advantage are the ‘Big Four’ firm’s economies of scale and scope.10 The ‘Big Four’ can call on global networks to match their global clients, and make this fact part of their branding.11 The reality is, smaller firms do not have enough reputational capital to perform audit services for large, complex issuers.12

Reputation is a fickle thing and hard to measure and there is room for debate as to whether, and to what extent, any one audit should reflect on an auditing firm as a whole. Most often, this debate concerns whether a firm should be held liable for the bad actions of its partners and employees.13 Mention of entity-liability in the context of public accounting conjures up memories of the collapse of Arthur Andersen, a fate which many observers believe would befall any of the remaining ‘Big Four’ firms should they too face entity-liability.14

The loss of the market’s trust led to the collapse of Arthur Andersen in the early 2000s, and reduced the number of large accounting firms in an already concentrated industry from five to four.15 The conventional story of the Andersen dissolution places the triggering event for the collapse at the moment the Department of Justice indicted the firm for obstruction of justice related to its destruction of documents detailing services it performed for Enron.16 The indictment had a negative effect on Andersen’s ability to conduct business because, if convicted, the firm would lose its authority to issue opinions for issuers subject to SEC regulations.17 This effect, the story goes, led to a mass exodus of clients from the firm and its ultimate dissolution.18

The indictment of Andersen may have quickened its demise, but it was not necessary to prompt the failure of the firm. A review of Andersen’s history before its indictment shows a firm primed and ready for disaster because of a string of failed audits and government scrutiny.19 Kathleen Brickey’s contemporaneous assessment of the ‘substantial cloud over Andersen’s future’ summarized the firm’s situation in the following way:

“Even without an indictment, Andersen was bracing to lose up to twenty-five percent of its United States revenue, and it is far from clear that the firm could have weathered so many storms. Andersen had already begun to lose clients, and knowledgeable commentators say this was only the last–not the first–serious blow to the firm. Even Andersen CEO Joseph Berardino had expressed concern that a rising number of flawed audits and lawsuits was putting Andersen’s reputation and financial condition at risk. In short, the government did not bring Andersen down. Andersen’s own failings brought Andersen down.”20

The Department of Justice has not indicted KPMG in relation to the ‘steal-the-exam’ scandal, but it is hard to know exactly what that decision says about the future of the firm and industry. It does not take an indictment to destroy a reputation a firm develops with market participants. Just as a firm builds reputation brick-by-brick through the aggregated track-record of successful audits with multiple issuers, a firm destroys trust through an aggregation of scandal and low-quality audits. Like Andersen pre-Enron, KPMG has suffered from a string of reputational hits over several years preceding its most recent scandal.21 Additionally, the scandals do not appear to be isolated to any one particular engagement or office, have involved the firm’s upper-management, and have had global reach.22

In fairness to KPMG, its scandals, while serious, have not had the same economic impact to the markets that the series of Andersen scandals had during the 90s and early 2000s. Enron itself was one of the largest, most important publicly traded companies in the United States during the time in which Andersen helped its executives perpetuate financial fraud.23 As such, when Enron collapsed in scandal, the public outcry demanded accountability for those involved, including for Andersen.

If public outcry, or lack thereof, is what distinguished KPMG from Andersen the future of public accounting sits in a vulnerable position. KPMG avoided entity level liability in this scandal, but if a significant accounting scandal came to the public’s attention right now, would the firm withstand the fire?


  1. Michael Rapoport, KPMG Ex-Partner Convicted in ‘Steal the Exam’ Scandal, Wall Street J., Mar. 11th, 2019, https://www.wsj.com/articles/kpmg-ex-partner-convicted-in-steal-the-exam-scandal-11552340232?mod=searchresults&page=1&pos=5. 

  2. U.S. Dep’t of Just., 5 Former KPMG Executives And PCAOB Employees Charged, Press Release, (Jan. 23, 2018). 

  3. Christopher C. Mckinnon, Auditing the Auditors: Antitrust Concerns in the Large Company Audit Market, 11 N.Y.U. J.L. & Bus. 533, 553 (2015). 

  4. Chris Marquette, PCAOB member says big four accounting firms are cause for concern, CQ ROLL CALL, Dec. 13, 2017; Mckinnon, supra note 3. at 554. 

  5. Madison Marriage et al. Concerns raised about ‘to big to fail’ KPMG, FINANCIAL TIMES, (July 19, 2018).  

  6. Mckinnon, supra note 3, at 533, 534. 

  7. Mckinnon, supra note 3, at 547. 

  8. Hannah L. Buxbaum, The Viability of Enterprise Jurisdiction: A Case Study of the Big Four Accounting Firms, 48 U.C. Davis L. Rev. 1769, 1795 (2015). 

  9. Buxbaum, supra note 8, at 1794–95. 

  10. Buxbaum, supra note 8, at 1793. 

  11. Id

  12. Mckinnon, supra note 3, at 547 (“Changing from a non-Big 4 to a Big 4 auditor on the whole is viewed neutrally or positively by the stock market, whereas changing from a Big 4 to non-Big 4 firm is generally viewed negatively”). 

  13. Kathleen F. Brickey, Andersen’s Fall from Grace, 81 Wash. U. L.Q. 917, 921–22 (2003).  

  14. Mckinnon, supra note 3, at 554. 

  15. Bryan J. Hall, Not My Brother’s Keeper: Accounting Firms Face Increased Securities Claims for Audits Performed by Affiliates in Other Countries, 84 St. John’s L. Rev. 1133, 1150 (2010). 

  16. Mckinnon, supra note 3, at 553. 

  17. Brickey, supra note 13, at 921. 

  18. Brickey, supra note 13, at 921. 

  19. Brickey, supra note 13, at 950–51. 

  20. Id

  21. see Search for KPMG PCAOB Inspection Reports, PCAOB, https://pcaobus.org/Inspections/Reports/Pages/default.aspx (search “KPMG” and filter country field for “United States”)(showing KPMG PCAOB inspection reports with public quality control criticisms for 2016, 2015, 2012, and 2011). See also Michael Rapoport, KPMG Gets Poor Marks From Audit Regulator, Wall Street J. Jan. 25, 2019, https://www.wsj.com/articles/kpmg-gets-poor-marks-from-audit-regulator-11548460081?mod=searchresults&page=1&pos=13. 

  22. See Madison Marriage et al. Concerns raised about ‘to big to fail’ KPMG, Financial Times, July 19, 2018 (citing KPMG accounting scandals in South Africa, the United States, and the United Kingdom). 

  23. CNN, Enron Fast Facts (Apr. 23, 2018), https://www.cnn.com/2013/07/02/us/enron-fast-facts/index.html. 

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