On April 11, 2017, KPMG LLP announced that five partners and one employee of the firm had been dismissed for failing to disclose confidential information obtained illicitly from the Public Company Accounting Oversight Board (PCAOB). According to the KPMG press release, the six individuals either had improper advance warnings of engagements to be inspected by the PCAOB or were aware that others had received such advance warnings and had failed to properly report the situation in a timely manner. 1 Lynne Doughtie, KPMG s CEO at the time, noted that her firm has zero tolerance for such unethical behavior. Quality and integrity are the cornerstones of all we do and that includes operating with the utmost respect and regard for the regulatory process... We are taking additional steps to ensure that such a situation should not happen again. 2 The five partners KPMG dismissed included Scott Marcello, the firm s Vice-Chair in charge of its U.S. audit practice, and David Middendorf, Marcello stop subordinate who held the title of National Managing Partner of Audit Quality & Professional Practice. Middendorf was also serving at the time on the PCAOB Standing Advisory Group that makes recommendations to the agency concerning new auditing standards. Since 2004, the PCAOB has performed regular inspections of the hundreds of independent accounting firms registered to perform public company audits Big Four firms are required to undergo annual inspections. The investment community, academic researchers, and the Big Four firms themselves closely monitor those inspection results since they provide an independent and powerful measure of the quality of the firms audit services. Shortly after KPMG announced the firing of the six employees, Compliance Week, a periodical focusing on regulatory issues in the business domain, noted caustically that KPMG had needed any edge 3 it could obtain to improve its PCAOB inspection results. For the prior two years, the New York Times had characterized those results as abysmal. 4 In 2016, the PCAOB had reported a 38 percent deficiency rate for the nationwide sample of 2015 KPMG audits inspected. That deficiency rate ranked as the highest among the Big Four firms. In 2015, the PCAOB reported a 54 percent deficiency rate for the 2014 KPMG audits inspected, which was nearly double the average deficiency rate that year for the three other Big Four firms. The heavy attention focused on the annual deficiency rates reported by the PCAOB has become a growing source of pressure and discomfort for not only the leadership of the Big Four firms but for their individual audit partners as well. In fact, in May 2016, David Middendorf told a reporter that PCAOB inspections were an area of stress and were causing some audit partners to leave our profession. 5 KPMG s disappointing PCAOB inspection results had prompted the firm to place the highly w respected Scott Marcello in charge of its U.S. audit practice in July 2015. With the exception of a two- year term with the Financial Accounting Standards Board, Marcello had spent his entire professional career with KPMG and had served for several years on the firm s managing board. As the Wall Street Journal reported in April 2017, Marcello was supposed to be the man to redeem KPMG LLP s audit business, 6 a mission that included reducing the firm s PCAOB deficiency rates. Unfortunately, instead of boosting KPMG s image, Marcello became the center of a scandal that [further] tarnished the firms reputation. In January 2018, the SEC issued two Accounting and Auditing Enforcement Releases that described in detail how certain KPMG partners, including David Middendorf, had obtained information from the PCAOB regarding KPMG audits to be inspected by the federal agency. The lynchpin of that effort was recruiting and eventually hiring a PCAOB official who had been a member of the agency s team that had inspected KPMG audits. KPMG made that individual a partner in its audit practice. After being asked to do so, the new audit partner supplied Middendorf and two other KPMG partners with information regarding the PCAOB s future inspection plans for KPMG audits. Shortly after being hired by KPMG, the new partner asked a former co-worker still employed by the PCAOB to send him additional information regarding the agency s KPMG inspections. KPMG ultimately hired that individual as well. Several months after this second former PCAOB official was hired by KPMG, she obtained additional information about the agency s planned inspections of KPMG audits from an individual still employed by the PCAOB.9 Three KPMG partners and an employee involved in the covert operation to obtain confidential information from the PCAOB ultimately pled guilty to criminal charges for their roles in the scandal. David Middendorf was the sole KPMG representative who chose to contest the charges he faced rather than plead guilty. In March 2019, Middendorf was convicted on four counts, including conspiracy and wire fraud, in a Manhattan federal court. Six months later, a federal judge sentenced Middendorf to serve one year and one day in federal prison for his indiscretions. Scott Marcello was never indicted in connection with the PCAOB scandal involving his subordinates. In June 2019, the SEC reported that KPMG was being fined $50 million for the PCAOB scandal. In addition to that fine, the SEC required KPMG to implement various remedial measures, including evaluating its quality controls relating to ethics and integrity. 1. Identify the PCAOB's reported deficiency rate for each Big Four firm for each of the past five years. Comment on any discernible trends in the firms' deficiency rates. [Note: The PCAOB deficiency rates for Big Four firms are widely reported each year in various business publications.] 2. Each year, the PCAOB posts to its website a report that summarizes the findings of the agency's most recent annual audit inspections. That report identifies the most common audit deficiencies found by PCAOB inspection teams. Review the most recent summary inspection report prepared by the PCAOB. What were the most common audit deficiencies identified by PCAOB inspection teams during the year in question? 3. What measures could Big Four firms take to mitigate the stress imposed on individual audit partners by the PCAOB inspection process? How effective do you believe the measures you identified would be in mitigating that stress? On April 11, 2017, KPMG LLP announced that five partners and one employee of the firm had been dismissed for failing to disclose confidential information obtained illicitly from the Public Company Accounting Oversight Board (PCAOB). According to the KPMG press release, the six individuals either had improper advance warnings of engagements to be inspected by the PCAOB or were aware that others had received such advance warnings and had failed to properly report the situation in a timely manner. 1 Lynne Doughtie, KPMG s CEO at the time, noted that her firm has zero tolerance for such unethical behavior. Quality and integrity are the cornerstones of all we do and that includes operating with the utmost respect and regard for the regulatory process... We are taking additional steps to ensure that such a situation should not happen again. 2 The five partners KPMG dismissed included Scott Marcello, the firm s Vice-Chair in charge of its U.S. audit practice, and David Middendorf, Marcello stop subordinate who held the title of National Managing Partner of Audit Quality & Professional Practice. Middendorf was also serving at the time on the PCAOB Standing Advisory Group that makes recommendations to the agency concerning new auditing standards. Since 2004, the PCAOB has performed regular inspections of the hundreds of independent accounting firms registered to perform public company audits Big Four firms are required to undergo annual inspections. The investment community, academic researchers, and the Big Four firms themselves closely monitor those inspection results since they provide an independent and powerful measure of the quality of the firms audit services. Shortly after KPMG announced the firing of the six employees, Compliance Week, a periodical focusing on regulatory issues in the business domain, noted caustically that KPMG had needed any edge 3 it could obtain to improve its PCAOB inspection results. For the prior two years, the New York Times had characterized those results as abysmal. 4 In 2016, the PCAOB had reported a 38 percent deficiency rate for the nationwide sample of 2015 KPMG audits inspected. That deficiency rate ranked as the highest among the Big Four firms. In 2015, the PCAOB reported a 54 percent deficiency rate for the 2014 KPMG audits inspected, which was nearly double the average deficiency rate that year for the three other Big Four firms. The heavy attention focused on the annual deficiency rates reported by the PCAOB has become a growing source of pressure and discomfort for not only the leadership of the Big Four firms but for their individual audit partners as well. In fact, in May 2016, David Middendorf told a reporter that PCAOB inspections were an area of stress and were causing some audit partners to leave our profession. 5 KPMG s disappointing PCAOB inspection results had prompted the firm to place the highly w respected Scott Marcello in charge of its U.S. audit practice in July 2015. With the exception of a two- year term with the Financial Accounting Standards Board, Marcello had spent his entire professional career with KPMG and had served for several years on the firm s managing board. As the Wall Street Journal reported in April 2017, Marcello was supposed to be the man to redeem KPMG LLP s audit business, 6 a mission that included reducing the firm s PCAOB deficiency rates. Unfortunately, instead of boosting KPMG s image, Marcello became the center of a scandal that [further] tarnished the firms reputation. In January 2018, the SEC issued two Accounting and Auditing Enforcement Releases that described in detail how certain KPMG partners, including David Middendorf, had obtained information from the PCAOB regarding KPMG audits to be inspected by the federal agency. The lynchpin of that effort was recruiting and eventually hiring a PCAOB official who had been a member of the agency s team that had inspected KPMG audits. KPMG made that individual a partner in its audit practice. After being asked to do so, the new audit partner supplied Middendorf and two other KPMG partners with information regarding the PCAOB s future inspection plans for KPMG audits. Shortly after being hired by KPMG, the new partner asked a former co-worker still employed by the PCAOB to send him additional information regarding the agency s KPMG inspections. KPMG ultimately hired that individual as well. Several months after this second former PCAOB official was hired by KPMG, she obtained additional information about the agency s planned inspections of KPMG audits from an individual still employed by the PCAOB.9 Three KPMG partners and an employee involved in the covert operation to obtain confidential information from the PCAOB ultimately pled guilty to criminal charges for their roles in the scandal. David Middendorf was the sole KPMG representative who chose to contest the charges he faced rather than plead guilty. In March 2019, Middendorf was convicted on four counts, including conspiracy and wire fraud, in a Manhattan federal court. Six months later, a federal judge sentenced Middendorf to serve one year and one day in federal prison for his indiscretions. Scott Marcello was never indicted in connection with the PCAOB scandal involving his subordinates. In June 2019, the SEC reported that KPMG was being fined $50 million for the PCAOB scandal. In addition to that fine, the SEC required KPMG to implement various remedial measures, including evaluating its quality controls relating to ethics and integrity. 1. Identify the PCAOB's reported deficiency rate for each Big Four firm for each of the past five years. Comment on any discernible trends in the firms' deficiency rates. [Note: The PCAOB deficiency rates for Big Four firms are widely reported each year in various business publications.] 2. Each year, the PCAOB posts to its website a report that summarizes the findings of the agency's most recent annual audit inspections. That report identifies the most common audit deficiencies found by PCAOB inspection teams. Review the most recent summary inspection report prepared by the PCAOB. What were the most common audit deficiencies identified by PCAOB inspection teams during the year in question? 3. What measures could Big Four firms take to mitigate the stress imposed on individual audit partners by the PCAOB inspection process? How effective do you believe the measures you identified would be in mitigating that stress