As I settle into an upstairs meeting room with the firm’s UK chairman, Bill Michael, I ask him what he thinks the building, with its swanky club vibe, says about KPMG and the profession in 2018.
“It is a symbol of a world in which we will collaborate more with clients and share problem solving,” he says. “It is an environment where we have moved from what we do to clients to what we do with clients.
“This is the most fascinating and challenging time for the profession. Every business model is affected. For professional services it is a pivot point. The big change is that will we co-create change.”
This narrative, of greater horizontal integration and disruption breaking down boundaries between organisations, is tested in the weeks after we meet. Already in the spotlight for perceived conflicts of interest in work it was asked to do for the Grenfell Tower inquiry (which we discuss), the collapse of Carillion the following week brought more awkward questions for the firm that was its auditor from launch in 1999 to collapse.
To be fair to Michael, when asked to respond to follow-up questions on Carillion, he does so in great detail and with disarming frankness. Asked whether he expects an investigation, he explains that there should be one. “We conducted a proper audit, but it’s right that following a corporate collapse of such size and social significance, a proper independent investigation is performed, so lessons can be learned by all the stakeholders, from company directors, to investors and our own profession. Without this transparency, we won’t build trust in our profession.”
Michael says Carillion was complex and the situation changed rapidly in the first half of last year. As it announced in July, the company suffered deterioration in cash flows on construction contracts. “This led the company to undertake an enhanced review of all the group’s material contracts. KPMG agreed to carry out accelerated audit procedures from June 2017 in relation to underperforming construction contracts. It was this review by management, following independent review and challenge by KPMG as Carillion’s auditor, that led to the write down of £845m being reported relating to large scale UK and overseas contracts,” he explains. “The nature of these kinds of contracts means a change in circumstances can have a significant impact on expected and estimated outturns previously considered to be achievable.”
Michael admits that, despite the profession’s best efforts to better disclose risks in financial information and explain the purpose of an audit report, “there remains an expectation gap between what an audit does and what investors and the public want it to do” and this gap has widened. “One of the real challenges we must consider is whether or not financial statements contain the relevant information users need to make informed judgements. We have to guard against the misconception that an audit can be a crystal ball.”
Michael says he understands critics pointing a finger at the claim the business was strong enough to last at least three years: “I have empathy for where they are coming from, but it’s worth remembering that there were a series of risks referred to in the annual report that are directly relevant to viability. The board has to make decisions on the likelihood of these risks coming to fruition and their ability to manage them. They make these judgements in real time, based on information available, yet the decisions are normally only questioned when something ‘goes wrong’ with the inevitable benefit of hindsight. The accounts are prepared at a point in time based on information available at that time, and even with the best of intentions subsequent developments can have a significant impact on future outcomes, particularly in relation to matters requiring significant judgement such as large, complex international contracts. The fact that outcomes are different to those expected does not mean that those judgements were invalid at the time.”
That kind of balanced, nuanced response is typical of Michael. He is a man also comfortable with contradictions. He has an easy, down-to-earth style but is also an intellectual, able to drop Chomsky and Socrates into conversation without it being clunky. He is alarmingly candid on some points, but at other times pauses before settling on the right words. He has a fondness for jargon but a keenness for plain and simple soundbites (“dogma is dangerous”). He is clearly keen to take on the big challenges of societal change and the role of the profession within them.
Michael is Australian, the son of Europeans who migrated to Australia with nothing. He landed the top job at KPMG in the UK after a career spent serving the firm in several countries and in different roles, most of them more recently in financial services. The fact he got his current job is, he says, credit to the firm’s desire for diversity. “I am an outsider here, as an immigrant from Australia, but also as an immigrant to Australia originally,” he says.
Refreshingly for a senior business leader, he is happy to talk on any subject. The week we meet the firm is in the spotlight for resigning from helping the Grenfell Tower inquiry after complaints over a conflict of interest (KPMG is auditor of three of the firms under scrutiny). Where many would duck the issue, Michael opts to discuss it at length.
“The challenge of managing conflict has increased. We became regulated because we pose a systemically significant risk. That creates different challenges for the profession. Regulation is important and it is almost inevitable it will expand. But if you look at public trust, which is what we ultimately stand for, it changes. Society’s expectations change and it has become more sophisticated at looking at conflicts and is demanding more clarity over what drives motivations. The longer you stare at something the more likely you are to find a conflict. If you look at the proliferation and broadening of services in the profession, it is inevitable the challenge of managing conflicts will increase.”
He says KPMG’s role in the Grenfell case is one example. “You can look at that story through different lenses and disclose your relationships and be very clear about what you are and are not going to do. Using one lens it is easy to explain there is no conflict of interest. But that lens is changing and the perception of what constitutes a conflict is changing. If you go back 25 years it was common for audit partners to go and work for their clients.”
He says Grenfell is typical of a more common problem. “We argue there probably wasn’t a conflict of interest in that case. But it is a microcosm of the conflicts the profession has to manage, especially when you have four big firms and a couple of good-sized medium firms. Those conflicts are going to increase in a more horizontal world. And the type of consulting work we are getting into, which is deeper into technology and data analytics and means working with clients for longer, creates greater conflicts especially where we do audits and tax work.”
This problem, he says, citing Chomsky, is aggravated by our skim-reading culture. “The power of perception over reality is intensifying. Because of technology and the media and the way we live and disseminate and absorb information, we make very quick judgements.”
But he says that life is about learning and adapting to stay relevant, something he criticises the audit profession for not doing enough. “Audit is core to our business and critical to our brand and what we do. But audits were invented in the 19th century and all we have done since is improve transparency and risks. They are historical, factual and evidence-based documents. But look at the way we are valuing companies today. And look at the unicorns and the way we put valuations on companies with new business models. The question then around the relevance of audit becomes important.”
Despite the best efforts of those in the profession, he says, there is still a major audit expectation gap. “I studied this in the 1980s and we have spent the years since trying to reduce it. But the gap has widened. I am passionate about reducing it and asking what it means for the future of audit.”
The answer lies partly in clarifying expectations. “The education point has got to be there,” he says. “We have to move to something more dynamic than the current model. We need stakeholders, investors, regulators and audit firms working collaboratively to come up with a more agile approach.”
He admits the perception of the value of audit is clouded by potential conflicts of interest and doesn’t rule out a separation of audit and other work. “I can give you strong arguments as to why a multidisciplinary firm is good for clients and social outcomes,” he says, “but I can also tell you that managing conflicts is getting harder. If I look at how the profession looks in five years in a mandatory audit environment, with increased regulation, in a world of increasing reputational risk and more conflicts of interest, I can see the need to re-evaluate our business models.”
Michael says what’s vital is how well we learn from audit failures. He points to the airline industry as a good model. “With every plane that crashes and every disaster, the National Transportation Safety Board improves standards. It is independent, objective and forensic and every crash means fewer future deaths.”
But businesses and markets are less rational and it is harder to prevent future failures or crashes. “We endeavour to learn from crises and certainly since the financial crisis the quality of reporting and audit evidence is better than it has ever been.”
Michael says the financial crisis confirmed his view on the need to seek contrary views. “I have always believed in the Socratic approach of asking what’s not right and what could be better. The key is listening to ideas you may not want to hear and not marginalising them. You have to ask why an answer could be wrong. It doesn’t mean it is wrong, but why could it be? That deductive reasoning, putting bias to one side and trying to find a route that comes up with a better answer, is one of the most important qualities of a leader. You have to train yourself to listen to voices you don’t like.”
Good leaders have a hunger for difficult questions. “Dogma is dangerous. If I start thinking I have drunk the Kool-Aid, I flip the channel and find views I don’t like. You have to work hard not to be the boiling frog. You need the pin prick to force you out of the bubble.”
Michael is clear on his goals. “The world is changing and the partnership has to change. I want us to stay relevant, purposeful and to help the functioning of capital markets. The profession has a unique opportunity because of our connections to all parts of society, business and government, our intellectual capital and the fact we are selling public trust. It’s an incredible opportunity and responsibility to shape things in a better way.”
He says a vital agenda item is trust. “People talk about rebuilding trust, but the issue is redefining it. The benchmarks have changed. Our profession has that challenge, but so does society and government. Our interdependency is more visceral than ever and the need to work together is more compelling than ever. It is a constant journey.”