25 May 2012

Watchdog not bloodhound

John Griffith-Jones is defensive of the role of auditors in the financial crisis, with good reason. The KPMG UK senior partner and chairman talks to Richard Cree about audit’s true calling as a guardian and not a detective

John Griffith-Jones is in bullish form. When we meet, the KPMG UK senior partner and chairman is a few months away from handing over the reins. After 38 years with the firm, he might be forgiven if there was an air of end-of-term valedictory to our conversation. But he is in no mood for nostalgia. This might be because his time at the top of the firm (and later its combined European operations) coincided with the most severe financial crisis for 70 years. The role of auditors in that crisis is being questioned like never before. And Griffith-Jones is keen to defend the role and quality of modern audit.

Some journalists are obsessed with kicking us, but if you talk to clients and investors, there isn’t a mutinous mood that auditors have done some terrible thing
John Griffith-Jones

In some ways, his view of the recession is understandable, since severe financial crises bookend his career. He entered accountancy in 1975, partly because the severity of the financial crisis meant banks weren’t recruiting. He’d always considered himself a numbers man, and chose accountancy over law (the only other option for a career in the City). When he became KPMG chief executive in 2001, it was again the start of another recession, this time caused by the bursting dotcom bubble, Enron and the fallout from the subsequent collapse of rival firm Arthur Andersen. 

For Griffith-Jones, the story of audit during this time has been of a continual improvement in quality. While some are wringing hands at the failure of auditors to spot the coming crash in 2007/08, Griffith-Jones is more positive. “Some journalists are obsessed with kicking us, but if you talk to clients and investors, there isn’t a mutinous mood that auditors have done some terrible thing,” he says. “There was a tsunami. It nearly knocked over the financial sector. And no one, including auditors, saw it coming. But we didn’t cause the tsunami. We have to ask what we could have done better. The best analogy is the Maginot line. All the pieces needed to be joined up better. If you look at each person in isolation you can find fault, but the issue was that the system wasn’t joined up as it should have been.”

One suggestion Griffith-Jones rejects is that auditors were too cosy with bank clients. “There is no correlation between the cosiness argument and the tsunami. The relationship between auditors and clients is a question that has lurked around explicitly or implicitly since time immemorial and it needs to be nailed. It starts because we are appointed by the client and paid by the client. For the avoidance of doubt, that is not our fault.”

Voice of reason

Griffith-Jones does accept that, along with various other parties (credit rating agencies, bank management, politicians, the FSA), auditors were “partly responsible” for what happened. So what needs to be done to strengthen audit to prevent a repeat? With a reputation as one of the more reasonable voices from the larger audit firms, Griffith-Jones admits there are things the profession could have done better.

“We need more robust audit committees and robust, independent relationships with clients. It is difficult, if not impossible, to do an audit at reasonable expense without the co-operation of the client. If you set out to do an audit using only independent evidence, without taking anything from the client, the cost would be prohibitive. There is a compromise between cost and effectiveness.”

It may be a contentious issue, but he also says the more public reporting of risk is required. “It is the responsibility of management, but it would be possible for that report to be audited. There is always a danger that this will lead to a whole lot of boilerplate that doesn’t add any value, but the financial crisis taught us that shareholders deserve to know the risk parameters of the businesses they are investing in.”

The main criticisms of the profession stem from the fact that so many banks were signed off as going concerns only months before they collapsed or needed bailing out. The extent to which audits should be forward-looking or retrospective is also contentious. “We are still dancing around the edge of whether when we sign off a set of accounts there is a going concern presumption,” he says. “We’ve had the Sharman Report into what counts as a going concern, but what happens if a going concern on 31 March turns into a dead duck on 1 June, because of something unforeseeable?”

Heart of the matter

While investors want to know if a company is well run or not, in practice it is not feasible for the auditors to be responsible for saying that a company is poorly run. But what really frustrates Griffith-Jones is that many of these issues have been discussed for years, without resolution. Moreover, he says the proposals from the EU seem to be aimed at solving different problems. “Barnier’s proposals are about joint auditors and mandatory rotation. They don’t seem to go to the heart of the issues that the banking crisis threw up or highlighted.”

Griffith-Jones is firmly set against these proposals. “We have auditing standards and rotation of auditor partners. Audit staff rotate frequently on their own accord and finance directors and audit committee chairman rotate naturally. There is a huge amount of personnel change. That is more effective at keeping the arms-length relationship than having everyone out every few years on a mandatory basis.” A key point that gets missed in this debate, says Griffith-Jones, is that high-quality audit is in auditors’ interests. “The phrase ‘an audit is of no value at all unless it is a good one’ is written on my heart.” 

Griffith-Jones separates out the art of audit from the science. The science of auditing, the sampling and the solid theoretical underpinning, is well documented and  is of a generally high standard. “Audit, in terms of the sampling, testing and backward-looking verification of numbers, is as good as it can be.”

Just as detectives don’t solve every crime, you’ll never get 100% detection of fraud
John Griffith-Jones

But there is also a subjective art to auditing. And while he repeats that auditors are meant to be “watchdog not bloodhound”, the art of a good audit is about “the nose” he says, raising a conspiratorial finger to the side of his nose whenever he does. “You can’t check 100% of everything. This is where trust and the nose come together. There has to be a reliance on the client up to a point.” A good auditor will use their nose, like a detective, to figure out when something isn’t right. “There is a degree of honesty that you have to take for granted. This nose is for when something is wrong, or if there is something you can’t pin down about someone. But just as detectives don’t solve every crime, you’ll never get 100% detection of fraud.” But he claims that done well, in accordance with auditing standards, it should pick up all material non-fraud error. That gets us back to the financial crisis.

“Before the tsunami, the numbers in those audits were in the narrowest, most backward-looking sense, mathematically right. But they were based on valuations and the values collapsed afterwards. It was all balanced on a pin and highly leveraged.”

Despite the fallout from the financial collapse, he remains optimistic about the respect the profession is held in. “I don’t think it’s gone downhill since 1975. My friends were rude about accountants then as being dull and boring, and they still are. But I continue to admire the quality of colleagues who do the big audits. They are signing off billions or trillions of pounds personally and saying they think the numbers are OK. They have no motivation for getting it wrong. The buck stops with the auditor. If they get it wrong they get shot out of the profession with a big black mark on their head and no chance of working in the profession again. People say we are too cosy with clients, but what motive is there for getting it wrong? There certainly is a motive for being on reasonable terms and having a decent relationship with the finance director on a day-to-day basis and persuading the audit committee to keep you as auditor next year. But the benefit is outweighed by the threat of this thing standing behind you saying if you get this wrong the sword of Damacles is unleashed from the ceiling above you.”

Improve access

With all this pressure, it’s questionable why anyone would want to join the profession. But under Griffith-Jones’s stewardship KPMG has launched some interesting schemes to attract younger employees, most notably a partnership with ICAEW and Durham University to take 18-year-old A-Level students on a six-year course combining a degree and the ACA qualification. The scheme was intended to improve access to the profession for those unable to afford it otherwise, but the introduction of tuition fees changed the rules. Demand for the scheme has outstripped expectations and applications are not coming just from the disadvantaged. “It cooked just at the time that tuition fees came in, and what was a good idea became a brilliant one overnight,” says Griffith-Jones. “Although it was designed for people who might not have had access, there is no regret. It just means we have to cope. It is a problem of success.”

There is, he says, a tension between the desire for wider access and the fact that accountancy demands high-quality people. “There aren’t barriers to people who are of the right academic quality. There isn’t a social background bias. But people without good A-levels are difficult for KPMG to cope with. It is easy to say we should do more to widen the talent pool, but the standard to which we work is incredibly high. This is a meritocracy and we are skimming the education system for the brightest people.

“If they don’t have the talent or raw material, they won’t keep up. The idea that we could take people who aren’t up to it and sprinkle KPMG magic dust on them isn’t possible.” It’s quite in keeping with Griffith-Jones’s approach to be opinionated and outspoken. He says he “likes a debate” and describes himself as “a laissez faire conservative radical open to new ideas”. He likes people around him to have an opinion and suggest new things, while getting on with business as usual.

Wider insight 

His claims to be conservative are at odds with the major change to the European structure of the firm. The merger with the Germans and other Europeans has offered him insights into wider European politics. “The need for the European market to join up in order for us to have relevance in the world isn’t going away. And just like the EU, we squabble like hell and have to find a consensus, which is difficult with more than two people.

“But we are closer to one another than we were five years ago and within the KPMG network we are better at having discussions about what to do when a given outcome doesn’t suit all of us. Where there are times that the Germans want to do something differently it is easier now to understand. You need a lot of trust to do that. Europe’s status in the world is diminishing. The need to speak with one voice is growing. We have achieved a lot but there is more to do. I have a better instinct for how Europe works and I am better at predicting the outcome of most issues in Europe. So, after four years working with Germans, I know they don’t want the euro to break up. And so far it hasn’t.”

At which point he returns to the main topic, audit. “The EU audit issue needs to be resolved. Even if Barnier’s proposals are implemented, the major issues won’t be resolved. There are no crystal balls, so audit in the future won’t be a certificate that guarantees nothing will go wrong. We need to make it clear that this is what an audit is and this is what it does. And then, as long as the profession sticks to using clever people to develop process driven ideas to help clients, our future is rosy.”

Highlights of a one-firm career

1975 Joins KPMG from Cambridge
1986 Joins the firm’s new corporate finance team
2001 CEO
2006 Senior partner and UK chairman
2008 EMA chairman
2012 Retires