Ex-KPMG Partner Sentenced to a Year and a Day in ‘Steal the Exam’ Scandal

The former No. 2 auditor at KPMG LLP will go to prison for one year and one day for his role in a “steal the exam” scandal that exposed serious weaknesses at one of the Big Four accounting firms.

David Middendorf,

the former second-in-command of KPMG’s U.S. audit practice, was convicted for his role in a scheme to steal the names of the firm’s clients whose audits were going to be reviewed by the nation’s accounting regulator.

“As the trial made clear, there were systemic problems at KPMG regarding the use of confidential [regulatory] information,” the government said in a court filing this month. The scheme “could have corrupted KPMG to its core,” prosecutors said. Mr. Middendorf, 55 years old, said at his sentencing hearing that “never in my wildest imagination” did he imagine that what he did might be criminal conduct. He said what had already happened to him was enough to deter any auditor in the world from similar conduct, adding he’d been arrested at 5.45 a.m., taken to court in leg shackles “and been in this nightmare ever since.” His lawyer told the court the case had ended Mr. Middendorf’s 30-year career at KPMG, tarnished his reputation, damaged his finances and left him unemployable as a certified public accountant. In relaying the sentence, U.S. District Judge J. Paul Oetken said the criminal conduct was serious because it involved the corruption of a regulatory process. “It did involve cheating by employees…to give their company a leg up,” he said. He added that be believed Mr. Middendorf “knew what he was doing was wrong.” The punishments imposed on the firm’s former auditors are unusual in their severity. Mr. Middendorf is the second former KPMG partner or employee sentenced to prison time because of the scheme; another two have pleaded guilty and await sentencing. One former partner, who denies wrongdoing, is due to go on trial this fall. “It’s very rare for a Big Four audit partner to face any kind of criminal penalty,” said

Stephen Sorensen,

a Venice, Calif.-based attorney who specializes in suing accounting firms. “This is an extreme case: they were trying to defraud a regulator.” The year-and-a-day sentence means Mr. Middendorf is potentially eligible for early release on the grounds of good conduct. “He was probably fortunate to have received the sentence he did, given the unprecedented conduct he was convicted of and the prosecutors’ recommendation he serve at least 37 months,” said

Michael Shaub,

accounting professor at Texas A&M University. Mr. Middendorf’s lawyer, prosecutors and accounting-industry observers agree problems at the firm were widespread. Some said the $50 million penalty KPMG was ordered to pay by the Securities and Exchange Commission, while one of the highest imposed on an audit firm, was too little. Dozens of KPMG auditors saw emails based on stolen data that discussed which audits the firm’s main regulator, the Public Company Accounting Oversight Board, was likely to analyze as part of its annual inspections, according to testimony at Mr. Middendorf’s trial earlier this year. Mr. Middendorf’s lawyer,

Nelson Boxer,

told jurors he’d “counted them up—47 recipients of these predictions and gossip emails…and no one yells fire.” In its settlement with the SEC in June, KPMG admitted that former auditors at the firm improperly accessed regulatory information. It also admitted that dozens of its auditors also cheated on internal exams. The firm has since added two independent directors to its board; invested in technology designed to improve its audit quality; and undertaken a firmwide “culture assessment.”

Lynne Doughtie,

KPMG’s U.S. chairman and chief executive, said in an interview, “People think of culture as soft stuff, but it’s the hard stuff. Our brand is based on trust and this is some of the most important work we’ve ever done.” She added that the firm “is stronger as a result of the steps we’ve taken.” But KPMG still has a way to go to comply with government-imposed conditions for cleaning up its act. It’s missed a 60-day deadline to appoint an independent consultant, imposed as part of the settlement. The consultant will oversee KPMG’s internal investigation into the cheating, as well as reviewing the firm’s quality controls. KPMG will next year elect a new chief executive and chairman, whose tasks will include signing an SEC-required certificate of compliance with ethics standards for 2020 and 2021. The firm’s current head, Ms. Doughtie, isn’t seeking a second term when her five-year term ends in June. “We have dealt with significant challenges, learned important lessons and we are well positioned for the future,” Ms. Doughtie said in the interview. “After serious reflection I believe it’s the right time to transition.” The accounting regulator has expressed concerns about the quality of KPMG’s audits since 2015. The publicly available results haven’t improved since then: in 2017—the most recent data available—half the 52 audits inspected by the PCAOB had serious deficiencies. The regulator chooses higher-risk audits for inspection, so the 50% failure rate isn’t representative of the firm’s overall audit work, a KPMG spokesman said. He added that the firm “expects its PCAOB inspection findings to show improvement for the 2018 inspections year as a result of the changes it has made.”

Prem Sikka,

accounting professor at Sheffield University in England, said “paying fines has become part of the cost of doing business” for the Big Four. He questioned why KPMG wasn’t charged criminally, saying financial sanctions appeared to have no deterrent effect. For example, KPMG in 2005 reached a deferred prosecution agreement with the Justice Department over its alleged involvement in a tax fraud. “They were fined $456 million—and what did that do?” Mr. Sikka asked. An SEC spokesman declined to comment. The $50 million SEC fine is 0.5% of KPMG’s $9.5 billion revenue for the year to September 2018, and equates to about $23,000 for each of the approximately 2,200 partners, according to the most recent data available for the U.S. firm. “Fifty million dollars is chump change to a Big Four firm,” said Jim Peterson, a lawyer and former partner at accounting firm Arthur Andersen LLP, which collapsed after being criminally convicted in the early 2000s. While scandals can affect a Big Four’s firm’s reputation, he said, their business model is protected by the virtual monopoly they enjoy on audits of big companies. “The Big Four own the large-company audit franchise,” Mr. Peterson said. “They can absorb almost anything thrown at them.” Write to Jean Eaglesham at jean.eaglesham@wsj.com

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