Why Was KPMG Still Auditing Silicon Valley Bank?

Long-term client relationships are a known risk to audit quality. KPMG’s near 30-year run at SVB demands a fresh look at the issue.

Chris Hughes

22 Mar 2023, 10:31 AM IST

SANTA CLARA, CALIFORNIA - MARCH 10: A customer stands outside of a shuttered Silicon Valley Bank (SVB) headquarters on March 10, 2023 in Santa Clara, California. Silicon Valley Bank was shut down on Friday morning by California regulators and was put in control of the U.S. Federal Deposit Insurance Corporation. Prior to being shut down by regulators, shares of SVB were halted Friday morning after falling more than 60% in premarket trading following a 60% declined on Thursday when the bank sold off a portfolio of US Treasuries and $1.75 billion in shares to cover declining customer deposits. (Photo by Justin Sullivan/Getty Images)

(Bloomberg Opinion) -- KPMG LLP began auditing Silicon Valley Bank in 1994. Why was it still there in 2023?

The firm signed off on SVB’s accounts shortly before the lender attempted an emergency capital increase that triggered a run by depositors. But SVB’s vulnerability was in the numbers. Liabilities comprised a big chunk of corporate deposits. These funded assets including long-dated bonds whose market value was below par. The risk was that a forced sale of those assets, to meet deposit withdrawals or rotate into shorter-dated assets, would crystalize a loss and deplete capital. And that’s what happened.

The transparency of the accounts may well have helped many investors see the dynamics. But that doesn’t let KPMG off the hook. At issue is whether it could have drawn more attention to the precariousness of the situation. Even if the auditors believed it was unnecessary to question SVB’s ability to continue as a going concern, they had other options. KPMG could, for example, have used a so-called “emphasis-of-matter” paragraph to flag the unrealized losses on the securities portfolio (especially as its designation as “held to maturity” avoided the hit being booked) and the concentration of the deposit base in the technology industry.

Of course, including sentences along these lines may have triggered a bank run too. But the prospect of this ought to have prompted SVB management to take remedial action sooner, alerting the authorities, raising capital privately or selling itself before the report was published.

Accounting standard-setters say the function of such notes is to flag parts of the financial statements that are “fundamental” to understanding the overall numbers. Admittedly there’s subjectivity involved in what’s fundamental, and investors should be aware banks are vulnerable to depositors moving money around, especially in a rising rate environment.

Even so, SVB’s shareholders and bondholders – who weren’t bailed out like depositors – ought to be asking KPMG why it felt further elaboration wasn’t necessary.

Why Was KPMG Still Auditing Silicon Valley Bank?

KPMG said it conducts its audits in accordance with professional standards. It stressed that audit opinions address only financial statements and internal controls and are based on the audit evidence available at the date of the opinion. The firm is not commenting on the specifics of SVB, citing client confidentiality.

As for the duration of KPMG’s relationship, it’s widely acknowledged that the longer an auditor serves, the greater the threat to audit quality arising from a loss of independent thinking. To manage this risk, European regulations require so-called public interest entities – like banks – to put their audit out to tender after 10 years (the incumbent can serve again, subject to a competitive process).

The US explored mandatory audit firm rotation in depth in 2011, deciding against it amid resistance from the industry. Instead, it favors mandatory rotation of the audit partner responsible for an account every five years.

Both the US and European approaches have pitfalls. A new partner in the same firm is going to be under tremendous pressure to rationalize any past accounting they disagreed with; a new audit firm will find it easier to criticize its predecessor’s work. But a new firm has a steep learning curve and that’s a threat to audit quality too. A halfway house is just to add a second auditor.

KPMG needs to show that, regardless of its compliance with the prevailing regulation, its internal processes were sufficient to ensure its audit work was truly objective here.

When nearly three decades have past, the balance of risks is surely in favor of bringing in a new firm rather than changing the responsible partner. As it happens, KPMG served as auditor to the failed Signature Bank since 2001. But this isn’t a KPMG matter per se. The issue is whether the US approach to long-term client engagements in the audit profession is too permissive.

The main lessons from SVB’s collapse surround the board’s poor risk management and banking supervisors’ failures. But there may well be lessons on audit quality too. The US Securities Exchange Commission and the Public Company Accounting Oversight Board should be asking if auditors have sufficient understanding of banking business models to provide a useful supporting narrative to the numbers. They should ask whether there may have been independence failings here and, either way, put audit-firm rotation back on the agenda – never mind the industry pushback.