Thursday, 23 January 2020

Ted Baker’s Woes Keeps the Heat on KPMG

In August 2018, KPMG were fined £3m for acting as an expert witness for Ted Baker in a civil case whilst also providing the fashion company with auditing services. On both sides of the Atlantic, KPMG has received numerous financial penalties for its misdemeanours so it is, of course, no stranger to getting into trouble. However, news this week of financial problems within Ted Baker may cause KPMG further trouble, with this coming hot on the heels of its £5m fine for its performance regarding the auditing of the Bank of New York Mellon. This short post will review the recent developments at Ted Baker and ask whether it is to be considered that auditors will naturally transgress, and that financial penalties are simply to be considered ‘par for the course’.

On Wednesday it was widely reported that Ted Baker had admitted to an accounting error – it has overstated the value of its stock by nearly £60m. Media reports confirm that, last month, the firm had hired Deloitte to investigate what had happened, after preliminary investigations suggested that the overvaluation could be between £20 and £25m. On the news that the actual figure was more than double the initial estimations, the shares in Ted Baker fell nearly 10%, putting the fashion company in real danger. Banks supporting the company have already started placing advisors within the business amid fears the company will need a cash injection to stay afloat at some point in the near future. In March, the company’s Chief Executive – Ray Kelvin – resigned over claims that he presided over a culture of ‘forced hugging’, whilst in October of last year the company reported a £23m loss for the six months to the 10th of August. There has been no official word yet of what area was overvalued, and why – initial reports suggest the overvaluation came from within its clothing line – with the company declaring that the cause will be made public with the release of its annual accounts due shortly. Yet, the bad news just keeps rolling in for Ted Baker, with Kelvin’s replacement, and the firm’s Executive Chairman, both resigning after continuously poor financial results. With the added pressure of increased competitive and environmental forces at play on the High Street, these stories make for a bleak outlook for the struggling firm. However, for KPMG, they may be about to encounter even more bad press as a result of this overvaluation.

The media is reporting that this situation represents a major embarrassment for the auditor, as it had declared during its time as Ted Baker’s auditor that it had uncovered some mis-statements, but that they were too small to affect the company’s accounts. With Deloitte coming in and uncovering this massive overvaluation, the attention will no doubt turn to why KPMG both a. did not catch this overvaluation, and b. decided that the mis-statements they did find were immaterial. The answer to those questions will likely result in some sort of regulatory investigation, particularly if Ted Baker continues to suffer and, ultimately, if it collapses.

KPMG, and in truth the other members of the Big Four auditors, are facing challenging times. For KPMG, it is currently attempting to take action in order to alter the perception of it, with Bill Michael – the Chairman – attempting to ‘restore stability to both its finances and brand’. That objective took a hit recently with the firm’s most senior female officer quitting the firm after two decades, the multitude of fines it is incurring around the globe, and its attempts to ward of British Governmental regulation by way of self-divesting from the ancillary services market which provide it with so much income. Michael is apparently mulling over the sale of a number of the firm’s advisory units before the British Government seeks to put pressure on its regulators to enact some sort of separation between the auditing and advisory arms of the Big Four auditing firms. However, I have warned about this before whilst making the case for a fundamental separation of core and ancillary services within the credit rating industry. After the Enron and WorldCom scandals at the turn of the century, the auditors were allowed to self-divest before it was forced upon; the result was that, just 10 years later, they had all re-implemented the divisions and restarted the lucrative business. Both the credit rating and auditing industries are vital to the efficient running of the marketplace (a stronger case can be made for auditors of course, but I digress), but within them they both have inherent conflicts of interest. The injection of remuneration is the key, but there are sometimes conflicts that we must live with. One that we fundamentally do not need to live with is the development of ancillary services. These industries are massive, and can recoup enough money from the delivery of their core services to both continue delivering those services, and also make massive profits. The development of ancillary services, I argue, feed directly into negating the only penalty that is politically palatable – financial penalties. Until personal liability is opened to the managers and partners of these financial firms, financial penalties must be impactful to deter future transgressions, and with the vast profits obtained from the delivery of ancillary services, that impact is minimal. The Big Four are, it seems, in the news almost every week being fined for something they have done, or not done, in a given area of the world. They continue to do this for a number of reasons. However, one of the main philosophical reasons why financial gatekeepers transgress is, simply, because they can. Some transgressions are much more complex, of course, but when there is simply no impact on the organisation or the people transgressing, and when there are such vast financial rewards to be had, human nature tells us that transgressive behaviour will continue. KPMG will no doubt have their knuckles wrapped for this particular transgression, but it will not matter. The Big Four will also divest from the ancillary service sector in some form in the UK, and British politicians will no doubt celebrate, but it will not matter. But, for those who need these financial gatekeepers to do their jobs honestly, and impartially, it matters.

Keywords – fashion, retail, business, audit, KPMG, @finregmatters

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