Views on improving the integrity of global capital markets
27 January 2012

GE and KPMG: Too Close for Investor Comfort, but Not for SEC?

KPMG has been the official auditor of General Electric for over 100 years. What’s more, KPMG had been loaning staff to GE and charging $8-10 million annually for the privilege. There is one slight problem with this arrangement — loaning staff to an audit client is prohibited by the Sarbanes-Oxley Act of 2002 and other regulations. It seems that after 100 years in a relationship, things can get quite cozy.

And, indeed, some shareowners thought things had gotten too chummy, and that such a longstanding relationship could compromise the impartiality of an auditor. Also, remember way back to 2009, when GE agreed to pay a $50 million fine to the SEC for earnings manipulation through accounting — all under the nose of a KPMG audit of course. The Carpenters Pension Fund therefore drafted a resolution to be included in GE’s 2012 proxy asking shareholders to vote on mandatory auditor rotation at the industrial giant, requiring the auditor to rotate at least every seven years — with a cooling-off period of at least three years before an auditor could return.

Seems like a reasonable proposal, right?

It didn’t seem reasonable to the SEC. After receiving a letter from GE notifying the regulator it intended to omit the proposal from its 2012 proxy and asking SEC staff  not to take action, the Commission did just that; it concurred and sent GE a “no-action” letter. For those who aren’t familiar with the term, a no-action letter means that the company does not have to take any action on the proposal and can exclude it from this year’s proxy statement. The SEC reasoned that the proposal dealt with “ordinary business operations.” Proposals are routinely tossed out if they deal with ordinary business operations so that nuisance proposals involving ordinary business issues do not overwhelm the proxy statement.

Perhaps throwing the Carpenters Pension Fund a bone, the SEC quietly wagged its finger at GE and KPMG, and asked them to behave themselves.

The Carpenters Pension Fund submitted similar proxy proposals at about 45 other large-cap companies with audit-firm relationships exceeding 10 years. What do you think the chances are that you will see any of those proposals on corporate proxies next year?

About the Author(s)
Matt Orsagh, CFA, CIPM

Matt Orsagh, CFA, CIPM, is a senior director of capital markets policy at CFA Institute, where he focuses on corporate governance, ESG, and climate change analysis. He writes and speaks frequently on these topics on behalf of CFA Institute. His paper, Climate Change Analysis in the Investment Process was named “Best ESG Paper” by Savvy Investor in 2021.

3 thoughts on “GE and KPMG: Too Close for Investor Comfort, but Not for SEC?”

  1. Very interesting blog, Matt.

    Coincidentally, Bob Heineman, GE’s former senior counsel has written a great book called “High Performance with High Integrity” and your blog reminds me of something he says early on: “High performance corporations put relentless financial pressure on their employees to increase net income, cash flow, stock price – pressure that can often cause corruption when unconstrained by high integrity.” (p2)

    Anyway, I have two specific questions:

    1) It’s great to see leadership from a pension fund. But is targeting companies one at a time really the best way to deal with such a systemic issue? In the US auditor tenure (for the largest 100 companies) averages 28 years http://pcaobus.org/Rules/Rulemaking/Docket037/Release_2011-006.pdf (p20) and in the UK, the FTSE350 average is 34 years http://www.grant-thornton.co.uk/pdf/corporate_governance.pdf Given the proven tendency to self censor when you become too close, these ossified relationships increase enormously the chances of high impact low probability events, what some call “black swans” but which I prefer to call “Preventable Surprises”. Here’s how it happens in the words of experienced auditor: http://retheauditors.com/2012/01/16/madoff-mlk-buddha-and-elusive-nature-of-self-interest/

    So my question is have CII heavy hitters pushed as hard as they can for auditor rotation across the board? Sadly I cant boast that some ABI/NAPF heavyweights have done well in the UK but if I’m wrong, I hope someone will correct me. And if institutions are struggling so hard with doing the right thing from a customer centric perspective, I wonder if it’s possible for individual analysts to move a bit faster? I’d love to hear from any CFA members who consider it part of their professional duty to ask management probing questions on this issue, and so send at least a soft message of concern. It seems to me that in our different ways, we are all co-creators of the dysfunctional markets we experience and progress will come when we all do our little bit within our sphere of control.

    2) The SEC’s self-censorship would seem to be yet another case of self-censorship/regulatory capture. And it’s not hard to see why the already beleaguered SEC wouldn’t want to upset GE (e.g. its CEO chairs the President’s Economic Advisory Panel). And that reminds me of another good piece Bob has done, this time on the risks associated with corporate political influence: http://blogs.law.harvard.edu/corpgov/tag/political-spending/ He spells out several criteria for defining good practice. Again, I’d be delighted to know if any of your readers think GE has met these criteria and or whether they could see using these criteria in their analysis/stewardship work more generally?

    Thanks again!

    Raj

  2. Uyota says:

    Exposing events will unfold.n they would be forced to include it.very very soon.

  3. Matt Orsagh says:

    We are seeing more shareowner resolutions in the US concerning political spending, but few on auditor rotation. With majority voting, say on pay and proxy access taking up most of the proxy limelight and political spending the focus in an election year, I would expect issues like auditor rotation to be pushed to the back burner.

    I was surprised that the average tenure of US and UK auditors was that long. I would expect this issue to get more attention in future years. I will have to go and check the CII statistics on this.

    Matt

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