A former KPMG leader was sentenced Wednesday to one year and one day in federal prison and three years of supervised release for his role in a scheme to subvert the regulatory inspection process.
The sentencing handed down by U.S. District Judge J. Paul Oetken comes six months after David Middendorf, former national managing partner for audit quality and professional practice at KPMG, was convicted of wire fraud charges by a Southern District of New York jury in March. Middendorf and four others were charged by both the U.S. Department of Justice and the Securities and Exchange Commission with a scheme to steal confidential inspection planning information from the Public Company Accounting Oversight Board regarding which KPMG audits would be selected for inspection. That would give engagement partners an opportunity to review their work before inspectors would begin poring over audit files.
“As the head of the KPMG department responsible for the quality of its audits, David Middendorf was at the top of a chain of corruption that threatened to corrupt KPMG and the PCAOB’s inspections process,” said Manhattan U.S. Attorney Geoffrey Berman. “Today’s sentence recognizes the harm this fraudulent scheme caused to the PCAOB and the auditing profession more generally.”
In recent years, KPMG fared poorly in PCAOB inspections and in 2014 received approximately twice as many comments as its competitor firms. Around 2015, KPMG was engaged in efforts to improve its PCAOB inspection results, including through illegitimate means.
Between 2015 and 2017, Middendorf and others “worked to illicitly acquire valuable confidential PCAOB information concerning which KPMG audits would be inspected in an effort to game the system and improve inspection results,” according to the evidence presented at trial. For example, beginning in 2015, Brian Sweet, a former PCAOB employee who had joined KPMG, provided Middendorf, Thomas Whittle, and others with the PCAOB’s confidential 2015 list of inspection selections, at Middendorf’s request, so the information could be used by himself, Whittle, and others to improve KPMG’s performance on PCAOB inspections.
In March 2016, Jeffrey Wada, an inspections leader at the PCAOB, provided Cynthia Holder, a KPMG employee, with confidential information on certain of the PCAOB’s 2016 inspection selections. Holder, in turn, provided the 2016 inspection selections to Sweet, who passed them to Middendorf, Whittle, and others.
Middendorf, Whittle, Sweet, and others then agreed to launch a stealth program to “re-review” the audits that had been selected and agreed to keep their stealth re-reviews within their “circle of trust.” To cover up their illicit conduct, other KPMG engagement partners were given a false explanation for the re-reviews. The stealth re-review program allowed KPMG to strengthen its work papers and, in some cases, identify deficiencies or perform new audit work that had not been done during the live audit.
In January 2017, Wada, who had been passed over for promotion at the PCAOB, again stole valuable confidential PCAOB information, misappropriating a preliminary list of confidential 2017 inspection selections for KPMG audits and passing it on to Holder, referring to it in a voicemail as the “grocery list.” At the same time, Wada provided Holder with his résumé and sought Holder’s assistance in helping him to acquire employment at KPMG. Sweet shared with Whittle the preliminary inspection selections provided by Wada; Wada in turn shared them with Middendorf, who approved their use to improve the audits on the list.
In February 2017, Wada texted Holder saying, “I have the grocery list … All the things you’ll need for the year.” Wada then spoke to Holder and provided her with the full confidential 2017 final inspection selections. Holder again shared the stolen information with Sweet, who shared it with Middendorf, Whittle, and others so that it could be acted upon to improve the audits on the list. In 2017, a KPMG partner who received early notice that her engagement was on the confidential 2017 inspection list reported the matter, and it was ultimately reported to KPMG’s Office of General Counsel.
As prosecutors stated in the court documents, “As the trial made clear, there were systemic problems at KPMG regarding the use of confidential PCAOB information. It is important to send a message in this case that such behavior in the auditing profession—particularly among executives—will not be tolerated.”
A non-incarceratory sentence, as Middendorf suggested, “simply will not accomplish that goal,” prosecutors said in the court documents. “Rather, it will feed into Middendorf’s effort to minimize this multi-year fraudulent scheme as a ‘mistake in judgment.’”
In August, Holder was sentenced to eight months in federal prison and two years of supervised release for her role in the scheme.
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