Will KPMG Ever Wake Up and Finally Learn Its Lesson after Being Duped into Completing Crazy Eddie’s Audits Too Early Twenty Three Years Ago?
KPMG cited by British authorities for prematurely signing off on audits
Recently, Adam Jones of the Financial Times reported that KPMG was “rapped for signing off on audits” before the completion of field work by the United Kingdom’s Financial Reporting Council:
KMPG has been rapped over the knuckles by the accounting watchdog for signing off on audits before all necessary work had been completed.
The criticism was made by the Financial Reporting Council as it told Deloitte, Ernst & Young, KMPG and PwC, the four biggest auditors, to do more to avoid conflicts of interest and be more sceptical of management claims.
The annual evaluations of the Big Four auditors comes amid increased regulatory scrutiny of the profession and its role in the financial crisis.
In the case of KPMG, the FRC’s Audit Inspection Unit looked at 15 audits and found that in three cases the auditor’s report had been signed too soon. Significant changes were subsequently made to the accounts in one case.
Paul George, director of auditing at the FRC’s Professional Oversight Board, which includes the AIU, said the early sign-off problem was not limited to KPMG: “It is a profession-wide challenge to some degree.”
KPMG said it accepted the AIU’s comments. “We are pleased to note that in no case did they think that the audit opinion we issued was incorrect,” said Oliver Tant, head of its UK audit arm.The next day, popular Going Concern blogger Caleb Newquist was cynical of Oliver Tant’s remarks attempting to minimize the gravity of his firm’s negligence:
Okay, sure signing off early on 20% of the audits sampled sorta looks bad but at least the numbers weren’t wrong. It would be really awkward to explain that.KPMG was plain lucky that no audit opinions had to be changed as a result of their negligence. Back in my criminal days as main architect of the Crazy Eddie fraud, KPMG was not so lucky. If KPMG had taken the time to properly complete its filed work, they would have uncovered Crazy Eddie’s massive fraud.
In the hope of providing a wake up lesson to accounting firms like KPMG, below is my story about how I was able to dupe them into certifying Crazy Eddie’s financial reports before the completion of field work and giving Crazy Eddie a clean audit opinion in fiscal year 1987.
1987 was a year of desperation at Crazy Eddie
From the early 1970’s to 1984, Crazy Eddie was a profitable private company. Our frauds were focused primarily on understating our profits by skimming cash to commit income tax evasion and steal sales taxes.
In 1984, Crazy Eddie hired Main Hurdman as its auditors because we needed a large accounting firm to add a false sense of credibility to our financial reporting. In 1987, Main Hurdman merged with another large accounting firm Peat Marwick and was called Peat Marwick Main (PMM). Today, Main Hurdman and Peat Marwick are the US audit partners of large international accounting firm KPMG They are the “P” and “M” in KPMG.
However, in 1987, Crazy Eddie started losing money for the first time in almost two decades because of increased competition and a steep decline in consumer electronic prices which reduced revenues. We resorted to desperate measures to report profits instead of losses.
Fraudulently increasing the value of assets like inventories and fraudulently decreasing liabilities such as accounts payable or amounts owed to vendors inflates reported income or understates reported losses. We fraudulently inflated our inventories by approximately $30 million, but that feat was still not enough to avoid reporting massive losses. Therefore, we conceived of a plan to generate $20 million in phony debit memos which were supposed to be charge backs or offsets against amounts owed to vendors for such items as advertising rebates, volume discounts, and other reimbursements due the company. Those phony debit memos helped us show smaller accounts payable balances or lower amounts owed to vendors on our books and records.
Our accounts payable was only $70 million. Therefore, reducing our reported accounts payable by almost 30% through the issuance of $20 million in phony debit memos was a huge undertaking and we risked scrutiny of those debit memo from our auditors. However, we were desperately trying to cover up massive losses in 1987.
We needed to keep KPMG on a very short string
The lesser the amount of time that KPMG (at that time called Peat Marwick Main) had available to audit Crazy Eddie’s books and records, the easier it was for us to dupe them into issuing clean audit opinions on our falsified financial reports. It was my job to make sure that KPMG did not have enough time to properly complete its audit field work and appropriately examine Crazy Eddie’s books and records.
To accommodate Crazy Eddie’s management, KPMG regularly signed off on its audits about 60 days after our fiscal year ended. For example, in the fiscal year ended March 3, 1985, KPMG signed off on Crazy Eddie’s audit on May 2, 1985. KPMG signed off on Crazy Eddie’s fiscal year ended March 2, 1986 audit on May 1, 1986. Likewise, we hoped that KPMG would sign off on Crazy Eddie’s audit for the fiscal year ended March 1, 1987 on April 30, 1987 in following previous year’s practices.
Ultimately, I was successful in pressuring KPMG to sign off on Crazy Eddie’s 1987 audit on April 28, two days earlier than expected, despite the fact that major audit work was incomplete!
Note: Crazy Eddie’s fiscal year ended on the first Sunday in March which explains the difference in dates for the end of fiscal year’s 1985, 1986, and 1987.
Crazy Eddie’s audit was expected to last about eight weeks and KPMG planned to complete its field work in regular increments during that period. For example, by the sixth week (of eight), KPMG expected to have about 75% of its field work completed and 25% of its work left to do.
My job was to stall KMPG into having only 25% of its field work completed by week six and having 75% of its work left to do during the remaining two weeks of the eight week audit. Thus, KPMG had to do three times the usual amount of field work in the remaining two weeks. To get the work done and satisfy Crazy Eddie’s management, KPMG would skimp on certain key procedures. The plan worked!
Understanding the human frailties of auditors and taking advantage of them
As a general practice, most large accounting firms use relatively inexperienced kids right out of college to do much of the basic audit leg work. They are supervised by slightly more experienced senior auditors who unfortunately depend on feedback from these inexperienced kids in making informed decisions on the conduct of the audit. During the 1980s, both these kids and their supervisors were mostly young single males between the ages of 22 and 29.
As a 28 year old CPA myself, I understood that audits are very boring, tedious, and mundane for these young single male auditors. It was difficult for them to pay close attention to their work. It was relatively easy for me to distract them from performing their jobs without blaming me for stalling them or obstructing their audit work.
|Photo from Going Concern blog|
Rather than overtly obstructing our auditors’ field work, I engaged in a calculated plan to subtly distract them. I made sure that most of our auditor’s interactions were with cute Crazy Eddie female employees reporting to me, even if some of those females had no knowledge of our cooking the books.
I encouraged my female employees to flirt and get friendly with their young male KPMG counterparts and discuss audit issues with them over lunch and dinner on Crazy Eddie’s tab. Meanwhile, I spent much of my time taking certain higher level KPMG counterparts to pick up bars and other establishments frequented by good-looking women.
My female staffers provided the perfect distraction for KPMG auditors as they engaged in constant small talk and wasted precious time. By April 26, just a few days before the scheduled audit sign off, KPMG had not even started many key procedures and still had many unanswered questions.
Unanswered questions and unfinished audit work
In the previous fiscal year, 1986, we had falsified our store level inventories (not warehouse inventories) by $3 to $4 million. However, in fiscal year 1987, Crazy Eddie's store level inventories were inflated by $15 to $20 million as we desperately tried to cover up staggering losses.
In stores that existed in both 1986 and 1987, where the auditors observed inventory counts, those gross inventory levels increased from $21.95 million to $37.47 million or a staggering 71%, despite a huge drop in consumer electronic prices. On April 26, 1987, I was able to convince a certain audit partner not order a re-count of store inventories despite his questioning the unusual increase in store level inventories during a period of dropping prices.
Better yet, the audit test work on verifying the validity of $20 million of charge backs to vendors, which were actually phony debit memos, did not even start because of the effectiveness female employees in distracting the male auditors from doing their work. Moreover, the audit partner respected me as a responsive client and trusted me - a grave mistake.
In past years, I always gave in to his recommendations on being “conservative” and reducing reported income, even though I was only giving back the excesses of my inflated fraudulent numbers. I effectively played poker with a marked deck, giving back the cards I did not need. Therefore, I was able to convince that audit partner to sit on a board of directors meeting the next day on April 27, where the board approved Crazy Eddie’s numbers after questioning him and me.
On April 28, 1987, KPMG formally signed off on Crazy Eddie’s financial reports and issued a clean audit opinion, despite red flags in store inventory levels and uncompleted field work in verifying $70 million of accounts payable that was fraudulently reduced to $50 million by our issuance of $20 million in phony debit memos.
Taking advantage of the inexperience of our auditors
The audit staff member who was responsible for leg work on accounts payable had no prior experience in auditing accounts payable and only started working for KPMG six months earlier fresh out of college. He first learned about offsetting charge backs to vendors against amounts purportedly owed them or debit memos during the Crazy Eddie audit, much of it from me.
Since the audit was already officially completed, KPMG only examined the accounts payable or amounts owed by Crazy Eddie to three major vendors, out of thousands of possible vendors. Each of those three vendors reported significant discrepancies in amounts they claimed that Crazy Eddie owed them due to our issuance of phony charge backs to vendors or debit memos.
For example, Sony claimed that Crazy Eddie owed them about $5 million more than Crazy Eddie claimed it owed them because Sony never acknowledged receiving any such debit memos. The auditors never did any follow up contact with any of the companies, whose accounts payable balances they examined, concerning any discrepancies in amounts owed by Crazy Eddie.
On April 28, 1987, the inexperienced auditor finally started his test work on Sony (which contained about $5 million of the $20 million in phony debit memos), the very same day our auditors signed off on the audit according to his testimony in a sworn deposition.
The questions below were asked by Stephen Howard, Attorney from Milbank, Tweed, Hadley, & McCloy, who represented the Oppenheimer-Palmieri Fund, L.P., one of the major shareholders who in November 2007 took over Crazy Eddie in a hostile takeover:
Question: There’s a date at the bottom of the page which appears to be 4/28/87. Do you see that?
KPMG staffer: Yes, I do.
Question: Is that your handwriting.
KPMG staffer: Yes, it is.
Question: What does that signify?
KPMG staffer: It was my policy to date my workpapers when I began to perform test work.
Question: So that tells us you started this work on the 28th but it doesn’t tell us when you finished it?In his other sworn testimony, young inexperienced auditor said that he continued his field work for more than one day, but couldn’t recall how many days it took for him to complete his work. In any case, KPMG already had signed off on Crazy Eddie’s audit. KPMG had no incentive to do any additional significant field work that may cause them to change their audit opinion.
KPMG staffer: That is correct.
Key audit procedures missed
|Crazy Eddie Antar mug shot after arrest|
However, for fiscal year 1987, we did not generate accounts payable aging analysis. Therefore, our auditors were unable to determine the how long the phony debit memos were on Crazy Eddie's book and records and why, after the passage of time, they were not used as an offset against payments to vendors.
In addition, the sheer volume of phony debit memos caused our books and records to show many vendors owing Crazy Eddie money, rather than the other way around! Those negative accounts payable balances were red flags that were never properly scrutinized by our auditors.
An excerpt from KPMG’s work papers said:
... traced all debit memos into A/P status report as of 03/01/87. No further work necessary.An “A/P status report” simply lists all invoices owed to vendors and offsetting debit memos. Therefore, the debit memos were traced to a report listing the phony debit memo, in other words known as “garbage in, garbage out.” Our auditors simply traced the phony debit memos to the books and records that reflected them, but did no work to confirm the validity of those debit memos.
Weeks later, a senior staff member finally did conduct an interview of Crazy Eddie's Accounts Payable Manager (a female co-conspirator) and his work paper is dated May 22, 1987 or 24 days after KPMG issued its clean audit opinion of Crazy Eddie’s books and records.
KPMG may have dodged the bullet by not having to change any of its audit reports as a result of its recent failure in “signing off on audits before all necessary work had been completed.” If history is any guide, KPMG demonstratively failed to learn the lesson of their misdeeds during the Crazy Eddie audit. I wonder if they are at least better in covering up their mistakes this time around.
Sam E. Antar
I am a convicted felon and a former CPA. As the criminal CFO of Crazy Eddie, I helped my cousin Eddie Antar and other members of our family mastermind one of the largest securities frauds uncovered during the 1980's. I committed my crimes in cold-blood for fun and profit, and simply because I could.
If it weren't for the valiant efforts of the FBI, SEC, Postal Inspector's Office, US Attorney's Office, and class action plaintiff's lawyers who investigated, prosecuted, and sued me, I would still be the criminal CFO of Crazy Eddie today.
There is a saying, "It takes one to know one." Today, I work very closely with the FBI, IRS, SEC, Justice Department, and other federal and state law enforcement agencies in training them to identify and catch white-collar criminals. As an independent whistleblower, I often refer cases to them.
I do not seek or want forgiveness for my vicious crimes from my victims. I plan on frying in hell with other white-collar criminals for a very long time.
Hopefully, this blog post can get me into heaven, though I doubt I will ever get there.