Sleeping With the Auditor

The Governmental Accounting Standards Board's Hildreth says, "The spinoff could alleviate the appearance of nonindependence to the extent that they are legally separate." He says he is aware that KPMG LLP maintained an ownership stake in KPMG Consulting. "That's why I said 'legally separate,'" he explains. "And legal separation helps, but does not prevent all unethical behavior."

Sharon Russell, who is an executive with the state of Alabama's Department of Examiners of Public Accounts, as well as an adviser to the Governmental Accounting Standards Board, was blunt: "If to most people it looks like they are not divested, then they are not a separate spinoff."

KPMG, however, believes the two companies are independent. "There are no conflicts of interest," a spokesperson for KPMG Consulting says.

This corporate name game is relevant to San Franciscans because it raises these questions: Would the city's auditor blow the whistle on, or make recommendations that would negatively affect, its spinoff's consulting business? Would it make recommendations based on benefiting its own business partners?

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Nowhere is the line between auditing and consulting blurrier than in KPMG's managing of the city's accounting software, called FAMIS.

For many years, KPMG has used its auditing relationship with the San Francisco Controller's Office as leverage to obtain consulting and software sales contracts. "KPMG's knowledge of the city's internal structure and operations is virtually unmatched," the firm wrote to Harrington in a job proposal, "as well as our longstanding financial statement audit relationship."

After winning an open competition in 1994, KPMG LLP signed a software consulting contract that was "not to exceed" $455,000. That contract, which KPMG LLP "assigned" to KPMG Consulting when the companies were split last year, has grown to nearly $12 million. Most of the money has gone to buying and maintaining KPMG's proprietary FAMIS software.

KPMG's selling of the software to the city it audits was by itself a violation of basic accounting tenets, say several experts. The rules of the American Institute of Certified Public Accountants, which KPMG promises to abide by in its city contracts, say, in no uncertain terms: "If the audit organization has been responsible for designing, developing, and/or installing the entity's accounting system, or is operating the system and then performed a financial statement audit of the entity, the audit organization would clearly be in violation of the two overarching principles of the independence standard."

Van Daniker, of the National Association of State Auditors, Controllers, and Treasurers, states point-blank that audit firms should not sell software to their clients. "Whether it is an independent action in fact or not -- it looks bad," he asserts.

Gregory Newington, the chief of enforcement for the California Board of Accountancy, which licenses certified public accountants, says it is more than a conflict of independence: It could be against the law.

"There is a law in California that expressly forbids audit firms from recommending products, such as Hewlett-Packard or Oracle, to their audit clients when they receive financial remuneration from the sale."

Ethics aside, KPMG's outdated software is apparently also riddled with problems. For many years, KPMG auditors and consultants have been finding terrible flaws in FAMIS and then recommending that the controller buy "upgrades" from KPMG. For instance, FAMIS has trouble "effectively" accounting in the general ledger for capital expenses, especially federal grants, according to KPMG's reports to the controller. Last year, the auditor found that, for some departments, "The existing general ledger payment data are based on contracted amounts and may not match actual expenditures," which means, rather shockingly, that the city may not be accurately accounting for projects that go over budget -- as many contracts do, including KPMG's. Harrington's response has been to pump more money into FAMIS, instead of looking for a superior system.

In April 2000, a KPMG LLP partner, Marc S. Diamond, drafted a report asserting that the city's financial information often had to be transferred from one database to another by hand. He questioned whether FAMIS "is capable of capturing financial data that is of a sufficiently high degree of resolution to support an effective capital management reporting capability."

Diamond revealed that, throughout the city, finance officers had set up "shadow systems," essentially second sets of books, in an attempt to keep track of transactions that FAMIS missed. The shadow systems, Diamond wrote, "can result in degradation of the integrity of the financial and management reporting process ... as transaction data travels in a circuitous route throughout the various systems employed by ... the city." Diamond asked for $480,000 to keep working on the problem.

Diamond's report seemed to infuriate a manager in the Controller's Office, Harold Guetersloh, who, in an amazingly frank e-mail to KPMG LLP, asked for "evidence that FAMIS can't be trusted or assure me that you will remove that statement from your report. It is possible that whoever you talked to had productive [work] to do so they decided to set up a competing set of books." Guetersloh, who recently retired, blamed humans for FAMIS's shortcomings.