Big 4 Audit Firms Play Big Role in Offshore Murk – ICIJ

Global accounting giants are prime architects of the offshore money maze – and supporting characters in an array of offshore scandals

For more than a decade, tax gurus at PricewaterhouseCoopers helped Caterpillar Inc., the U.S. heavy equipment maker, move profits produced by its lucrative spare-parts business from the U.S. to a tiny subsidiary in Switzerland.

Little changed except the bookkeeping. Parts were still shipped from suppliers to a warehouse in Morton, Illinois, and then shipped from the warehouse to independent dealers. But the profits were booked by the Swiss subsidiary, which paid corporate taxes of less than 6 percent a year, far lower than Caterpillar’s 29 percent rate in the U.S.

By 2008, partners at the “Big 4” accounting firm worried the strategy might be threatened by Caterpillar’s decision to move some managers from Switzerland to the U.S., a shift that would underline the parts business’s small footprint in the mountain-peaked tax haven.

Thomas F. Quinn, a PricewaterhouseCoopers partner who helped design the tax-savings plan, wrote a PwC colleague that if they wanted to keep the strategy alive, they needed to “create a story” that “put some distance” between the managers and the spare-parts business.

“Get ready to do some dancing,” Quinn said.

The colleague, managing director Steven Williams, replied: “What the heck. We’ll all be retired when this … comes up on audit. … Baby boomers have their fun, and leave it to the kids to pay for it.”


In a congressional hearing this spring, U.S. Sen. Carl Levin blasted the email exchange and the profit-shifting strategy as exercises in the art of creating “unreality.” An investigation led by Levin revealed that the accounting firm exploited legal loopholes to help Caterpillar shuffle $8 billion in paper profits from America to Switzerland, reducing the equipment maker’s U.S. tax bill by $2.4 billion.   

The flare up over the Swiss strategy that PwC orchestrated for Caterpillar is among the latest in a series of investigations and legal clashes that shine light on the murky role that the world’s four largest audit firms — PwC, KPMG, Ernst & Young and Deloitte — play in the offshore financial system.

A review of court cases, government records and secret offshore files unearthed by the International Consortium of Investigative Journalists reveals that the Big 4 firms are central architects of the offshore system — and key players in an array of cross-border transactions that raise legal and ethical questions.

In Luxembourg, internal company documents reviewed by ICIJ show, PwC helped Pepsi, IKEA and other corporate giants from around the world embrace inventive profit-shifting strategies that allowed them to collectively slash their tax bills by billions of dollars.  

In the U.S., authorities charged, KPMG peddled offshore tax shelters that created billions of dollars in fake losses for rich clients, then misled the Internal Revenue Service about how the shelters worked.

In Dubai, anti-corruption advocates claim, Ernst & Young helped the Middle East’s largest gold refiner obscure practices that may violate international standards aimed at combatting trafficking in “conflict gold,” which comes from regions where competition for the mineral breeds bloodshed.

In New York, authorities charged, Deloitte helped a British bank violate sanctions against Iran, submitting a “watered-down” report to regulators that omitted information about how the bank might be evading money-laundering controls.

“These firms are supposed to be built on honor and integrity and being a watchdog, but they’re so big now it’s all about making money,” says Francine McKenna, an accountant who has worked for PwC and KMPG and now writes a blog, re: The Auditors, about big accounting firms’ misbehavior. “They’re not worried about reputation, because all of this stuff has not affected their ability to get bigger and bigger and bigger.”

Big 4 firms deny their practices are skewed by bottom-line considerations. Ernst & Young told ICIJ that it “operates strictly within the law and has exhaustive controls” that ensure it follows legal and regulatory rules. KPMG and PwC said they had strict codes of conduct for everyone working under their banners worldwide. Deloitte didn’t answer questions for this story, but has laid out its views in various public statements.

In cases when they’ve run into trouble, the Big 4 have generally blamed rogue employees or said that their actions have been misunderstood or taken out of context. During April’s Senate hearing on PwC’s work for Caterpillar, for example, Quinn said he’d made “a very poor choice of words” in his email exchange with Williams, and Williams said he’d made an inappropriate “attempt at humor.” A top PwC executive told Levin that the Swiss strategy designed by the firm was simply intended “to eliminate the unnecessary middleman.”

“We do not invent artificial business structures,” the executive testified.

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Too Big to Fail

In June 2005, top KPMG executives and their lawyers met with a gaggle of prosecutors to discuss the Justice Department’s criminal probe into the firm’s tax shelter business. The government claimed KPMG had lied to the IRS about how its shelters were put together and that OPIS and other KPMG shelters were shams that used shell companies and bogus loans to generate at least $11 billion in paper losses that cost the U.S. Treasury $2.5 billion.

As the meeting began, a top prosecutor noted that the government hadn’t ruled out filing criminal charges against the firm. But the discussion quickly turned to mutual agreement, according to a memo written by one of KPMG’s lawyers. Neither the government nor KPMG wanted to see a criminal prosecution that might put the accounting firm out of business. What had happened to Arthur Andersen three years before was on everyone’s minds.

Robert Bennett, the powerful Washington lawyer who’d represented President Clinton during the Monica Lewinsky scandal, did most of the talking for KMPG. He said the firm understood it would have to pay “a lot” and suffer “a lot of pain.” It could probably survive a tax fraud charge, but an obstruction charge “would kill us,” Bennett said.

In the end, the government charged the company with a single count of tax fraud, then quickly dismissed the charge under a “deferred prosecution” agreement that allowed KPMG to put the criminal case behind it by paying $456 million in penalties.

The case made it clear, anticorruption activists say, that a “Too Big To Fail” philosophy discourages authorities from getting too tough with big audit firms.

Similar questions arose in the Netherlands after KPMG partners were accused of helping a Dutch construction firm hide bribes used to help the builder win billions of dollars in contracts in Saudi Arabia. In December 2013, KPMG agreed to pay a settlement of almost $10 million to head off criminal charges against the audit firm.

Officials with KPMG’s member firm in the Netherlands placed the blame on three partners who now face criminal prosecution, saying they were “shocked by the facts that have emerged from this case.”

Some lawmakers complained the case should have been taken into court so the public could learn the full story of the accounting firm’s conduct.

“There is no word about the guilt of KPMG in this affair,” Jan de Wit, a member of the Netherlands’ Parliament, said. “It seems to be a cover up.”

The Netherlands’ justice ministry defended the deal, saying that the bribes and cover up had taken place many years ago, and that the KPMG had cooperated with prosecutors and taken steps to prevent similar problems. As a result of the case, KPMG officials say, they’ve put in new procedures that “focus on quality and integrity as absolute priorities.”

Ernst and Young's New York office


In recent years the Big 4 have expanded their reach and revenues beyond corporate audits and tax shelters by marketing themselves as jack-of-all-trades watchdogs that can help companies discourage bribery and other misconduct.

Through their consulting businesses, they act as anti-money-laundering experts, internal investigators and stand in for government as monitors in regulatory actions.

Early this year, an Ernest & Young partner quit his job and went public with claims the firm had helped a gold refiner in Dubai downplay the buying and selling of “conflict gold.”

According to a report by the anti-corruption group Global Witness, records provided by the ex-partner indicated the firm had toned down an audit report submitted to Dubai regulators, cutting explicit findings that the refiner failed to report billions of dollars in suspect transactions.

Ernst & Young’s member firm in Dubai said it had acted properly, telling ICIJ that it “refutes entirely the suggestion that we did anything but highly professional work” in the matter. All examples of rule violations by its client were reported to regulators, and there was no evidence that conflict gold moved through the client’s refinery, the firm said.

Two other Big 4 firms have also been accused of softening reports to regulators, as a result of the work with banks doing business in New York.

New York state regulators concluded that Deloitte helped U.K.-headquartered Standard Chartered cover its tracks by yielding to pressure from bank officials to keep quiet about suspect money transfers. A Deloitte partner explained in an email to a colleague that the transactions were “too politically sensitive” to include in a report to regulators. “That is why I drafted the watered-down version,” he said.

Deloitte denied wrongdoing. It called the reference to a watered-down report “an unfortunate choice of words that was pulled out of context.”

American authorities eventually concluded Standard Chartered had hidden thousands of transactions totaling more than $250 billion by banks controlled by the government of Iran, which is under U.S. and international sanctions related to its nuclear program and support for terrorist groups.

In 2013, New York’s banking superintendent, Benjamin Lawsky, punished Deloitte for its role in the Standard Chartered affair by fining the firm $10 million and suspending it for one year from doing consulting work for banks overseen by New York regulators.

Benjamin Lawsky

In August of this year, in a case involving questionable transfers of cash through the Bank of Tokyo-Mitsubishi UFJ, Lawsky hit PwC with a $25 million penalty and a two-year suspension from taking consulting engagements with banks regulated by his agency. He said PwC had given in to pressure from the bank to “whitewash” a report to regulators.  

For example, Lawsky said, PwC deleted a section revealing the bank had used hashtags and other “special characters” to prevent automatic filters from flagging wire transfers involving sanctioned nations.

SUDAN, for instance, became SUD#AN.

In a statement, PwC said its report “disclosed the relevant facts” and that the firm was “proud of its long history of contributing to the safety and soundness of the financial system.”

Paper Dragons

Questions about how far Big 4 firms will go to help their clients avoid government oversight have also come up as they have pushed into a new market: China.

China is emerging as an important mover in the offshore world, with most offshore professionals predicting it will become the greatest source of new business over the next five years, according a recent industry survey.

Over the past decade, the Big 4 have gained a foothold in China by auditing Chinese firms that hope to sell shares in America. In order to roll out a U.S. public offering, Chinese businesses need the approval of the U.S. Securities and Exchange Commission. The Big 4 provided the gloss of respectability that Chinese executives needed to win over American regulators and investors.

In many cases, the seal of approval from big accounting firms didn’t mean the companies were safe bets for investors. In 2012, the Pittsburgh Tribune-Review found that dozens of Chinese companies peddling their shares in U.S. have been accused of fraud by investors or the SEC.

As the SEC began investigating suspect Chinese firms, the Big 4’s member firms in China refused to turn over documents to the agency. The firms argue that if they provide documents to U.S. law enforcers, they’ll run afoul of Chinese corporate secrecy laws.

It should be up to the U.S. and Chinese governments to resolve the standoff, the firms say. “We’re just piggy in the middle,” the partner in charge of compliance for PwC in Greater China, told Reuters.

In January, U.S. Administrative Law Judge Cameron Elliott sided with the government, suspending the Big 4’s Chinese units for six months from auditing U.S.-regulated companies.

“If the big accounting firms “found themselves between a rock and a hard place,” the judge said in his ruling, it was “because they wanted to be there. A good faith effort to obey the law means good faith effort to obey all law, not just the law one wishes to follow.”