Shareholder activism is on the rise and private-sector shareholders could start to help the public sector fight corruption, write Sean Gossel and Timothy London
Accounting and consulting firm, KPMG SA, is reeling after it was exposed to have played a part in the Gupta-inspired state-capture activity. The fallout has been remarkable. Some major firms have fired KPMG as their auditor and more JSE-listed companies are expected to follow suit.
KPMG offers tax, advisory and auditing services and is one of the Big Four auditors, along with Deloitte, EY, and PwC. Despite their integration into the economy, all four of these audit firms have experienced significant lapses of judgment.
The KPMG case provides a potential example of how shareholders can attack the soft underbelly of the private-sector state-capture enablers. Globally, the number of shareholder challenges has increased dramatically from 520 episodes in 2013 to 758 in 2016. About two thirds of these challenges were successful, double the rate of just a decade ago.
SA’s shareholder activism is following international trends. This is partly function of the fact that more than 50% of the market capitalisation of the JSE is owned by foreigners. Shareholder activists are using their powers as company owners to examine company financial reports, monitor executive remuneration, enforce good corporate governance, and push for increased sustainability and transparency.
KPMG has a client base of about 70 listed companies in SA. This means that pressure from shareholder activists is likely to pile up. Some companies have already cancelled their use of KPMG services and others have stated that they are reconsidering their relationship. But most of KPMG’s clients have remained silent. Others said they’re waiting for the outcome of reviews by the country’s regulator, the Independent Regulatory Board for Auditors, as well as KPMG International.
The directors of companies that have chosen not to take a stand fail to realise one critical thing. In a world of shareholder activism, they may soon face serious questions from their own shareholders about their inaction and ongoing association with KPMG.
A key driver of shareholder activism in SA has been the introduction of minorities’ rights in the new Companies Act. Minority shareholders with as little as 10% holdings can call an annual general meeting. This means it’s become easier for shareholders to take legal action against directors and officers, including having directors removed.
‘Was it really only a case of a few rotten apples among an ethical and professional workforce of thousands?’
The King III codes of corporate governance have also played a significant role. They emphasise ethical leadership, sustainability and good corporate citizenship. The codes have entrenched the idea that boards of directors must act in the best interests of the company and that their responsibilities extend to shareholders and other stakeholders.
Companies are expected to establish sound governance structures, create “an ethical culture” and ensure they’re “seen to be a responsible corporate citizen”. A key factor underpinning these governance principles is the creation of more transparency. By putting more information in the hands of shareholders and the public, these measures create greater potential to hold boards to account for behaviour that fails to meet minimum standards.
Alongside other names, such as consultants McKinsey, the IT giant SAP, heavy machinery manufacturer Liebherr, and Shanghai Zhenhua Heavy Industries, KPMG has been implicated in alleged large-scale corruption involving the Gupta family.
The firm stands accused of:
• Allegedly overlooking numerous conflicts of interest while auditing 36 Gupta-linked companies until dumping the Guptas in 2016 by withdrawing their auditing services. A local auditing firm, SizweNtsalubaGobodo, replaced KPMG but seems to have also felt the pressure and has withdrawn its services.
• Allegedly providing tax advice to ensure the public funds extracted from the South African fiscus were placed in Dubai to avoid tax payments. KPMG may have thus also become a possible enabler of illicit capital flows in the process.
• Compiling a report for South African Revenue Services about an alleged rogue spy unit within the tax authority. The report was used as part of a campaign against former finance minister Pravin Gordhan, and other senior government officials. By its own admission, KPMG appears to have ignored both sector-wide best practice as well as its own standards of due diligence.
On a wider scale, KPMG seems to have given little consideration to the risks and damage that its activities would do to SA’s institutional integrity and governance frameworks.
Pressure has been building. Eight senior executives of the South African office, including the CEO Trevor Hoole, have resigned. The firm has withdrawn all its findings‚ recommendations and conclusions contained in the notorious “rogue unit” report. It has also instituted an international review of all work done for the Gupta family.
It’s unlikely that these actions will be enough to forestall litigation and possible collapse of KPMG SA.
Shareholder activism in SA has historically mostly been between institutional investors or individual activists and investee companies. But this may well begin to change. Mounting frustration at the slow pace of investigations into allegations of state capture by state institutions, such as the Hawks and the National Prosecuting Authority, is forcing investors to become more active. Shareholders could start directing their attention to fighting corruption through the private sector.
But are South African shareholders prepared to step up to ensure good governance in the face of governance failures elsewhere in the system? There’s a great deal to lose if they don’t. In a world of shareholder activism, they may soon face serious questions from their own shareholders about their inaction and ongoing association with KPMG.
If shareholders don’t take a proactive role, SA is in far more danger than simply losing its top spot on the World Economic Forum’s Global Competitiveness Report for auditing and reporting standards.
Once trust is lost in both the public and private sectors’ ability to root out or prevent corruption, the country could see further capital flight, greater tax avoidance, and a more pervasive sense that the rule of law is negotiable.
As revelations of systemic failures in governance pile up, the economy may very well depend on shareholders taking up the burden of providing the necessary levels of accountability. KPMG may be teaching SA an important lesson. Shareholders can also be anti-corruption activists. Anyone who is connected to the South African economy, must dearly hope that shareholders are up to the task.
This article first appeared in The Conversation, and is used with permission