Is this KPMG's Arthur Andersen moment?

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Correction: This story is a corrected version of one that ran earlier. In the earlier post, the writer incorrectly stated that KPMG's UK firm parted company with its former chairman and alleged that the firm issued a statement which accused him of wrongdoing. That was false. The statement referred to in the article related to a different case in the U.S. recently, which led KPMG to fire Scott London, formerly a US audit partner. We regret the error.

(MoneyWatch)  "Audit" used to be a byword for boring because that's what clients wanted from their auditors: quiet professionals who would, without too much difficulty, give them a clean bill of health. But after all the failed banks, derivatives and governments which were passed by their auditors has called into question just how meaningful the process really is.

Nowhere is this a bigger issue than at the U.K. offices of KPMG, the firm which audited the British bank HBOS. That bank was recently investigated by the U.K. government, which issued an excoriating report arguing that, even without the credit crunch, the bank would have failed. External pressures only made worse a fundamental management failure caused by excessive risk taking and bad governance. The report's title, "An Accident Waiting to Happen," says it all.

That would be bad enough for the auditors who signed off on the bank's health. But the head of risk at HBOS was a former KPMG partner, Paul Moore who, in 2004, warned the bank specifically that it was heading for trouble. Moore was doing his job -- but he was promptly fired by Andy Hornby, the CEO who didn't wish to hear bad news. Moore was replaced by an executive with no experience in risk oversight.

When Moore protested at his firing, his old firm KPMG was hired to investigate him. The firm supported their clients, the HBOS management, arguing that Moore was too difficult and that the bank had been right to fire him. The obvious conflict of interest didn't apparently bother anyone.

Meanwhile, the senior partner responsible for the so-called investigation into Moore -- John Griffith Jones -- also advised the Financial Services Authority, which was inquiring into the bank's collapse, not to look at the conduct of its auditors.

The fact that the firm and a senior partner were so intimately associated with one of the biggest banking failures in UK history suggests how dubious the much vaunted objectivity of auditing really is. That this has all blown up at the same time that insider trading allegations forced KPMG to resign two clients -- Herbalife and Skechers --  means that the firm is under intense scrutiny.

This case also raises the question of whether the audit practice can be structured in such a way that there is not a conflict of interest between telling the unvarnished truth and keeping the business. How do you impede the close identification between auditor and client? Where does an auditor's loyalty lie -- with the client, his own firm's commercial interests or with the wider body of stakeholders? These are  important questions. At heart is a multi-billion dollar business which many now argue doesn't deliver the level of assurance the public requires.

According to Paul Moore, in an off-guard moment at an event organized by KPMG in the Waldorf Astoria on October 2, 2008, Griffith-Jones let slip that accountants would never challenge client managements outside the specific remit of the audit for fear of committing "commercial suicide." Griffith-Jones subsequently attempted to deny the remark by saying that "pre crisis, it was not the generally understood role of the auditor to criticise his client's business model and that he might have got short shrift from management for so doing." But that, of course, is the problem in a nut shell: how can the public trust auditors who want to keep their clients happy?

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    Margaret Heffernan has been CEO of five businesses in the United States and United Kingdom. A speaker and writer, her most recent book Willful Blindness was shortlisted for the Financial Times Best Business Book 2011. Visit her on