What we teach | The Lesson: “Actively monitor for any questionable transactions.” 

Reality Check: Kaloti Jewellery International, Wirecard, London Capital & Finance, PwC, and EY 

Guardians or Bystanders? When Auditors Fail to Spot Financial Red Flags

We’ve worked our way through technical competencies, resources, and independence. Now, the next key milestone on the TRIMROT checklist is here. It is money laundering. 

It is here, in principle, where auditing firms make much by way of detecting and following up such suspicious transactions. The bright-eyed newbies, still wet behind the ears are schooled in the niceties of anti-money laundering procedures. And this generally takes place during induction week.

They are then tested on their ability to identify what may be indicative of illegal activity.

Why such a rush?

Because left unchecked, financial crimes such as money laundering cost investors dear, besides taking overall confidence in the whole market on a nosedive. But here’s the catch: translate this lofty ideal to the concrete world, and sometimes, well, it simply doesn’t hold water.

Practical experience, however, provides quite a different tale.

Let’s unpack.

Auditors should be guardians of integrity-the last line of defense against financial misfeasance. Recent cases suggest that they often fall notably short of such a lofty expectation. Not least, the vulnerability seems to show in underperforming cases of spotting red flags about money laundering.

Then there was the infamous case of Wirecard-what was once hailed as the German tech darling became one of the largest financial scandals.

EY audited the company for more than a decade.

But it did not delve into key balance sheet items. It did not detect-or perhaps just overlooked-evidence of fake revenues and imaginary assets. Its accounts were, therefore, overstated by about US$2 billion.

That wasn’t just a rounding error!

It was a financial black hole. And this gap eventually consumed investor wealth during EY’s watch.

Consider the case of Dubai-based Kaloti Jewellery International, one of the world’s largest gold refiners. Quite a few alarms were raised by an EY compliance audit back in 2014. The company reportedly accepted undocumented shipments of gold, and huge amounts of money in cash were paid out-a classic case of money laundering.

It is said that management at EY would instead ‘tone down’ the findings in the Report of Compliance rather than follow this evidence. This had the effect of toning down every issue that would have woken up the interest of regulatory bodies. Other than being robust, all this was soft-pedaling to let Kaloti slip under the radar.

These are not isolated cases; they have been indicative of something more disturbing: auditors failing to address or minimizing obvious glaring red flags.

Guidelines regarding anti-money-laundering theory never marry up with practice on the ground.

Box-ticking for compliance is problematic in that it may not embed a culture of transparency and accountability, thus meaning the real mission will be lost, and that mission is to protect the public from financial crime.

If you think all of the above is just a couple of isolated high-profile cases, think again.

Consider London Capital & Finance in 2019.

Think of what became of it back then. At that time, PwC and EY signed accounts which concealed fraud. The collapse of LCF was not an unexpected event. It was an accident happening right before one’s eyes. The investors lost their money, and auditors just carried on, whatever, with deficient practices against the background of waving red flags around high-risk businesses.

When the fines finally came, it was too little, too late.

It was not the failure to address the problem, but it was the failure to identify and take up that risk which has remained so poignantly unaddressed.

Moving right along to our next incursion into TRIMROT, we will disclose another very important concept, ‘Risk’.