The SEC agreed with the initial decision of an administrative law judge (ALJ) that two KPMG accountants engaged in improper professional conduct in the audit of the financial statements of TierOne Bank. The ALJ had imposed suspensions of one year and six months, respectively; however, a divided Commission ordered that the respondents be suspended with the right to apply for reinstatement after three and two years, respectively. Commissioner Piwowar agreed with the finding of improper professional conduct, but dissented from the imposition of permanent bars, finding it to be too punitive (In the Matter of John J. Aesoph, Release No. 34-78490, August 5, 2016).
TierOne. In August 2012, the SEC charged TierOne executives with understating by millions of dollars its loan-related losses as well as losses on real estate repossessed by the bank. In January 2013, the SEC instituted administrative proceedings against the engagement partner and the senior manager (the respondents) on KPMG’s audit of TierOne’s 2008 financial statements, alleging that they engaged in improper professional conduct by failing to appropriately scrutinize management’s estimates of TierOne’s allowance for loan and lease losses (ALLL). The ALJ agreed that their actions constituted improper professional conduct and imposed suspensions of one year and six months, respectively. Both the Enforcement Division and the respondents sought review by the full Commission, with the Division seeking lengthier suspensions and the respondents challenging the finding of improper professional conduct. The Commission heard oral arguments on July 12, 2016.
Professional standards and professional conduct. The Commission agreed with the Division that the respondents had violated PCAOB auditing standards. The Commission’s opinion noted that the respondents had identified the risk of collateral overvaluation as a high risk of material misstatement and fraud; however, they failed to identify effective internal controls addressing that risk, which would have helped prevent or detect the fraud.
The respondents also failed to exercise due professional care or obtain sufficient competent evidential matter in their evaluation of management’s collateral value estimates of the ALLL, according to the Commission. They failed to take into consideration that the market had plummeted and that TierOne’s policies were inconsistent with KPMG’s documented approach. The opinion advised that the respondents "simply accepted, without question, management’s estimates for loan collateral values" and that "they ignored evidence that those estimates were inconsistent with current market information."
In addition, the opinion noted that after KPMG issued its 2008 audit opinion, the respondents discovered two appraisals that reflected $3.6 million in additional probable losses, but they failed to perform audit procedures under AU Section 561, which requires auditors to perform some inquiry if new information is available that may affect the audit report.
According to the Commission, the respondents’ violations of the PCAOB auditing standards constitute improper professional conduct worthy of sanctions under Rule 102(e), which permits the Commission to deny accountants the privilege of appearing or practicing before the Commission. Describing the respondents’ conduct as "egregious, highly unreasonable, and conclusively demostrat[ing] that they lack competence" to practice before the Commission, including noting that the respondents have not acknowledged the wrongful nature of their conduct, the Commission imposed the three- and two- year suspensions, with the right to apply for reinstatement at the end of their suspensions.
Constitutional and fairness arguments. The respondents made several arguments regarding the lack of due process, including the procedural limitations on discovery that would not be imposed in federal court. The Commission rejected these arguments, stating that the respondents had not established a violation of due process or any prejudice to their defense.
The Commission also rejected the respondents’ argument that the ALJ who issued the initial decision is an inferior officer and was not appointed in a matter consistent with the Appointments Clause. The respondents relied on Freytag v. Commissioner, which concluded that a "special trial judge" of the Tax Court was an inferior officer. The Commission pointed out, however, that the D.C. Circuit held in Landry v. FDIC that FDIC ALJs are employees, not inferior officers, and that the SEC’s ALJs, who do not issue "final decisions," are comparable to those at the FDIC.
Piwowar dissent. Commissioner Piwowar concurred in the Commission’s opinion that the respondents engaged in improper professional conduct. He disagreed with the sanction of a permanent bar from practicing before the Commission with the right to apply for reinstatement, however. He noted that at oral argument, he inquired of Division counsel whether it was seeking three- and two-year suspensions, or permanent bars. Counsel responded the former, Piwowar pointed out, and he saw no compelling reason for going beyond the Division’s request. The process of applying for reinstatement can take years and the sanction imposed on the respondents is unduly punitive because it results in the destruction of their professional careers, Piwowar explained.
The release is No. 34-78490.
Attorneys: George B. Curtis (Gibson, Dunn & Crutcher LLP) for John J. Aesoph, CPA. Gary F. Bendinger (Sidley Austin LLP) for Darren M. Bennett, CPA. Nicholas Heinke for the Division of Enforcement.
Companies: KPMG, LLP; TierOne Bank
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