Securities Regulation Daily KPMG settles with SEC over oil-and-gas audit failures
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Tuesday, August 15, 2017

KPMG settles with SEC over oil-and-gas audit failures

By Anne Sherry, J.D.

KPMG agreed to pay $6.2 million for failing to audit the financial statements of Miller Energy Resources. In fiscal 2010, Miller acquired oil and gas interests for approximately $4.5 million and then valued them at $480 million in its financial statements. When KPMG was hired as auditor for fiscal 2011, it failed to sufficiently analyze the impact of Miller’s opening account balances. In addition to censuringKPMG and imposing $6.2 million in penalties and disgorgement, the SEC’s order bars the engagement partner, with a right to reapply in two years (In the Matter of KPMG LLPRelease No. 34-81396, August 15, 2017).

Acquisition and valuation. According to the order instituting proceedings, Miller was a thinly traded penny stock company when it learned in 2009 that the oil and gas interests were about to be legally abandoned in a California company’s bankruptcy proceedings. The former owner had extensively, but unsuccessfully, marketed the interests. They were then offered at auction within the bankruptcy proceedings, and two bidders agreed to pay $8.1 million and $7 million, respectively—but neither closed. The bankruptcy court rescinded its abandonment order to hold another auction, at which Miller prevailed over the world’s then-largest land drilling contractor. Miller paid $2.25 million in cash and assumed certain liabilities.

In its Q3 2010 Form 10-Q, Miller disclosed that it had valued the assets at $480 million: $368 million for oil and gas properties and $110 million for fixed assets. To arrive at the $368 million figure, Miller relied on a reserve report that was not prepared for fair value purposes, and indeed expressly disclaimed its estimates for purposes of fair value. Specifically, the report failed to incorporate assumptions necessary to a fair value analysis, such as an appropriate discount rate and risk adjustments. The report also contained understated and unsubstantiated forecasted cost information provided by Miller. Miller also double-counted the acquired fixed assets by recording them separately, when they were already included in the reserve report value.

KPMG engagement. In early 2011, Miller replaced its independent audit firm with KPMG. KPMG lacked adequate policies and procedures for client acceptance and inadequately assessed the risks of the Miller engagement. The firm’s initial evaluation failed to adequately consider Miller’s bargain purchase, its history as a penny-stock company, the lack of experience within its executive and accounting staff, weaknesses in its internal control over financial reporting, its long history of reported financial losses, and its need to obtain financing to operate the oil-and-gas interests. In fact, the engagement posed a high degree of risk, and it was improper of KPMG to assign an engagement partner who had no experience auditing companies in the oil-and-gas industry.

The audit departed from PCAOB auditing standards in several ways, and many of these departures occurred because the engagement partner lacked industry-specific knowledge. Even though they knew that no proper fair value assessment had been performed by management in the prior year, KPMG and the engagement partner failed to obtain sufficient competent evidence to assess the impact of the opening balance of the oil-and-gas interests on Miller’s current year financial statements. Their audit procedures relating to the opening balances failed to appropriately consider the multiple offers received for the oil-and-gas interests and the abandonment of those assets by the prior owner.

KPMG’s national office became familiar with Miller and the nature of its purchase of the oil-and-gas interests via overlapping consultations, comment letters and a formal investigation by CorpFin, and a negative online article. Had the firm’s Department of Professional Practice inquired further into Miller’s fair value assessment and KPMG’s procedures for that valuation, it could have discovered information that would cast doubt on the prior financial statements.

SEC enforcement proceedings. The SEC’s investigation into Miller eventually resulted in a $5 million settlement with the company. The KPMG settlement censures the firm, imposes a $1 million penalty and about $5.2 million in disgorgement and interest, and requires significant undertakings designed to improve quality control. The engagement partner also agreed to pay a $25,000 penalty and be suspended from practicing before the SEC as an accountant, with the right to apply for reinstatement after two years.

The release is No. 34-81396.

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