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SEC Takes a Bold Stance Against Auditors

Posted in Banks and Financial Services

Yesterday the SEC took a relatively unique stance against two auditors at KPMG.  Yes, that’s right, the auditors; not the bank itself or the bankers that led their Nebraska-based bank into bankruptcy.  While the SEC cannot file charges or impose fines upon auditors, by instituting administrative proceedings for engaging in improper professional conduct the SEC can ban an individual from practicing before the SEC – and since every single public company is regulated by the SEC that is essentially a career-ending ban.

So what exactly did these two auditors do to find themselves accused of unprofessional conduct by the SEC?  Some pretty bad stuff.  According to Robert Khuzami, Director of the SEC’s Division of Enforcement:

“Aesoph and Bennett merely rubber-stamped TierOne’s collateral value estimates and ignored the red flags surrounding the bank’s troubled real estate loans,” … “Auditors must adhere to professional auditing standards and exercise due diligence rather than merely relying on the management’s representations.”

These guys did more than simply turn their heads at the wrong moment; all signs indicate that these two had to actively commit themselves to “ignoring” major signs that something was seriously wrong at this bank.  The New York Times points to a multitude of evidence that was staring these two auditors in the face: evidence that they had been misled about the value of certain real estate development loans, new appraisals that showed losses had been underestimated, and warnings from the bank’s regulator, the Office of Thrift Supervision, that there were serious problems.  Instead, these two relied on the bank’s management’s word that old appraisals were accurate reflections of current values.

Auditors are essentially professional whistleblowers.  These two individuals were paid to examine books, records and documents for signs of wrongdoing.  Why then would they ever have stayed silent in the face of so much evidence pointing towards serious trouble at the bank?  Peer pressure might be one reason.  Its difficult to be the one to raise your hand and say, “hey, this isn’t right”, when everyone else is looking the other way.  Another reason might be financial.  KPMG paid the salaries of these auditors, and don’t think for a second that these two auditors didn’t know that the bank they were auditing was the one paying KPMG.

The interesting thing is that these auditors were not actively promoting fraud; it was their lack of action that allowed a huge fraud to occur – one of many that helped destabilize our financial system and led to the largest recession in nearly a century.  By filing these charges the SEC is taking a very important stance against passive wrongdoing.  It sends a clear message to people who might have stayed silent in the past or been afraid of speaking up when they saw something wrong.  And in some ways, it promotes whistleblowing – an important tool that can help keep entire industries honest.

Overall, the charges against these two auditors are a welcome message to the entire banking and finance community.  The SEC is saying that the culture of risk taking and willingness to ignore regulatory requirements is not acceptable: whether you are actively taking that path or merely a bystander.  Its too early to tell whether the SEC’s action will have an effect but it is definitely a step in the right direction.