United States: SEC Settles Charges Against Accounting Firm For Conducting Improper Audit

The SEC settled charges against an accounting firm for failing to properly audit an oil company in 2011.

According to an Order Instituting Proceedings, KPMG was hired to audit Miller Energy Resources, Inc. ("Miller") for fiscal year 2011 following Miller's acquisition of oil and gas interests in Alaska ("Alaska assets"). Miller acquired the Alaska assets for $4.5 million and reported the value of the assets as $480 million, a valuation that the SEC characterized as "violat[ing] generally accepted accounting principles" and "overstat[ing] the fair value of the assets by hundreds of millions of dollars." Despite the significantly inflated valuation, KPMG issued an unqualified audit report of Miller's financial statements for fiscal year 2011.

The SEC alleged that KPMG and John Riordan, the engagement partner in charge of the 2011 audit, did not comply with professional standards for compiling evidence regarding the basis of Miller's valuation of the Alaska assets. The SEC contended that KPMG and Mr. Riordan did not appropriately evaluate the circumstances of purchase or the manner in which Miller assessed the Alaska assets. The SEC alleged that KPMG and Mr. Riordan overlooked various red flags raised by the valuation and did not sufficiently investigate indications that Miller double-counted the value of certain fixed assets. The SEC also charged KPMG and Riordan with failing to properly (i) assess the risks of taking on Miller as a client, (ii) staff the audit, and (iii) address the misconduct of the engagement team when circumstances surrounding the overvaluation were revealed.

To settle the charges, KPMG agreed to pay over $6 million in combined penalties, disgorgement, and interest. Mr. Riordan agreed to pay a $25,000 penalty, and is suspended from practicing as an accountant. Mr. Riordan can apply for reinstatement after a period of two years.

Commentary / Jodi Avergun

This case is a reminder of the obvious: a third party auditor or advisor is expected to have a full understanding of the industry in which he is working, particularly if he is making representations as to the soundness of a company's financials on which investors are going to rely.

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