SEC Hits KPMG with $6.2 Million Fine for Audit Failures

By:
Chris Gaetano
Published Date:
Aug 15, 2017
SECURITIES-AND-EXCHANGE-COMMISSION-facebook

The Securities and Exchange Commission announced that it has leveled a $6.2 million fine against Big Four firm KPMG over failure to properly audit an oil and gas company, which gave investors a false impression as to its worth. The firm was hired as outside auditor for Miller Energy Resources in 2011. The company, according to the SEC, grossly overstated values for key oil and gas assets.

The complaint said that Miller Energy acquired oil and gas interests in Alaska that the company estimated were worth about $4.5 million. However, when reporting these assets in its 2010 financial statements, Miller Energy said they were worth $480 million. Under this valuation, the Alaskan interests represented 95 percent of the company's total assets. Miller Energy came to this figure by relying on a reserve report prepared by a third-party engineering firm that explicitly said that none of the estimates it contained were estimates of fair value. This was because it did not incorporate necessary assumptions like appropriate discount rates and risk adjustments for certain speculative reserve categories, and also used understated and unsubstantiated forecasted cost information. Despite this, Miller Energy decided to record the sum derived in the report ($368 million) as fair value without undertaking any additional analysis.

The SEC added that the company also double counted pretty much all of the value of the acquired fixed assets, like facilities and pipelines that were ancillary to the oil and gas reserves, further inflating the total asset value by an additional $110 million. To support this, the company relied on an insurance report that said it had estimates from a third-party insurance broker but, in fact, did not. So, instead, the SEC said Miller refashioned a pre-existing insurance report to make it look like the broker had independently calculated the $110 million value. 

Despite all this, KPMG auditors gave the company a clean bill of health. The SEC said that the firm's initial evaluation failed to adequately consider Miller Energy's bargain purchase, its recent history as a penny-stock company, its lack of experienced executives and qualified accounting staff, its existing material weaknesses in internal controls over financial reporting, its long history of reported financial losses and its pressing need to obtain financing to operate the newly acquired Alaska assets. In fact, While this might sound like a risky client to take on, KPMG in fact designated the company a low-risk client, with an overall risk grade of "medium," only changing to "high" after reevaluating the client after it issued its unqualified opinion on the 2011 financial statements. 

The SEC said this was because KPMG had not established adequate policies and procedures for client acceptance and continuation. This meant that the firm failed to account for the audit team's lack of experience in that industry, with the engagement partner and senior manager both having no experience with oil and gas companies. The firm was aware of this, but felt there was no concern regarding the skills and experience of the engagement team. 

“Auditing firms must fully comprehend the industries of their clients. KPMG retained a new client and failed to grasp how it valued oil and gas properties, resulting in investors being misinformed that properties purchased for less than $5 million were worth a half-billion dollars,” said Walter E. Jospin, Director of the SEC’s Atlanta Regional Office.

The SEC’s order finds that KPMG and Riordan, the engagement partner, engaged in improper professional conduct and caused Miller Energy’s violation of Section 13(a) of the Securities Exchange Act and Rules 13a-1 and 13a-13. Without admitting or denying the findings, KPMG agreed to be censured and pay $4,675,680 in disgorgement of all the audit fees received from Miller Energy plus $558,319 in interest and a $1 million penalty.  KPMG also agreed to significant undertakings designed to improve its system of quality control. Riordan agreed, without admitting or denying the findings, to pay a $25,000 penalty and be suspended from appearing or practicing before the SEC as an accountant, which includes not participating in the financial reporting or audits of public companies.  The SEC’s order permits Riordan to apply for reinstatement after two years. 

Miller Energy was charged with accounting fraud in 2015 and later settled the charges.

 

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