KPMG Under Pressure After Clean Audits of SVB, Signature Bank
March 14, 2023
Silicon Valley Bank and Signature Bank collapsed days apart within two weeks of their auditor KPMG LLP signing off on their books.
The Big Four audit firm’s responsibility included assessing the odds of whether the banks could survive the next 12 months. Regulators shuttered Silicon Valley and placed it into Federal Deposit Insurance Co. receivership two weeks after KPMG signed off on the bank’s financials. Signature Bank made it 11 days.
Auditors aren’t fortune tellers, but they are responsible for making sure corporate financials give a fair and up-to-date portrayal of the company’s financial health. With two clients collapsing within days of each other—Silicon Valley fell Friday, and regulators raced to shut down Signature Bank on Sunday night—KPMG’s work will come under scrutiny.
“It’s not a good look,” said Harold Schroeder, a former Financial Accounting Standards Board member and bank analyst who teaches accounting at Rutgers University.
Auditors must consider whether there is substantial doubt about a company’s ability to continue as a going concern, an assessment of the company’s viability over the next year. “Substantial doubt,” however, is a high bar, and auditors raise these red flags sparingly; headlines from a going concern warning can pile on to a struggling company’s woes as it tries to right itself.
KPMG raised no such problems with either bank. Going concern evaluations continue up until the auditor’s report date and would consider important negative shifts in the company’s business outlook, including struggles meeting capital requirements or selling off significant assets.
Under US audit standards, the auditor isn’t expected to foresee events, said Kecia Williams Smith, assistant accounting professor at North Carolina A&T State University.
“They can’t predict the future,” Williams Smith said, but they have to consider risks inherent to the company, and for a bank that might include a run by its customers, even if a rare occurrence. “The nature of the issuer, the nature of the industry. Those are things that auditors still have to be responsible for.”
Auditors must separately consider whether market moving events such as a merger or layoffs at significant deposit holders could alter the company’s financial picture, triggering disclosures or even adjustments.
KPMG declined to comment on specific clients and wouldn’t comment on whether it should have scrutinized threats that could undermine the banks’ ability to continue operating. The firm said its audit opinions are based on evidence available up to the date of its opinion.
Those audit reports were dated Feb. 24 for Silicon Valley and March 1 for Signature Bank.
“Any unanticipated events or actions taken by management after the date of an opinion could not be contemplated as part of the audit,” the firm said in a statement.
‘A Lot of Smoke’
But the close proximity between the clean audit reports and the crashes indicates important information was either missing or ignored, said Laura Posner, who represents institutional investors in securities fraud class actions and has sued Big Four audit firms previously.
Auditors should have considered whether liquidity challenges and threats from still-rising interest rates posed substantial risks to the company going forward, said Posner, a partner with Cohen Milstein Sellers & Toll PLLC.
“I certainly would argue that there are a lot of red flags, a lot of smoke,” she said. “The timing is really problematic.”
Companies themselves also must assess their ability to continue as a going concern. Under a FASB rule that went into effect in 2017, companies must evaluate every quarter any substantial risks about their ability to stay afloat and disclose their plans to mitigate the risks. The company-driven disclosure requirements were designed to provide an earlier warning than the yearly auditor check. Neither Silicon Valley nor Signature flagged these risks.
Indeed, the initial litigation surfacing Monday targeted management, not the auditors. A securities class action suit said the bank filed multiple quarterly reports over the last two years that failed to disclose the risk that interest rate hikes posed to the bank, according to the complaint filed in federal court in San Jose, California.
KPMG could face increased pressure if more banks teeter. KPMG also audits regional bank First Republic Bank, whose shares plummeted 60% Monday.
Outsized Exposures
The Public Company Accounting Oversight Board, which sets US audit rules, plans to reconsider its going concern requirements, opening the door to revisions that investor advocates have long sought.
SVB Financial Corp., the holding company for Silicon Valley Bank, had an outsized exposure to tech startups and their founders. When prominent venture capitalists told customers to pull their deposits, the bank faced a run, and regulators had to intervene. Signature Bank faced a similar run on its deposits, but the company also had risks related to working with crypto customers.
Jim Peterson, former in-house attorney for collapsed accounting firm Arthur Andersen, said he saw little evidence yet that auditor missteps were to blame.
“This reads so much like just a business strategy gone wrong,” he said, describing bank managers’ “over commitment to a particular niche strategy that was pursued with too much enthusiasm too long.”
The two bank failures followed the collapse of Silvergate Financial Corp., which catered largely to cryptocurrency companies, including failed exchange FTX.
Unlike its troubled successors, Silvergate never filed its 10-K. On March 1, it warned the market that it wouldn’t make the deadline to release its annual report. Its audit firm, Crowe LLP, needed more time to review adjustments not yet recorded and to evaluate the effectiveness of the bank’s internal control over financial reporting as well as information about investigations into the bank. The bank also warned that it had substantial doubt about its ability to continue as a going concern. Silvergate voluntarily wound down its operations one week later.
[Bloomberg Tax]
