An administrative law judge of the Securities and Exchange Commission has recommended barring two KPMG auditors from appearing before the SEC based on their conduct during a 2008 year-end audit for a regional bank that ultimately failed in the wake of the financial crisis.

The SEC says KPMG engagement partner John Aesoph and senior manager Darren Bennett failed to exercise proper professional conduct in scrutinizing allowances for loan losses, one of the highest risk areas in the audit, for TierOne based in Lincoln, Nebraska. While the SEC Division of Enforcement asked the administrative law judge to bar Aesoph for three years and Bennett for two, ALJ Carol Fox Foelak issued an initial decision to sanction Aesoph for one year and Bennett for six months.

“We are disappointed by this ruling,” said a KPMG spokesman, who confirmed both Aesoph and Bennett are still employed with the firm. KPMG had no further comment on the proceedings. Aesoph and Bennett can appeal the ALJ decision.

The ALJ decision says TierOne acquired nine loan-production offices from 2002 through 2005 to originate construction and land development loans, but closed them by September 2008 as real estate values collapsed. KPMG conducted the 2008 year-end audit after the Office of Thrift Supervision downgraded the banks' rating and criticized its management and loan practices. The SEC says OTS found “the bank had collateral-dependent loans either without appraisals or with unsupported or stale appraisals.”

KPMG's opinion on TierOne was clean, both for the financial statements and the internal controls over financial reporting, after which the bank obtained updated appraisals and recorded $120 million in loan losses. The SEC says KPMG obtained evidence in April 2010 that the company failed to disclose an internal analysis in the first quarter of 2009 that showed varying estimates of additional loan losses higher than those disclosed to KPMG at the time of the audit. KPMG withdrew its opinion and resigned the audit, and OTS closed the bank. The SEC pursued charges against both TierOne executives and KPMG auditors alleging fraud and deceit with respect to loan-related losses.

The SEC says KPMG's missed or ignored “numerous red flags” indicating management was inept and had an incentive to understate losses. KPMG's audit team considered the heightened risk and planned its audit accordingly, but failed to adequately question management's rosy assessment of market conditions and relied too easily on stale appraisals, the decision says. Aesoph and Bennett said fair value measurement rules preclude relying on distressed sales, which were increasing in frequency at that time, as determinative of fair value. The SEC says the audit work papers don't show enough about how auditors looked at recent appraisals. “There is no evidence that TierOne adjusted, or that the auditors recommended adjusting, an appraisal because of concerns the appraisal did not reflect fair value,” the decision says. “Instead, TierOne continued to use appraisals to estimate fair value in 2008 through early 2009.”

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