Audit Firm Sanctioned for Deficient Quality Control Systems

Quality control policies and procedures are critical components of many systems. For auditors the American Institute of Certified Accountants established quality control standards for accounting and auditing practice. Generally, the system should be designed to provide reasonable assurance that the firm and its personnel comply with the applicable professional standards and legal and regulatory requirements. Reports issued by the firm are appropriate under the circumstances.

The Commission’s most recent auditing action centers on the failure of an audit firm to properly comply with the quality control requirements of the AICPA when auditing certain private funds over a period of years. In the Matter of RSM US LLP, Adm. Proc. File No. 3-19710 (Feb. 26, 2020).

Respondent is a Chicago based audit and advisory firm registered with the PCAOB. The firm provides audit, tax and consulting services. SBB Research Group, LLC is a registered investment adviser that has provided advisory services to Private Funds since 2011. Those funds invested largely in structured notes that were generally tied to the performance of the S&P Index and the Russell 2000 Index. To comply with the Custody Rule SBB retained RSM US to audit each of the Private Funds for the years 2013 through 2017.

At the beginning of the engagement the audit firm employed a risk-based model to evaluate the work. The SBB engagements, under that model, represented a mid-range risk. The Engagement partner and the related staff members were selected in view of the rating. The Engagement Partner selected was authorized to work on audit engagements at all risk levels. That Engagement Partner, however, had no prior experience auditing or valuing structured notes. The staff assigned to the engagement had virtually no structured note experience.

In planning the engagements, the audit team identified the valuation of the structured notes as a “significant risk” of a material misstatement since it involved “significant accounting estimates with high estimation uncertainty.” Indeed, the audit team would be required, under the applicable standards, to assess the accounting estimates, determine how the estimates were made and evaluate the data on which they were based. Since the valuation issue presented a significant risk the audit team would also be required to considered alternatives.

The RSM audit team failed to properly conduct its work on the Private Funds engagements. In 2013, for example, RSM used an independent estimate approach to test the reasonableness of SBB’s fair value estimates for the notes. The software used by the provider, however, was only approved for valuing Level 1 and 2 assets. The structured notes were Level 3. Since SBB had mischaracterized the notes as Level 2, the audit team, using the provider’s estimates, found the SBB valuations reasonable. In reaching its conclusion, the audit team failed to obtain an understanding of the inputs, methods and assumptions underlying the valuation model as required.

The next year the audit team began with the same methodology. This time, however, the variance between the third party estimates and those of SBB exceeded, on a fund level, RSM’s allowable variance for three of the Private Funds – the SBB estimates were uniformly higher.

The variance suggested that the financial statements may have been materially misstated, a point that should have been documented in the work papers. Engagement Partner concluded that he lacked the competence and capabilities to adequately assess the reasonableness of SBB’s valuation model inputs and assumptions – a specialist was required.

Thirteen days prior to the deadline for completing the work, Valuation Specialist 1 was summoned. That person supposedly had the requisite expertise. Valuation Specialist 1 in fact had no expertise. Valuation Specialist 2 was summoned. That person had never worked on structured notes. After consultation with others at the firm, two tests were conducted. Neither provided the kind of audit evidence required to properly evaluate the valuations. Nevertheless, the audit was completed.

Following similar failures during the 2016 and 2017 engagements, and weeks before the completion of the 2018 Private Funds engagement, RSM resigned. The firm withdrew its prior opinions, citing inconsistencies between what SBB’s management told the firm and documents and testimony furnished by management to the SEC enforcement staff in connection with an investigation. The Oder alleges that Respondent failed to comply with applicable Quality Control standards and violated Rule 102(e)(1)(ii) of the Rules of Practice.

In resolving the matter RSM agreed to implement a series of undertakings regarding is Quality Control policies and procedures. Those included a remediation plan and a requirement to obtain a remediation certification.

The Commission sanctioned Respondent, entering a censure, and directed that RSM comply with its undertakings.