by T. GormanPosted on Posted in SECActions

The broker windows approach of filing groups of actions together which center on common theme is expanding to auditor independence. The Commission grouped proceedings naming as Respondents eight audit firms. Each Order alleges violations of the independence rules. In each instance the audit firm conducted audits for a number of broker-dealers clients. In each action the Order alleges that in one or more instances the firm assisted in preparing the financial statements which were the subject of the audit. In each instance the audit firm settled, agreeing to implement certain procedures and to the entry of a cease and desist order, a censure and a directive to pay a penalty.

Typical of these actions is the one which names as a Respondent BKD, LLP. In the Matter of BKD, LLC, Adm. Proc. File No. 3-16299 (Dec. 8, 2014). BKD is an accounting and auditing firm registered with the PCAOB. It has 245 partners and approximately 1,200 additional professional staff in 34 offices located in 15 states. The firm is based in Missouri.

During the fiscal years 2010 through 2012 BKD served as the independent public accountant for 21 broker-dealer audit clients. For at least “one audit performed for nine of its broker-dealer audit clients . . . BKD prepared the financial statements and/or notes to the financial statements that were filed with the Commission . . .” according to the Order.

The example in the Order involved Broker-Dealer A. For that client for the fiscal year ending 2011 BKD audited the annual financial statements. During the audit the firm was given financial documents generated by the Broker-Dealer, including a trial balance and FOCUS reports. The firm used these documents and other financial information to create a set of financial statements for filing with the Commission. BKD gave the financial statements it generated to the client for approval.

In February 2012 Broker-Dealer A filed Form X-17A-5 Part III for 2011 with the Commission. It contained an audit report signed by BKD. That report represented that the audit had been in accord with GAAS.

Exchange Act Section 17(e)(1)(A) requires that every registered broker or dealer annually file a balance sheet and income statement with the Commission that has been certified by an independent public accounting firm. The auditor has to be independent under the Commission’s Rules. The audit has to be conducted in accord with GAAS. Rule 2-01(c)(4) of Regulation S-X provides that accountants are not independent if, during the engagement, the accountant provides prohibited non-audit services to an audit client. Those services include preparing the audit client’s accounting records, the financial statements or originating source data underlying the financial statements.

Here BKD violated Exchange Act Rule 17a-5(i) by representing in its audit reports that it had performed the engagements in accord with GAAS because its independence had been impaired by preparing the financial statements. The audit firm also caused its client to violate Exchange Act Section 17(a) because it knew, or should have known, that its conduct contributed violations of Exchange Act Section 17(a) and Rule 17a-5. Under Rule 102(e) the Commission can censure a person who engages in improper professional conduct within the meaning of the Rule. In this case BKD engaged in highly unreasonable conduct that resulted in violations of the applicable professional standards since it knew, or should have know, that heightened scrutiny was required which is always warranted when independence questions are presented.

In resolving the action BKD entered into a series of undertakings. Those include establishing written policies and procedures or revising existing procedures regarding independence requirements; establishing a policy regarding training; providing a copy of the Order to all personnel and broker-dealer audit clients; adopting procedures to provide reasonable assurances that prohibited bookkeeping services are not provided to broker-dealer clients; and certifying to the staff that it has complied with all of the undertakings.

The firm also consented to the entry of a cease and desist order based on Exchange Act Section 17(a) and Rule 17a-5 and a censure. BKD will pay a penalty of $15,000.

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by T. GormanPosted on Posted in SECActions

The SEC filed settled accounting actions with a financial institution and its CFO, keyed to a restatement. The accounting issue focused on deferred tax assets and the failure to have the related reserve. In the Matter of Hampton Roads Bankshares, Inc., Adm. Proc. File No. 3-16296 (Dec. 5, 2014); In the Matter of Neal A. Petrovich, CPA, Adm. Proc. File No. 3-16297 (Dec. 5, 20154).

Hampton Roads is a bank holding company for Bank of Hampton Roads and Shore Bank, its primary subsidiaries. Mr. Petrovich was the Executive Vice President and CFO of Hampton Roads until his resignation, effective June 4, 2010.

Prior to 2008 Hampton Roads did not record significant deferred tax assets. In 2008 as its loan portfolio deteriorated and loan losses increased, the firm recorded a deferred tax assets of $32.6 million. These assets reflects the right to offset a future tax expense or obligation with a future tax benefit or refund. They arise from timing differences that occur between reporting the effect of taxes accrued for under U.S. GAAP and calculating the tax impact under the enacted tax law. When recording such assets the firm must determine if it is more likely than not that the deferred tax asset will be realized in a future period. Where it may not all be utilized, a valuation allowance that is sufficient to reduce the deferred tax asset to the amount that is more likely than not to be realized must be established.

In May 2009 Bank of Hampton Roads merged with Gateway Bank. The acquisition increased the assets of the Hampton Roads from about $1 billion to $3.1 billion. During that year the company disclosed that its problem loans had increased significantly, This was due in large part to the loans obtained in the merger. As the firm’s losses increased, the deferred tax asset grew. By the first quarter of 2010 it was $70.32 million. The vast majority of the assets recorded in 2009 and the first quarter of 2010 related to the firms loan losses. The only valuation allowance record by the company during the period was for $1 million related to capital losses realized.

In assessing if a valuation allowance should be taken, the critical question was if the credit could be used which was a function of future financial performance. In a March 2010 analysis, made with the assistance of an outside accounting expert, the firm determined that its losses were not expected to continue. Accordingly, no valuation allowance related to the loans was taken. Two months later the firm updated its analysis. Again the analysis projected profits in 2011. This same approach continued through June and July.

Actual results differed significantly from the projections relied on by the bank. Those results are also consistent with other internal documents which projected continued loan losses. The company actually reported loan loss provisions of $54.6 million, $83.7 million and $27.9 million for the second, third and fourth quarters of 2010.

On August 13, 2010 Hampton Roads issued an amended Form 10K/A for 2009 and an amended Form 10Q/A for the first quarter of 2010, restating the financial statements for those periods. The restated financial statements reflected a valuation allowance against the entire deferred tax asset.

The valuation allowance question also impacted the firm’s capitalization level. Prior to restatement the financial institution reported that it was “adequately capitalized” as of December 31, 2009 and “undercapitalized” as of March 31, 2010. Following the restatement Hampton Roads reported that it was “undercapitalized” as of December 31, 2009 and “significantly undercapitalized” as of March 31, 2009. These changes are material to investors.

The Order alleges that the projections relied on by Hampton Roads were not reasonable in view of the totality of the evidence. Each proceeding alleges violations of Exchange Act Sections 13(a), 13(b)(2)(A) and 13(b)(2)(B). To resolve the proceeding the bank consented to the entry of a cease and desist order based on the Sections cited in the Order. It also agreed to pay a penalty of $200,000.

Mr. Petrovich also resolved the proceeding which names him as a Respondent. He undertook to pay a penalty of $25,000 and consented to the entry of a cease and desist order based on the same Sections as Hampton Roads.

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