The Securities and Exchange Commission’s decision to impose relatively short bars and no financial penalties on the auditors of the College of New Rochelle indicates that the commission takes seriously the work of these disclosure gatekeepers despite their not being complicit in the fraud uncovered in 2019.
The SEC charged two former KPMG auditors on Tuesday and suspended them from practicing for issuing an unmodified audit opinion of the New York college’s 2015 fiscal year financial statements, despite not having completed critical audit steps.
Without admitting or denying the findings auditors Christopher Stanley and Jennifer Stewart agreed to be suspended from appearing or practicing before the SEC as an accountant and can apply for reinstatement after three years and one year, respectively.
“This is a relatively short bar for the SEC, and there is no accompanying financial penalty,” said Kathleen Marcus, shareholder at Stradling law firm and a former SEC enforcement lawyer. “While this sanction is serious for the livelihood and career trajectory of the auditors, it could have been far more severe, which likely means that the SEC believes that the auditors failed in their role as gatekeepers but were not complicit in the financial fraud.”
The SEC’s move isn’t commonplace in the municipal space, but there have been many enforcement actions involving auditors in the public and private company arenas, Marcus said.
This specific case is important for the municipal market, other sources said, and affects other participants.
“Underwriters in performing their gatekeeper function in underwriting municipal securities must be able to rely on the integrity of auditors to perform proper audit procedures regardless of whether they cause friction to their relationship to their client,” said Rebecca Lawrence, senior counsel at Ballard Spahr. “An audited financial statement is one of the pillars of truth about an issuer’s financial health and auditors play an essential role in uncovering that.”
Starting in spring 2013, the 115-year old not-for-profit Catholic College of New Rochelle began experiencing financial challenges resulting from decreases in student enrollment and tuition revenues.
On Nov. 30, 2015, the CNR’s controller Keith Borge and the college’s president told Stanley and Stewart that they needed KPMG to issue their audit report before the end of the day. That afternoon, despite numerous open items and unanswered questions, both decided to issue the audit report, the SEC said.
The SEC charged Borge in 2019 for defrauding municipal securities investors and concealing the school’s crumbling finances. Borge agreed to a partial settlement. The school closed that year.
As a result of Borge’s fraud, CNR’s net assets were overstated by $33.8 million, the SEC said.
KPMG’s audit team encountered significant challenges right off the bat due to Borge’s untimely and inaccurate responses, the SEC said.
“First, when the audit team arrived to begin fieldwork in August 2015 they discovered large amounts of information which was scheduled to be available, including the critical trial balance, was not yet ready,” the SEC said. “In addition, the information that the college was able to provide, such as supporting documentation for the college’s investment balances, contained reconciling issues and contradictions.”
Those challenges worsened as the audit continued. Borge, who was the audit team’s primary contact, took extended periods of leave during critical times in the audit, leaving the auditors without the necessary information to complete the audit, the SEC said.
In November, CNR’s president said the audit was needed that day. In the next few hours, Stanley and Stewart reviewed the outstanding open items and unanswered questions and unreasonably concluded that none of the items or questions should prevent KPMG from issuing its audit report, the SEC said.
Under Stanley’s supervision, the audit team failed to verify the existence of assets or the completeness of liabilities, the SEC added. In November 2016, after Borge’s fraud was discovered, KPMG withdrew its audit of CNR’s FY 15 financial statements.
The SEC found that both Stanley and Stewart violated Generally Accepted Auditing Standards such as failing to get sufficient appropriate audit evidence, adequately assess audit risk, and others.
CNR’s 2015 audited financial statements were submitted to the Municipal Securities Rulemaking Board, overstating the college’s net assets by $33.8 million.
“Audited financial statements for municipal issuers are submitted to the MSRB pursuant to the continuing disclosure undertakings required by the Exchange Act,” said LeeAnn Ghazil Gaunt, chief of the SEC Enforcement Division’s Public Finance Abuse Unit. “We will investigate auditors’ conduct in municipal audits and, where appropriate, hold them accountable when they act improperly.”
KPMG said they were committed to quality audits.
“We are committed to executing quality audits, while continuing to foster a culture of integrity, a KPMG spokesperson said. “The actions as described in the SEC orders do not live up to KPMG standards.”
It was “egregious” that the auditors knew they were filing incomplete audits, said Phil Stern, senior counsel at Neal, Gerber & Eisenberg LLP.
“When you have outstanding items and questions that are relative to the audit that have not been answered and because you’re under pressure from your client, you issue it anyway, which results in the assets being overstated by over $34 million dollars, that’s what so signficant about this,” Stern said.