Reference no: EM132783379

On August 15, 2017, the SEC completed an Administrative Hearing process initiated by a PCAOB investigation of KPMG, LLP and one of their audit partners John Riordan, CPA1 for conducting a materially deficient audit of Miller Energy Resources Inc. KPMG became the successor auditor of Miller for fiscal 2011. Miller was charged with accounting fraud in 2015.

Among other things, the SEC found that KPMG and Riordan:

• failed to properly assess the risks associated with accepting Miller Energy as a client and to properly staff the audit;
• failed to adequately address the audit team's lack of industry experience resulting in a lack of planning, supervision, due care, and professional skepticism;
• failed to obtain sufficient competent evidence to assess the impact of the opening balance of the Alaska Assets on Miller Energy's current year financial statements;
• failed to adequately assess whether Miller Energy's valuation of the Alaska Assets conformed with GAAP (Miller inaccurately revalued an asset costing $4.5 million at $480 million);
• did not obtain sufficient competent evidence regarding the assumptions on which Miller Energy's valuation of the Alaska Assets was based; and
• ailed to take reasonable steps to assess Miller Energy's recorded value of $110 million for certain fixed assets included in the Alaska acquisition.

In a class action lawsuit against one-half dozen former executives of Miller, the plaintiffs charged that Miller overlooked the overvaluation of certain oil and gas interests that the company had purchased in Alaska the previous year. According to the lawsuit, David M. Hall, who served as chief operating officer, understated the cost to run the oil field. Also, it charged that the former CFO, Paul W., Boyd, and Hall, provided expense projections that were, in many cases, significantly lower than expenses recorded by the previous owners of the field. For example, the lawsuit claims internal documents maintained by Hall indicated that the cost to drill a new well was roughly $13 million, however he told the engineering firm preparing reports used to determine the value of the company that the costs to drill at the field was only $4.6 million per well. Additional understatements were made.

As a result of the above, in addition to agreeing to pay $6.2 million in penalties to settle SEC charges that it failed to properly audit Miller Energy, KPMG agreed to complete a firm wide review and evaluation "of the sufficiency and adequacy of their quality controls, including their policies and procedures for audits and interim reviews" of specific items identified by the SEC. KPMG also had to hire and bear the cost of having an independent consultant evaluate the adequacy of KPMG's internal policies and procedures to ensure compliance with all relevant commission regulations and PCAOB standards. In addition, KPMG must certify they have implemented the recommendations of the consultant and then certify the adequacy of their controls at the end of 2018 and 2019, as well.

Mintz, Steven. Ethical Obligations and Decision-Making in Accounting: Text and Cases (p. 346). McGraw-Hill Higher Education.

Question

Problem 1: Assume Miller Energy negotiated a $10 million loan with a financial institution during 2015. Subsequent to the SEC's finding of accounting fraud in 2015, the financial institution brought a lawsuit against KPMG for negligence. What judicial approaches might be used to decide the case?