What KPMG knew and missed about the financial condition of the two banks will be the subject of regulatory scrutiny and lawsuits.
KPMG signed off on the audit report for SVB Financial Group, the parent of Silicon Valley Bank, on 24 February. Regulators seized on March 10 after a surge of withdrawals threatened to leave the bank short of cash.
“Common sense tells you that an auditor issuing a clean report on the 16th largest bank in the United States that fails within two weeks without warning is trouble for the auditor,” Lin said. Turner, who was the Securities and Exchange Commission’s chief accountant from 1998 to 2001.
Two important facts to determine whether KPMG missed the banks’ problems are when the banks began operating in good faith and when the banks’ management and KPMG’s auditors became aware of the crisis.
What is known about the Silicon Valley bank is that deposit withdrawals accelerated last month. In its March 8 statement, the Silicon Valley bank said, “Client cash burn has increased and further increased in February.” The bank said its deposits at the end of February were lower than predicted in January.
Both bank audits were for 2022, so auditors weren’t examining the banks’ books for the time period they were in trouble. But auditors are expected to highlight the risks faced by the companies they audit. They are expected to raise important issues that arise after the companies have closed their books and before the completion of the audit.
A KPMG spokeswoman declined to comment on specific audits due to client confidentiality. In a statement, the firm said it is not responsible for things that happen after the completion of the audit.
Silicon Valley bank deposits peaked at the end of the first quarter of 2022 and fell by $25 billion, or 13%, during the last nine months of the year. This means that deposits were declining during the period of KPMG’s audit. If the decline was affecting the bank’s liquidity when KPMG signed off on the audit report, that information should have been included. Since it was not, the question becomes, did KPMG know or should have known what was happening?
Auditors should warn investors if companies are in trouble. They are required to assess “whether there is substantial doubt about the entity’s ability to continue as a going concern” for the next 12 months following the issue of financial statements.
Auditors also use their reports to highlight “significant audit matters” that involve challenging, subjective or complex decisions. KPMG focused on accounting for credit losses at Silicon Valley Bank in that section of its report. But it didn’t address the potential of Silicon Valley Bank. Continuing to hold debt securities till maturity—which the bank lacked at the end.
Even if the bank was not struggling last year, KPMG had to evaluate developments occurring after the balance-sheet date, so as to fairly present the company’s financial position.
Signature Bank, which was seized by regulators on Sunday, also suffered a run last week, but it does not have the same balance-sheet issues as Silicon Valley Bank. KPMG signed off on its audit on 1 March.
Signature’s bet on the crypto industry increased deposits, which turned upside down as that market struggled. A large amount of its deposits were not insured, making it more likely that customers would flee at any sign of trouble. But it did not disclose losses on its investments as a Silicon Valley bank, which provided more capacity to pay depositors.
The auditing firm may face additional scrutiny. KPMG also audited First Republic Bank, whose shares were down 76% on Monday morning even after boosting liquidity to the bank from JPMorgan Chase and the Federal Reserve.
Professor Eric Gordon of the University of Michigan’s Ross School of Business said KPMG’s audit work will be scrutinized by regulators including the Public Company Accounting Oversight Board and the SEC, as well as private litigants who lost money in the Silicon Valley bank collapse. Will go , A shareholder lawsuit against the firm related to the Silicon Valley bank audit “will not be easy for the people to win, even if the timing is spectacularly embarrassing for KPMG,” Mr. Gordon said.
A PCAOB spokeswoman said the regulator “cannot comment on ongoing inspections or enforcement matters.” An SEC spokeswoman declined to comment on the Silicon Valley Bank audit.
One argument KPMG could try in court is that the bank run began after the firm signed off on its audit report. The California Department of Financial Protection and Innovation, a state banking regulator, said in a filing Friday that the bank was “in good financial condition prior to March 9,” when depositors pulled out $42 billion.
Douglas Carmichael, the PCAOB’s chief auditor from 2003 to 2006, said it was unclear how the California regulator was able to determine the bank’s financial condition. “It sounds like a premature analysis. How could they know without checking?” He said.
“Auditors are always under the microscope when a company fails shortly after issuing a clean opinion,” Mr. Carmichael said. “The shorter the period, the greater the concern.”
Silicon Valley Bank nearly doubled its assets and deposits during 2021. It got into trouble because it bought long-term, low-yielding bonds with short-term funding from depositors that were repayable on demand. Accounting rules state that he doesn’t have to recognize a loss on assets until he sells them. When the value of bonds fell due to rising interest rates, it imploded in them and they kept falling. The Silicon Valley bank still had to maintain sufficient liquidity to pay the withdrawals, which became increasingly difficult.
Silicon Valley Bank disclosed last week an investment loss of $1.8 billion that stemmed from Silicon Valley Bank’s decision to sell all of its “available for sale” securities during the first quarter. Silicon Valley Bank did not say when it started or completed the sale. It is unclear whether Silicon Valley Bank used the proceeds of those sales to help cover the withdrawals.
In a March 8 disclosure, the Silicon Valley bank said it expected to reinvest the proceeds from the sale. But the money is redeemable, and it’s unclear whether selling available-for-sale securities could free up other sources of cash to help pay customers.
Most of the capital hole on Silicon Valley Bank’s balance sheet was in government-sponsored mortgage bonds classified by Silicon Valley Bank as “held to maturity”. Capital.
In a footnote, the Silicon Valley bank said the fair-market value of its held-to-maturity securities as of December 31 was $76.2 billion, or $15.1 billion below their balance-sheet value. The fair-value gap was as large as the Silicon Valley bank’s total equity of $16.3 billion—which, KPMG can point out, anyone reading the financial statements could see.
The Silicon Valley bank stuck to its position that it intended—and had the ability—to hold those bonds to maturity. KPMG permitted accounting treatment. Now it will be up to the Federal Deposit Insurance Corporation to sell the securities.
The bank’s troubles put KPMG in a win-win position. Had it taken note of Silicon Valley Bank’s declining deposits, or issued a warning about Silicon Valley Bank’s ability to continue as a going concern, it could have set off a run on the bank. By not raising these issues, it would have to face questions as to how it missed the signs that the bank was headed for trouble.
The FDIC is one of the agencies that may ask KPMG pointed questions. After a bank fails, the FDIC’s Office of the Inspector General regularly conducts investigations and publishes detailed reports called failed-bank reviews that identify the causes of the collapse and the parties most responsible.
Such reports are carefully studied by private litigants who look for defendants to sue for damages. On that front KPMG caught a break over the weekend: The government said it would freeze all uninsured depositors of both banks, helping KPMG bail out as well. The backstop will not affect the losses suffered by the shareholders of the banks.
Write to Jonathan Weil at jonathan.weil@wsj.com and Jean Eaglesham at Jean.Eaglesham@wsj.com