The Ontario Securities Commission recently filed an Application for Enforcement Proceeding against KPMG LLP, for audit failures relating to KPMG’s 2019 and 2020 audits of four funds managed by Bridging Finance Inc.

As the news release summarizes things:

• After completing its audits, KPMG issued independent auditor’s reports directed to fund unitholders stating KPMG’s opinion that the funds’ financial statements presented fairly, in all material respects, their financial position. KPMG represented in those reports that it had conducted its audits in accordance with Canadian generally accepted auditing standards. The OSC alleges that these representations were false.
• The OSC alleges that KPMG failed to perform sufficient and appropriate audit procedures over the most critical aspect of the financial statements – the valuation of the loans held within the funds.
• On April 30, 2021, one month after the last of KPMG’s auditor’s reports was issued, Bridging Finance Inc. and all its assets were put into receivership by the Ontario Superior Court of Justice.

The application groups the allegations into four categories:

• KPMG’s review of the expected credit loss model was inadequate Throughout the Audits, KPMG repeatedly uncovered evidence that BFI’s ECL Model did not reliably estimate appropriate and accurate expected credit losses for loans in the loan portfolio. Nevertheless, KPMG failed to collect sufficient and appropriate audit evidence to assess the key data elements and assumptions included in the ECL Model…KPMG did not ask fundamental questions such as whether the (metrics used to estimate the loss on a loan’s collateral in the event of default) and percentage of probability of default rates were appropriate for any particular loan given the characteristics of the borrower, whether (the subjective factor applied to global corporate default rates obtained from third-party rating agencies) was appropriate for any particular loan, whether the collateral supporting the loan existed and was valued appropriately, and whether the overall ECL provision was sufficient to cover the risks of default of the borrower.
• KPMG’s response to testing of high-risk loans was flawed KPMG Audit selected loans and engaged a team from KPMG Valuation to assess the recoverability of four loans that KPMG Audit considered complex and high-risk from a valuation perspective. KPMG uncovered problems with BFI’s calculations and methodologies for valuing all four high-risk loans. KPMG recorded the findings of KPMG Valuation as “uncorrected audit misstatements,” with KPMG Audit declining to engage KPMG Valuation for assessment of any further loans for the 2019 audit and continuing to rely uncritically on BFI’s ECL Model.
• KPMG’s testing of material loans was inadequate KPMG selected a second set of loans to be audited by KPMG Audit. (These) were not assessed by KPMG to be complex, high-risk loans, and as a result, the testing performed was less rigorous than the valuation work performed by KPMG Valuation on the high-risk loans. KPMG failed to conduct appropriate and adequate testing for audit purposes and failed to adequately respond to evidence that certain borrowers were financially distressed. KPMG Audit did not critically or adequately assess whether the ECL provision, including BFI’s subjective data inputs, was appropriate for any of the material loans given the financial condition of the borrower.
• KPMG ignored the untested balance Despite the inherent risks of the loan portfolio, the problems identified by KPMG Valuation, and the inadequate testing and response by KPMG Audit, KPMG assessed all loans not selected for testing by either KPMG Valuation or KPMG Audit as low risk with a low risk of material misstatement.

It’s perhaps bleakly ironic that there was no requirement under Ontario securities law for the entities in question to be audited in the first place, but BFI elected to get it done: “The Audits were intended to build trust with actual and potential investors, to attract and retain investment, and give Unitholders the confidence to reasonably assume they had a true and fair view of the Four Funds’ financial position.” That aside, I imagine any reader will be struck by the sheer range and volume of the OSC’s allegations (which, of course, are no more than that for now): to say the least, they create an impression of a somewhat hapless and complacent audit team. Of course, that’s a few years ago now, and even if it’s all true, KPMG (notwithstanding recent bad publicity from other quarters) may subsequently have transformed itself. We learn elsewhere, for instance, that the firm has “announced deployment of AI agents embedded into KPMG Clara, our smart audit platform. Clara’s digital agents will also help standardize workflows, accelerate decision making and harmonize processes to produce more consistent outcomes, which in turn, improves audit quality and enhances public trust.” The firm emphasizes though that “the need to train and develop humans that are curious is a critical skill set for the profession. Curiosity drives the level of professional skepticism that is foundational in the audit profession.” Well, indeed…

The opinions expressed are solely those of the author.