August 21, 2018

Judge Allows Class-Action Suit to Proceed Against KPMG Over Shoddy Miller Energy Audit

A federal judge in Tennessee on Aug. 2 declined to throw out a securities class-action lawsuit against KPMG, in which investors are accusing the Big 4 firm of screwing up the audit of now-defunct oil and gas company Miller Energy Resources Inc.

In Lewis Cosby et al. v. KPMG L.L.P., the investors say they got duped when Miller Energy overstated the value of its oil and gas interests in Alaska. The lawsuit also condemns Miller Energy and its auditors of using “a plethora of false statements, fraudulent accounting, and other fraudulent reporting devices to falsify the financial results of Miller Energy, conspiring to perpetrate a massive fraud on plaintiff and others in member of the investing public.”

The investors claim that KPMG violated Section 10(b) of the Securities Exchange Act and Rule 10b-5 by making material misrepresentations in relation to the sale or purchase of securities. And they argue that KPMG’s review of Miller Energy’s quarterly financial statements were not in compliance with GAAP, GAAS, and Public Company Accounting Oversight Board standards.

As Caleb mentioned last August, Miller Energy bought a bunch of land in Alaska in late 2009 for next to nothing (well, roughly $4.25 million) and then told investors that it was worth $480 million.

KPMG was hired by Miller Energy in 2011 and issued an unqualified audit report despite the value of the Alaskan assets being grossly overstated, according to the Securities and Exchange Commission:

KPMG and the engagement partner John Riordan failed to properly assess the risks associated with accepting Miller Energy as a client and did not properly staff the audit, which overlooked the overvaluation of certain oil and gas interests that the company had purchased in Alaska the previous year. Among other audit failures, KPMG and Riordan did not adequately consider and address facts known to them that should have raised serious doubts about the company’s valuation, and they failed to detect that certain fixed assets were double-counted in the company’s valuation.

KPMG settled SEC charges for $6.2 million on Aug. 15, 2017, due to its shoddy Miller Energy audit. Riordan also settled charges against him, agreeing to a $25,000 fine and a suspension to practice before the SEC. KPMG did not admit or deny any wrongdoing.

In his Aug. 2 ruling, Judge Thomas Varlan of the U.S. District Court Eastern District of Tennessee said after KPMG was hired by Miller Energy in 2011, it failed to complete an independent audit but instead relied on previous reports and defended the valuation of the assets:

Even after a report from TheStreetSweepers questioned the valuation of Miller Energy’s assets, defendant represented to shareholders that the valuation was accurate and that the article was inaccurate.

The 2011 blog from The Street Sweeper, which was published on the financial markets news website Seeking Alpha, was skeptical of the value of assets that Miller Energy purchased in late 2009. At the time, Miller Energy said the assets were valued at more than $327 million, but The Street Sweeper quoted an energy executive who estimated the assets were worth “only $25 million to $30 million and were offset by $40 million worth of liabilities,” according to an article by the Knoxville News Sentinel.

The judge also said that the investors “adequately alleged that defendant’s conduct was an ‘egregious refusal to see the obvious, or to investigate the doubtful.’”

In a statement emailed to Going Concern, Steven Toll, a managing partner at law firm Cohen Milstein, who represents the investors in the case, said:

“We are very pleased by Chief Judge Varlan’s opinion as he ruled upon some very important issues affecting auditor liability. Specifically, he ruled that we had alleged sufficient facts to give rise of a strong inference of ‘scienter,’ which involves showing knowledge or recklessness by the defendant. The court also found that we had adequately pled loss causation, that is a causal link between the investors’ loss and the alleged misrepresentation. Finally, the court rejected their effort to dismiss the case on statute of limitations ground, upheld our argument that the claims related back to the original complaint, and denied KPMG’s argument that the Section 11 claim was barred by the statute of repose. Thus, it was a very good ruling for the investors in this case.”

KPMG has yet to respond to a request for comment.

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Image: Shutterstock/Novikov Aleksey

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