KPMG Gets Sued Because Their Longtime Client Went Down in Flames

We knew this was coming. Bloomberg has reported that Silicon Valley Bank auditors KPMG have been sued — along with underwriters Goldman Sachs, Bank of America, and Morgan Stanley — after SVB’s spectacular collapse on March 10. KPMG audited the bank for nearly 30 years.

Similar to previous suits, a complaint filed Friday in the federal court in San Francisco names Silicon Valley Bank Chief Executive Officer Greg Becker and other bank directors and officers as defendants. The complaint appears to be the first to target the bank’s auditors and underwriters.

Collectively, the defendants “misrepresented the strength of the company’s balance sheet, liquidity, and position in the market,” according to the lawsuit. The executives, auditor and underwriters “understated and concealed the magnitude of the risks” facing the bank, which undermined the value of its own securities portfolio, it said.

As you may recall, KPMG issued an unqualified audit opinion two weeks before SVB went down in flames. There was a really good explainer on what exactly happened at SVB written by a CPA and posted on Medium.com shortly after SVB collapsed but looks like OP deleted their account and took the explainer with them. No worries though, here’s an excerpt:

Just like in 2008, there were events which preceded the crisis and events which preceded the failure of SVB. Most of these events were the result of the Covid-19 Pandemic and included but are not limited to:

1. Historically low levels of interest rates (a result of 2008)
2. A rapid increase in the money supply to stabilize markets and the economy during and after the pandemic lockdowns
3. Historically high levels of savings and high asset valuation
4. Inflation caused by both supply and demand fallout from the pandemic
5. The invasion of Ukraine by Russia
6. The rise in interest rates by the Federal Reserve (“The Fed”) in order to combat higher levels of inflation
7. The failure and fallout of several large cryptocurrency companies due to both decreasing prices of cryptocurrencies and alleged fraud of FTX

As interest rates rise prices and thus value of securities decline. So like many other banks SVB was holding these longer dates fixed income assets, while the FED was increasing rates over the past year. The price and ultimately the value of these assets, which are Available-For-Sale (“AFS”), declined causing what is known an unrealized losses. AFS securities are subject to fair value or mark to market (“MTM”). This is in contrast to Held-To-Maturity (“HTM”) securities which are marked at amortized cost. In the case of SVB, the losses are unrealized until the securities are sold and become realized.

Just like other banks SVB had these fixed income assets incur unrealized losses but what SVB failed to do was manage their risk and portfolio duration (duration can be thought of as time). As a publicly traded company, SVB would be required to provide a 10-Q, which is an unaudited and condensed version of a 10-K, which are audited financial statements. Over the last year or so, you could read SVB’s, 10-Qs which would provide insight on a quarterly basis through unaudited financial statements and disclosures. SVB kept holding these assets with unrealized losses, but finally their clients realized that the bank had a liquidity issue, which meant the bank had to sell these fixed income assets to meet their customers withdrawal requests to get their deposits out for payroll, day to day expenses, etc. However, in the wake of FTX, which was first a liquidity crisis and ultimately turned out to be an alleged fraud, with assets which could not make their customers whole, customers of SVB began to worry and that worry turned into panic.

Speaking of panic, banks in the United States are holding onto about $620 billion of unrealized losses. Good read about that with some pretty graphics here.

On March 8, two days before the bank went under, SVB sold a bond portfolio consisting mostly of U.S. Treasuries with a book value of $23.97 billion to Goldman Sachs, leading to a $1.8 billion loss for SVB. And you know what happened after that.

“Even though SVB’s deposits began to decline in 2022, falling $25 billion during the final nine months of 2022 and reducing SVB’s liquidity, KPMG did not identify risks associated with SVB’s declining deposits or SVB’s ability to hold debt securities to maturity in its report,” reads the lawsuit. It adds that KPMG “was silent” on whether there is substantial doubt about the entity’s ability to continue as a going concern. KPMG did communicate a critical audit issue — allowance for credit losses for loans and unfunded loan commitments for certain portfolio segments evaluated on a collective basis — otherwise the audit report is pretty standard. 10-K can be found here, you’re looking for Part II, Item 8 “Report of Independent Registered Public Accounting Firm”

KPMG stands behind the SVB audit and told us last month that “any unanticipated events or actions taken by management after the date of an opinion could not be contemplated as part of the audit.”