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February 2, 2023

If There Was a PCAOB In the Metaverse, It Would Probably Find a Bunch of Errors In Prager Metis’s Audits Too

In an article for CoinDesk, Francine McKenna took a crack at why the FTX debacle happened, and like she always does when there’s really bad accounting at a company going through a financial crisis, who are/were the auditors:

It’s not clear why FTX commissioned two different audit firms to audit its 2020 and 2021 financial statements. The reports by Armanino LLP, which signed the report for the U.S. operation, and by Prager Metis LLP, which signed the opinion for the offshore operations, were issued at the end of March 2022.

[…]

The first red flag anyone receiving these reports should have seen is that there were two different audit firms producing them. Why hire two different firms rather than one to produce an opinion on consolidated results? With the benefit of hindsight, we can see it perhaps suggested that [FTX founder Sam] Bankman-Fried didn’t want any firm to see the whole picture.

The choice of firms itself is questionable. These are two small outfits, not even on the next tier to the Big Four global audit firms – Deloitte, Ernst &Young, KPMG and PricewaterhouseCoopers. Armanino and Prager Metis do audit a few public companies but none of the size or complexity of FTX. Because the firms are so small, the audit regulator, the Public Company Accounting Oversight Board (PCAOB), inspects them only once every three years.

Prager Metis has a poor recent track record with the PCAOB (first reported by the Financial Times but publicly available here) and Armanino does, too.

The Financial Times mentioned last month that everyone’s favorite audit firm in the metaverse had deficiencies in all four of its audits most recently inspected by the PCAOB. Prager Metis’s 2020 auditing report card is below:

And in other instances of noncompliance with PCAOB standards …

  • In one of four audits reviewed, [Prager Metis] did not assemble a complete and final set of audit documentation for retention within 45 days following the report release date. In this instance, the firm was noncompliant with AS 1215, Audit Documentation.
  • In one audit, the firm’s audit report was not addressed to the shareholders. In this instance, the firm was noncompliant with AS 3101, The Auditor’s Report on the Audit of Financial Statements When the Auditor Expresses an Unqualified Opinion.
  • In one of four audits reviewed and in 10 other audits, the firm did not file one or more of its reports on Form AP by the relevant deadline. In one of four audits reviewed and in two other audits, the firm’s report on Form AP omitted information related to the participation in the audit by other accounting firms. In these instances, the firm was noncompliant with PCAOB Rule 3211, Auditor Reporting of Certain Audit Participants.
  • In two of four audits reviewed, the firm did not provide the audit committee the required independence communications. In these instances, the firm was noncompliant with PCAOB Rule 3526, Communication with Audit Committees Concerning Independence.

Prager Metis is the 45th largest public accounting firm by revenue in the non-metaverse, bringing in $139 million during its most recent fiscal year, according to INSIDE Public Accounting.

To be fair to PM, Armanino isn’t winning any auditing awards anytime soon either. In her article for CoinDesk, Francine wrote:

In 2019, the PCAOB published its private comments about deficiencies in Armanino’s overall quality-control processes related to its 2018 inspection because the firm hadn’t corrected the board within a year.

Armanino was also the auditor for Lottery.com and issued an opinion for 2021. The lottery-sales startup reported that it had overstated its available unrestricted cash balance by $30 million and improperly recognized revenue. There was substantial doubt about its ability to continue as a going concern. Armanino resigned from its audit role this past September, right before a class-action lawsuit was filed against Lottery.com’s executives.

Then there was that whole thing on social media where Armanino was acting like, as the Wall Street Journal put it, “crypto industry cheerleaders.” Our esteemed former colleague Caleb Newquist wrote about this in the latest Gusto “On the Margins” e-newsletter:

Auditors should not be friends with their clients. It’s too fraught with pitfalls, and well-intentioned people have gotten snagged by these rules plenty of times. To be fair, there have been plenty of auditors who have flaunted the independence rules too. So if you’re erring on the side of caution—and auditors should be—you should not be friends with clients.

Anyway, wouldn’t you know it, among the many, many bizarre things that have emerged from the FTX saga, we have a little auditor-client weirdness:

When FTX faced a liquidity crunch, the auditor of its U.S. unit seized the moment to promote its services for other crypto companies that were under the spotlight.

It is a “great time to remember” Armanino LLP’s specialized crypto assurance, the firm tweeted last week, referring to a product that verifies customer assets held by crypto firms.

Okay, so the world’s third largest crypto exchange—whose U.S. entity you provided assurance services to—is going down for the dirt nap, and you take it as an opportunity to plug your crypto assurance services? I mean, a) Okay, but also b) NOT NOW. The house is on fire, guys. Maybe you could tell us about a home security system another time?

Also:

When FTX’s former chief executive, Sam Bankman-Fried, gave evidence to a congressional committee in December, the firm, which is in the Top 20 firm by revenue, cheered him on. “Let’s go buddy!” the firm tweeted.

I doubt that an audit firm tweeting “Let’s go buddy!” in support of the then-CEO of a client’s parent company somehow violated auditor independence rules, but it sure looks strange. If your firm needs to be “independent in fact and appearance,” tweeting “Let’s go buddy” does not appear independent. At all! Quite the opposite, actually! Let’s try a little harder, people.

Francine also reminded us that neither the Armanino nor the Prager Metis audit reports for 2021 provides an opinion on the FTX US or FTX Trading internal controls over accounting and financial reporting:

Thursday’s filing by FTX’s new CEO, restructuring expert John J. Ray III, who was appointed after the FTX bankruptcy filing, confirms what reading the year-end 2021 financial statements should have screamed to any auditor or reader of the reports: There were no controls.

“Never in my career have I seen such a complete failure of corporate controls and such a complete absence of trustworthy financial information as I occurred here,” he wrote.

“From compromised systems integrity and faulty regulatory oversight abroad, to the concentration of control in the hands of a very small group of inexperienced, unsophisticated and potentially compromised individuals, this situation is unprecedented.”

That’s a pretty damning comment coming from that guy because Ray has seen some things.

Despite these revelations about FTX’s auditors, if you’re hoping the PCAOB will take up pitchforks and torches and march down to Armanino’s and Prager Metis’s headquarters (its actual headquarters, not the one in the metaverse), you’ll be disappointed

PCAOB Chair Erica Williams set the record straight about the board’s audit inspection program, with questions being raised about not only the role of accountants and auditors but also that of the board following the spectacular collapse of crypto empire FTX Trading Ltd. and subsequent bankruptcy filing of crypto lender BlockFi Inc.

For example, FTX said that financial results were audited by Armanino LLP, which is reportedly one of the 20 largest accounting firms in the country by revenue, and Prager Metis CPAs.

“I want to offer a word of caution to investors about what it means for a firm to be registered with the PCAOB,” Williams said in response to a question about the board’s view on audits of crypto at the 17th Annual Audit Conference hosted by the Baruch College Zicklin School of Business in New York. She spoke via Zoom.

“The PCAOB only has jurisdiction over the audits of public companies and broker dealers. FTX was not a public company, and therefore the PCAOB could not inspect its audits,” Williams explained. “At the same time, you may have seen FTX touted the use of the auditors that were registered with the PCAOB. And it’s important to understand that PCAOB-registered firms only have to follow PCAOB standards and rules when they’re auditing public issuer or broker dealer under our jurisdiction, not for any other clients. We don’t have authority to inspect their audit of other clients like FTX. So, we were not able to evaluate the work on those engagements or hold them accountable for insufficient work.”

Also, the PCAOB doesn’t have authority because its fiscal 2023 budget didn’t allow for virtual reality headsets for inspectors.

‘A Complete Failure of Corporate Controls’: What Investors and Accountants Missed in FTX’s Audits [CoinDesk]
Chair Williams Says PCAOB Has No Authority to Inspect Audits of FTX [Thomson Reuters Tax & Accounting]

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