Accounting firm Prager Metis CPAs, LLC and its California professional services firm, Prager Metis CPAs LLP agreed to pay $1.95 million to settle two Securities and Exchange Commission (SEC) charges for negligence in auditing cryptocurrency trading platform FTX and for widespread violations of auditor independence rules, the commission announced on September 17, 2024.
Previously a relatively obscure firm, Prager Metis had made headlines late 2022 as it was one of the two auditors of failed cryptocurrency exchange FTX founded by Sam Bankman-Fried. He was sentenced 25 years in prison for massive fraud that costs investors billions of dollars. Before its spectacular failure, FTX was one of the largest crypto trading platforms in the world.
Faulty Audit of FTX
Prager Metis started to audit the financial statements of FTX in February 2021, but less than two years later, FTX collapsed. The SEC said that the auditor knew at the time that FTX was raising funds from equity investors and that FTX intended to go public.
Prager Metis issued two audit reports, one in July the other in April 2022, saying that it audited following GAAS.
These statements were material to FTX equity investors. “And Prager Metis knew or should have known that the statements were not true: its audits of FTX were not in fact conducted in accordance with Generally Accepted Auditing Standards,” the SEC complaint states.
The SEC alleged that the audit engagement partner did not understand FTX or the crypto markets, thus failing to comply with even the most fundamental GAAS requirements.
“In its rush to accept FTX as an audit client, Prager Metis assembled an engagement team that collectively lacked the competence, experience, and knowledge to appropriately conduct the audits,” the SEC criticized. “From this initial failure flowed a series of other auditing failures in the design and execution of the audits. These failures resulted in the issuance of audit reports that each contained an opinion that FTX’s financial statements presented fairly, in all material respects, the financial position of FTX and its subsidiaries in accordance with” GAAP.
Due to the auditing failures, the SEC said Prager Metis did not have appropriate audit evidence to support its opinions.
In particular, the engagement team did not understand FTX’s relationship with Alameda Research LLC and the pivotal role it played in FTX’s business. But the audit engagement team failed to adequately assess the risk of material misstatement from the related party. As a result, the auditor largely excluded Alameda from its audit.
“Ultimately, the FTX-Alameda relationship was at the heart of the misappropriation of billions of dollars of FTX customer assets that led to the collapse of FTX in November 2022,” the SEC said.
In a statement, SEC Enforcement Director Gurbir Grewal said that auditors must be independent, exercise due professional care and skepticism, and comply with all applicable professional standards. But Prager Metis fell short in all of those areas.
“Because Prager’s audits of FTX were conducted without due care, for example, FTX investors lacked crucial protections when making their investment decisions,” Grewal said. “Ultimately, they were defrauded out of billions of dollars by FTX and bore the consequences when FTX collapsed.”
Prager Metis agreed to permanent injunctions, to pay a $745,000 penalty, and to undertake remedial actions, the SEC said.
“By limiting Prager’s ability to take on new business and by requiring it to retain an independent compliance consultant, today’s resolutions not only enhance investor protection, they also serve as a warning to audit professionals that are not appropriately meeting their gatekeeping obligations,” Grewal added.
The firm’s lawyer on FTX audit did not immediately respond to a request for comment.
Independence Violations
As for the separate enforcement action related to independence rule violation, Prager Metis agreed to settle the charges by paying a total of $1,205,000. The final judgments also include permanent injunctive relief. The settlement is subject to court approval.
In this case, the SEC complaint alleged that, between December 2017 and October 2020, the Prager Metis improperly included indemnification provisions in engagement letters for more than 200 audits, reviews, and exams. Thus, their auditors were not independent from their clients. (See Securities Regulator Charges Accounting Firm Prager Metis with Widespread Auditor Violations in the October 2, 2023, edition of Accounting & Compliance Alert.)
In particular, Prager allegedly failed to comply with auditor independence Rule 2-01 of Regulation S-X in 62 audits, 11 examinations, and 144 reviews under 87 engagement letters.
These engagements affected 62 companies, comprised of 54 publicly traded companies, four broker-dealers, and four investment advisers, from which the firm collectively made more than $3 million in fees. Clients are not named.
The SEC has interpreted that indemnification provisions impair auditor independence since at least 1982 when the commission created the Codification of Financial Reporting Policies, which codified certain existing Accounting Series Releases.
“Auditor independence is critical to investor protection and a fundamental cornerstone of the integrity of our financial markets,” Eric Bustillo, director of the SEC’s Miami Regional Office, said in a statement. “We are committed to this principle, and we will hold accountable auditors who violate their independence requirements.”
Attorneys on this case did not immediately respond to request for comment.
The final judgments follow tentative settlement terms reached on August 1 on the use of indemnification provisions in engagement letters. (See SEC, Prager Metis Reach ‘Tentative Settlement Terms’ in Independence Case in the August 7, 2024, edition of ACA.)
This article originally appeared in the September 18, 2024, edition of Accounting & Compliance Alert, available on Checkpoint.
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