1. Was TierOne’s accounting for the loan loss reserve indicative of “managed earnings”?  How would you make that determination?
2. What is the purpose of the auditor's assessment of ICFR? Describe the deficiencies in KPMG's audit work in that regard?
3. Would you conclude from the facts of this case that Tier One's fraud caused KPMG's auditing standards violations? Explain.
4. Which rules of conduct in the AICPA Code were violated by KPMG auditors? Be specific.

It took a long time but the Securities and Exchange Commission finally acted and held auditors responsible for the fraud that occurred in banks during the financial recession in 2014. Surprisingly to some, the TierOne bank case explained below was the nation’s first case brought by federal securities regulators against auditors of a company that went down in the multibillion-dollar financial crisis and real estate meltdown. Federal banking authorities had brought a handful of cases against auditors, but the SEC hadn’t brought one until TierOne.

TierOne Corporation, a holding company for TierOne Bank, had $3 billion in assets when it collapsed in 2010. The facts of the case are drawn from the initial decision reached by the SEC, In the Matter of John J. Aesoph, CPA, and Darren M. Bennett, CPA, unless otherwise noted. 

TierOne was a regional bank headquartered in Lincoln, Nebraska, that originated and purchased loans, and loan participation interests, with its primary market area in Nebraska, Iowa, and Kansas. From 2002 to 2005, TierOne opened or acquired nine loan production offices (LPO) in Arizona, Colorado, Florida, Minnesota, Nevada, and North Carolina, the main purpose of which was to originate construction and land-development loans. Over time, TierOne increased its portfolio in these high-risk loans. By September 2008, TierOne closed the LPOs, in the wake of real estate market deterioration. By year-end 2008, TierOne had a total net loan portfolio of approximately $2.8 billion, with a quarter of its loans concentrated in the LPO states. In October 2008, TierOne’s regulator, the Office of Thrift Supervision (OTS), issued a report following its June 2008 examination of the bank, in which it downgraded TierOne’s bank rating; criticized management and loan practices; and found that the bank had collateral-dependent loans either without appraisals or with unsupported or stale appraisals. The bank was closed by OTS in 2010. TierOne Corp. filed for bankruptcy three weeks later.

Tier One Management

The SEC alleged in the indictment that TierOne’s executives hid loan losses as OTS repeatedly requested information. On December 10, 2014, Gilbert Lundstrom, the former chief executive officer of TierOne, was indicted for hiding the condition of the bank from regulators, investors, and auditors. Allegedly, Lundstrom conspired with others to hide the bank’s problems as losses mounted on its loan portfolio. “Lundstrom is essentially charged with having two sets of books, with the books shown to regulators concealing tens of millions of dollars in delinquent loans,” said Christy L. Romero, special inspector general for the U.S. Troubled Asset Relief Program, established during the financial meltdown. 

The trigger for the fraudulent activities by TierOne management was that TierOne’s core capital ratio had fallen below the 8.5 percent minimum threshold mandated by the OTS. Lundstrom and others caused the bank to issue false statements that it met or exceeded the ratio.

Lundstrom knew that the bank needed to increase its reserves to cover loan losses and didn’t report this, according to the indictment. Lundstrom in 2012 settled a lawsuit brought by the SEC claiming he understated TierOne’s loan losses and losses on real estate repossessed by the bank so that the bank would appear to meet its mandated regulatory capital requirements. Lundstrom, who didn’t admit the allegations when settling, agreed to pay $500,921 in penalties.