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This report covers the audit failure of TierOne Bank that was hiding millions of dollars in loan losses from investors and banking regulators during the financial crisis in 2008 and finally filed for bankruptcy in 2010. Incorporated in 1907, the TierOne Bank acts as First Federal Savings and Loan Association located in Lincoln, Nebraska. After a change of the name to First Federal Lincoln Bank in 1995 and a rechange to TierOne Bank in 2002, the bank was established as a wholly owned subsidiary of TierOne Corporation. In the same year TierOne completed a mutual-to-stock conversion and shares of TierOne Corporation began to sellwere sold in an Initial Public Offering (IPO). The shares were traded on NASDAQ. Before the IPO, the main business was to set the focus on was set on residential and agricultural loans in the Nebraska/Iowa/Kansas region. With the IPO, especially with the obtained capital from stock conversions, TierOne expanded its operations into areas outside of the thrift’s traditional geographical market. For example, in 2004, the bank engaged in high-risk types of lending in regions such as Las Vegas, Florida and Arizona, which were experiencing unusual, rapid escalation in market values. From 2002 through 2005, TierOne opened or acquired nine loan production offices (LPO), covering six states. The primary purpose of the LPOs was to originate construction and land development loans. This shift in the corporation’s strategy made the bank particularly vulnerable to the fallout from the financial crisis, as these areas were hit the hardest by the precipitous fall in real estate prices, which began in late 2006 and early 2007. Thus TierOne failed because of significant loan losses from its concentration of construction and land development loans. A huge problem was that TierOne’s board and management did not provide effective oversight or establish adequate credit underwriting and administration controls, particularly at the thrift’s LPO in Las Vegas, Nevada. The Las Vegas LPO was responsible for a majority of these losses. During the financial crisis TierOne was experiencing a dramatic rise in problematic high-risk area loans, including land and land development and residential construction. In June 2008, the Office of Thrift Supervision (OTS), a US federal agency under the Department of the Treasury that chartered, supervised, and regulated all federally chartered and state-chartered savings banks and savings and loans associations conducted a “risk-focused examination” of the bank that focused on asset quality, credit administration, management and earnings. As a result of that examination, the OTS downgraded the bank’s composite CAMELS (an international bank-rating system where bank supervisory authorities rate institutions according to six factors) rating from a one (indicating a financial institution that was “sound in every respect”) to a four (indicating a financial institution with “serious financial or managerial deficiencies” that require close supervisory attention). The OTS cited data demonstrating that real estate values were declining at unprecedented rates in states and markets where the bank had a concentration of loans. The OTS also directed TierOne to maintain higher minimum capital ratios. Failure to correct the problems identified by the OTS or to meet the heightened capital requirements would result in additional OTS enforcement action. Gilbert G. Lundstrom, the CEO and chairman of the board of TierOne Bank, president and chief operating officer James A. Laphen and chief credit officer Don A. Langford understated loan-related losses in the financial statements for the year 2008 to comply with the required minimum capital ratios. According to FAS 114 many of the bank’s loans were deemed impaired, as it was not probable to collect all amounts as contractually due. TierOne’s reported FAS 114 impaired loan balance had increased from less than $4 million as of December 31, 2006 to nearly $186 million as of December 31, 2008. Under Generally Accepted Accounting Principles (GAAP), TierOne was required to assess probable losses associated with its impaired loans and to record those losses in its allowance for loan and lease losses (ALLL). As a valuation reserve, the ALLL is an estimate of uncollectible amounts that is used to reduce the book value of loans and leases to the amount that is expected to be collected. TierOne’s management estimated the ALLL for a key component of the loan portfolio by using the fair value of the collateral underlying these loans. According to GAAP this valuation method is applicable for loans that are collateral dependent. A loan is considered “collateral dependent” if the repayment of the debt will be provided only by liquidation of the underlying collateral, and there are no other available and reliable sources of repayment. By presenting appraisals that were based on stale information and not in line with current market data, management inflated the value of the underlying collateral to conceal non-compliance with the regulations of the OTS. TierOne generally based the valuation on the most recent appraisal in its loan files, but often failed to get updated appraisals, although material deterioration in collateral values was evident. In many cases, the original appraisal report was over two years old. Sometimes discounts, which were determined by an informal committee at the bank, were applied to the dated appraisals. The committee’s rationale for applying any particular discount or for not discounting an appraisal were neither documented nor supported by reliable data. In January 2009, after OTS identified excessive concentrations, deficient credit underwriting and administration practices, and poor board and management oversight, OTS executed a supervisory agreement requiring TierOne to correct these problems. In the summer of 2009, when the OTS began its annual exam, the bank was forced to get a significant number of updated appraisals and to use those appraisals in its loan loss calculations. In the fall of 2009, TierOne disclosed over $130 million in additional loan loss provisions. TierOne was shut down by bank regulators on June 4, 2010 and filed for bankruptcy later that month. In April 2010, KPMG resigned as TierOne’s auditor and withdrew its audit opinion relating to the 2008 financial statements. KPMG partner John J. Aesoph and senior manager Darren M. Bennett failed to scrutinize management’s estimates of the ALLL, although they considered this account to be both a fraud risk and a significant risk of material misstatement in their risk assessment. Moreover, they didn’t obtain appropriate and sufficient evidence supporting management’s estimates of the fair value of the collateral for the bank’s troubled loans. They violated several PCAOB standards, concerning both the audit of internal control over financial reporting and the audit of the financial statements. On January 9, 2013, the SEC charged both Aesoph and Bennett for their roles in the failed 2008 audit of TierOne Bank. Both auditors are subject of public administrative proceedings to determine whether they engaged in repeated improper professional conduct by violating a number of auditing standards. It was set forth by the SEC that auditors are charged with negligent rather than intentional or knowing misconduct in this case. Hearings, initially scheduled for July 1, 2013, took place between October 7 and 11, 2013, and October 28 and 31, 2013. The delay of over 3 months was caused by the medical condition of a counsel of Bennett and uncertainty regarding a government shutdown in early October 2013. The initial decision being due on January 1, 2014, the delay in hearings, complexity of the case and the workload of the presiding law judge lead to an extension of the deadline for issuance of a decision in this case to July 1, 2014. The SEC also charged Gilbert G. Lundstrom, who was the CEO and chairman of the board at TierOne Bank, along with president and chief operating officer James A. Laphen and chief credit officer Don A. Langford to have played a role in TierOne Bank understating its loan-and real estate related losses on September 25, 2012. The management team is alleged to have disregarded information showing that the collateral securing the loan portfolio was overvalued due to the management’s reliance on outdated and inaccurate appraisals, not reflecting actual market conditions. The SEC states that Lundstrom and Laphen knew, or were severely reckless in not knowing, that the loss provisions of TierOne were severely understated and that they made false statements in the periodical filings with the commission. Lundstrom was also charged with giving his son, Trevor Lundstrom, insider information in 2009 about a proposed asset sale between TierOne and Great Western Bank, which Trevor used to buy 210.000 TierOne shares, making an illicit profit of $225.921. The Lundstroms and Laphen settled the case off-court by paying $952.763 and $225.000, respectively. The agreement also excludes them from serving as officers or directors of public companies in the future. Langford decided to litigate his case, the trial is still ongoing. Auditors should have identified the internal control system of the company and tested if the company follows its own policy, especially focusing on the loan appraisal policy, as it represents a high risk area of the audit. TierOne Bank’s loan policy states that appraisals have to be “current”, which was interpreted as “less than a year old” in the 2008 audit. Auditors should have not only relied on a timeframe to determine if an appraisal was current but also looked at underlying market and/or other factors that may indicate the appraisal does not reflect underlying value even though it was less than a year old. This was even stated in TierOne Bank’s appraisal policy expressing that “in a rapidly escalating or deteriorating market, an appraisal value may be valid for only a few months”. Auditors should also have made sure that an eventual delay in the updates of appraisals was sufficiently explained by management.#p#分页标题#e# The key control identified for prevention of a material misstatement of the ALLL was TierOne’s Asset Classification Committee review. It was the key control instance within TierOne’s internal control structure. It failed to sufficiently review TierOne’s calculations regarding the appraisal values and did not produce any written documentation. While the audit work papers identified of the Asset Classification Committee as key control for the ALLL, there is no reference to whether or how the Committee assessed the value of the collateral underlying individual loans evaluated under FAS 114, including any necessary adjustments to appraised values. If one or more material weaknesses exist, the company’s internal control over financial reporting cannot be considered effective. As the results of tests of internal controls determine the extent of substantive procedures, the weak or even non-existent internal control should have initiated more substantive procedures. The higher control risk should have been compensated by a decrease in detection risk.
The audit failure could have been avoided by the auditors if they exercised professional care and professional skepticism. The auditors failed to reflect management’s assertions about the value of the real estate underlying the loan portfolio with appropriate scrutiny. In concrete terms, the auditors should have collected evidence that the process of applying a discount to aged appraisals followed a convincing rationale and was well documented. The process of applying discounts to appraisals should have been understood for the biggest (and/or a number of randomly chosen) loans and it should have been stated whether the discounted amount reflects sufficiently influential factors like the real estate prices in the relevant market. Auditors should therefore have not only relied on management data but also gathered independent evidence supporting the correctness of management’s assertions, making sure it is in line with third-party information.
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