The Securities and Exchange Commission has barred two KPMG auditors from public company practice over their role as engagement partner and senior manager on the audit of a failed financial institution in the aftermath of the financial crisis.

The SEC says John Aesoph is barred for three years and Darren Bennett for two for “improper professional conduct” over their audit of 2008 financial statements of TierOne Corp, a holding company for TierOne bank. Their conduct, says the SEC, led to violations of auditing standards set by the Public Company Accounting Oversight Board, indicating a lack of competence to practice before the SEC.

Both Aesoph and Bennett remain with the firm, according to a spokesman, but KPMG had not other comment on the SEC action.

The case surrounds the allowance for loan and lease losses on TierOne’s balance sheet, a number that jumped drastically in 2008 because of sharp deterioration in the real estate market. TierOne was a regional bank that saw a big increase from 2002 to 2005  in its origination of high-risk construction and loan-development loans in states like Nevada, Arizona, Florida, North Carolina, and Colorado. The bank closed nine loan production offices when the real estate market tanked, but the high-risk loans remained on the books.

The Office of Thrift Supervision issued a report in October 2008 calling out TierOne’s allowances for loan and lease losses, saying the bank failed to satisfactorily monitor, assess, and respond to the effect of the weakening markets where it held high-risk loans. Meanwhile the market deterioration only grew worse in the second half of 2008, the SEC says.

Aesoph and Bennett considered the OTS report and the continued strife in the real estate market as they planned their year-end audit, and they identified the allowance for loan and leases as a high risk for misstatement. Ultimately, the firm issued an unqualified opinion on the bank’s 2008 financial statements.

After issuing the clean audit opinion, Aesoph and Bennett discovered two new appraisals that the bank has received before the audit report was issued, which ultimately led to additional loss reserves in the first quarter 2009 financial statements. The SEC says the audit firm did not perform any additional procedures when it learned of the new appraisals to determine whether the new appraisals affected the year-end financial statements.

In early 2010, the SEC says, KPMG learned the bank had not disclosed to auditors an internal analysis from the first quarter of 2009 estimating additional potential loan loss reserves. Soon after, KPMG resigned and withdrew its 2009 audit opinion. OTS closed the bank in June 2010, as the PCAOB was calling out auditors for failing to adhere to auditing standards during the heightened economic strife. 

The SEC’s administrative law judge found Aesoph and Bennett knew or should have known that the allowance called for extra scrutiny because banking regulators had already increased capital requirements on TierOne due to its deteriorating financial condition. The ALJ said the auditors knew TierOne’s management had an incentive to intentionally misstate the allowance to meet the increased capital requirements and prevent an enforcement action from OTS.

The SEC says Aesoph and Bennett violated PCAOB auditing standards in three aspects of their audit of the allowance for loan and lease losses. They failed to to assure the effectiveness of internal control over financial reporting, to perform substantive audit test work, and to perform post-audit procedures. Both auditors are allowed to apply for reinstatement after their bars expire.