SEC Brings Case Against an Auditor in Connection with a Private Equity Valuation

Background:

• On March 29, 2023, the Securities and Exchange Commission (“SEC”) settled Rule 102(e) charges with a Denver based auditor, Spicer Jeffries LLP (“Spicer Jeffries”) and audit partner Sean Tafaro (“Tafaro”), in connection with their audit of two private funds.
• Tafaro was suspended from practice for one year.
• No concurrent valuation charges were brought by the Commission against the private fund manager, and no allegation of improper valuations has yet been made, however the facts in the case might suggest a parallel case against this adviser might be in the works.
• Rule 102(e) cases against auditors are extremely rare, and the fact that this involves a valuation matter may make this case even more of a rarity.

Key Facts and Allegations:

• Valuation Matter – The two funds in question appear to be private equity funds that purchased securities in two portfolio companies:
  • The securities had certain liquidation preference rights that enabled the funds to receive a multiple of their original investment before other equity security holders received liquidity.
  • The liquidation preference was triggered by the occurrence of a “qualifying liquidation event,” such as a dissolution, bankruptcy, or reorganization.
  • In its internal valuation of the securities, the fund manager assumed that those liquidation preferences were automatically triggered even though no triggering event had occurred.
  • The manager, therefore, incorrectly recorded a significant increase in the value of the funds’ holdings.
    • Analysis – This demonstrates staff’s ability to conduct a sophisticated valuation analysis.

• Audit Failures – The Order suggests that Spicer Jeffries and Tafaro blindly supported the manager’s valuation and issued an unqualified audit opinion without adequately performing their role as GAAP auditors.  Specifically, the SEC states:
  • Spicer Jeffries and Tafaro tested the valuation model only for mathematical accuracy but did not test the underlying assumptions.
  • Spicer Jeffries and Tafaro never developed an independent opinion of the appropriate valuation methodology or an independent view of the associated mark.
  • In an email, Tafaro was asked to “sign off on” a valuation methodology “where we take a Day 1 markup of security [greater than] Transaction Price.”  He responded that he “would have no problem signing an audit opinion” supporting such an approach, but that Spicer Jeffries “would definitely require a write-up…about factors why [sic] the recent transaction price is considered but not equally weighted.”  However, Tafaro never developed such support.
  • Spicer Jeffries and Tafaro did not document their analyses.
  • Spicer Jeffries and Tafaro did not exercise due care, including appropriate professional skepticism, when reviewing the manager’s valuation approach.
  • Spicer Jeffries and Tafaro generally failed to adhere to U.S. generally accepted audit standards and failed to supervise the audit.
    • Analysis – It appears that Tafaro was improperly influenced by this manager to support a problematic valuation.