Accounting apocalypse: FTX auditor Prager Metis sued by the SEC

Prager Metis, one of the auditors that took care of the books for FTX — and had office space in the metaverse — has had a complaint filed against it for failing to follow rules for certified public accountants. These include getting indemnification clauses so that it wasn’t legally bound to the audits, attestations, and reviews it was providing.

During this time, the accounting firm took in millions of dollars from dozens of different engagements that were improperly conducted, and while this spells bad news for Prager Metis, it could imply that a far bigger shoe has yet to drop for the accounting industry as a whole.

The SEC is moving against auditors

This action against Prager Metis isn’t the first time the government regulator has taken on an auditor this year. In June, the SEC settled with Marcum LLP over its “control deficiencies” in regard to SPACs (Special Purpose Acquisition Companies). Marcum took on roughly 600 different SPACs as their auditor, with 25-50% of those audits showing violations from the auditor. For the 150-300 penalized audits Marcum was ordered to pay a fine of $10 million.

However, the Prager Metis complaint is pushing for more than a relatively small fine for the auditor. Indeed, it’s asking for a permanent injunction from violating the laws and rules that have already been broken, a disgorgement of ill-gotten gains, and civil monetary penalties.

According to Francine McKenna, former lecturer at Wharton School of Business and former auditor, “an indemnification clause in the engagement contract is absolutely forbidden and has been forbidden forever.”

“It violates every tenet of being an auditor,” she said.

Clarity on indemnification

Indemnification simply means that an individual or company is protected against some sort of loss or legal action.

While indemnification clauses are quite common in certain contracts, terms of service, or other obligations, they more or less render an audit, attestation, or review useless due to the fact that part of an auditor’s responsibility is to stand by the work it’s conducted in both a legal and financial sense. This is clearly seen in the downfall of Arthur Andersen after the revelation that Enron had disclosed false financials to it and the company had more or less gone along with it.

Read more: Your guide to the Sam Bankman-Fried trial — starting today

Bigger than crypto

“This has nothing to do with crypto or FTX,” McKenna clarified, “it has do with the fact that they (Prager Metis) were growing and they were doing a lot of stuff that came under the jurisdiction of the PCAOB (Public Company Accounting Oversight Board).”

Prager Metis could indeed be one of many smaller-sized auditors that have included indemnification clauses in their auditing contracts, which could be part of the reason that it’s choosing to fight rather than settle with the SEC.

The concern with how smaller auditing firms are conducting themselves in the wake of the Global Financial Crisis seems to mirror the recent regional banking crisis in the US. Specifically, smaller firms taking on far more risk due to a lack of regulatory oversight and guidance. The ramifications have been harsh for both industries.

“Everybody’s greedy,” said McKenna, “they’re getting these audits as a stamp of approval… Prager Metis were taking on certain types of work, they got clients to indemnify them, everybody was happy with that arrangement, and that’s how they minimized the liability.”

Whether or not the Prager Metis complaint is a shot over the bow to the accounting industry or the beginning of a full-on regulatory assault has yet to be seen. Either way, it’s clear that auditors have a new reason to be spooked, namely their own shoddy work.

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