This is the fourth time in the last two years that a Deloitte firm has run into trouble with the US audit watchdog over audit violations.
In March last year, the board fined and banned the former chairman of Deloitte’s governing body in Brazil and the former CEO and managing partner of Deloitte Brazil for failing to cooperate with a PCAOB investigation into improper alteration of documents and provision of false testimony.
This was followed by fines and bans handed out to two audit partners and Deloitte’s Turkish firm over a plot to enable audit teams to improperly alter their audit documentation ahead of a PCAOB inspection.
Then just two weeks ago, Deloitte Canada was fined $350,000 fine for failing to maintain its independence during three consecutive audits of Canada-based gold mining company, Banro Corporation.
The latest case involved the audit of a Mexican subsidiary of a US listed company. Texas-based EZCORP, which was audited by Deloitte US, was a loan provider with operations in several countries, including Mexico where its largest subsidiary, Prestaciones Finmart, a payroll-withholding lender, was based.
In 2013 and 2014, Finmart accounted for approximately 21% and 26% of EZCORP’s consolidated assets and approximately 23% and 42% of its consolidated pre-tax income.
Deloitte US engaged the services of its Mexican affiliate to perform component audit work in accordance with PCAOB auditing standards.
In 2015, EZCORP was forced to file restated financial statements for fiscal years 2012 to 2014, partly because of Finmart’s misclassification of certain loans. The misclassification had resulted in an understatement of Finmart’s loan reserve and loan bad debt expense.
The three Deloitte Mexico partners – Ricardo Agustín García Chagoyán, José Ignacio Valle Aparicio and Rubén Eduardo Guerrero Cervera (who was a manager at the time) – had all worked on the Finmart audit.
García and Guerrero in the 2013 audit, and Valle and Guerrero in the 2014 audit, assessed Finmart's allowance for loan losses (the total amount that Finmart estimated it would not be able to collect from borrowers) as a significant risk.
In each of the audits, the auditors understood that a critical element of Finmart’s loan reserve calculation was its classification of a loan as “in-payroll” or “out-of-payroll”.
A loan was considered to be in-payroll if the borrower remained a government employee with repayment amounts withheld from his or her paycheck. It was considered out-of-payroll if the borrower was no longer a government employee having amounts withheld.
During the audits, the auditors were aware that out-of-payroll loans carried a much higher risk of non-payment. They were also aware of the importance of whether Finmart was accurately classifying loans as in-payroll or out-of-payroll when estimating its loan reserve.
Yet in each audit they failed to test the accuracy of the classification. Nor did they perform retrospective reviews of the loan reserve and so failed to obtain sufficient evidence that the loan reserve was reasonable.
They also failed to perform procedures relating to Finmart’s internal controls over financial reporting (ICFR) that they claimed to have performed in communications with Deloitte US.
In the 2013 audit, García and Guerrero misrepresented to the US firm that they had evaluated the design and operating effectiveness of 28 specified controls. In fact, they had failed to evaluate the operating effectiveness of all but one of those controls, and also had failed to evaluate the design effectiveness of nine reported controls relating to the loan reserve.
In the 2014 audit, Valle and Guerrero misrepresented in Deloitte Mexico’s final deliverables that they had evaluated the operating effectiveness of controls relating to Finmart’s loan reserve, when in fact they had failed to perform any operating effectiveness testing of Finmart’s loan reserve controls.
When EZCORP restated its financial statements in 2015, it blamed the need to do so in part on Finmart’s reclassification of certain loans as in-payroll when they were actually out-of-payroll. As these misclassified loans involved a far higher risk of non-payment than those subject to payroll withholding, they caused Finmart to understate its loan reserve and loan bad debt expense.
EZCORP also admitted that it had not maintained effective ICFR during the period in question and had failed to understand the extent of the non-performing loans at Finmart as a result of control deficiencies.
All three partners were censured and barred for two years from working with a registered public accounting firm. García and Valle were fined $50,000 each while Guerrero was fined $30,000.
“The quality of cross-border audits depends significantly on auditors of subsidiaries adhering to their commitments to comply with PCAOB standards,” said PCAOB acting director of enforcement and investigations Mark Adler. “Today’s order makes clear that, when auditors fail to live up to those commitments and put investors at risk, the Board will take appropriate action.
“The three Deloitte Mexico partners not only failed to perform appropriate procedures in a critical audit area, but also compounded their failures by telling the principal auditor that they had done work that they, in fact, had not done,” he added. “That sort of misconduct warrants the significant sanctions imposed.”
The three agreed to the sanctions to settle the case without admitting or denying the PCAOB’s findings.