SEC Charges FTX Auditor Prager Metis Over Independence Violations

On September 29, 2023, the Securities and Exchange Commission (SEC) announced legal charges against the international accounting firm Prager Metis CPAs, LLC and its Californian counterpart, Prager Metis CPAs LLP (jointly referred to as Prager), for alleged violations of auditor independence rules and for supposedly aiding and abetting their clients in breaching federal securities laws. The complaints pointed to improper conduct over approximately three years, from December 2017 to October 2020, during which Prager was alleged to have included indemnification clauses in engagement letters for more than 200 audit-related assignments, thereby compromising its independence as required by federal securities laws.

Prager’s alleged misconduct involved repeatedly signing engagement letters with indemnification clauses and issuing “accountant’s reports” purporting independence, despite senior partners being notified that such actions jeopardized the firm’s independence. The SEC complaint suggests that many of Prager’s clients incorporated these “accountant’s reports” in their SEC filings, and accuses Prager of not advising its clients about these violations even after being informed by the Public Company Accounting Oversight Board (PCAOB) that such actions were in violation of federal laws concerning auditor independence.

The SEC’s action against Prager gains additional significance considering the firm’s prior engagement with cryptocurrency exchange FTX before the latter filed for Chapter 11 bankruptcy in November 2022. Prager Metis provided audit and tax preparation services to FTX, a notable engagement revealed in earlier court documents. Although the SEC’s complaint did not specifically name FTX, it highlighted “hundreds” of auditor independence violations over a span of nearly three years.

The case underscores the stringent auditor independence framework that prevents an auditor from providing additional services that might pose a conflict of interest. Eric I. Bustillo, Director of the SEC’s Miami Regional Office, emphasized the importance of auditor independence in safeguarding financial reporting integrity and fostering public trust.

The SEC’s complaint seeks a permanent injunction, disgorgement plus prejudgment interest, and a civil monetary penalty against Prager, marking a stern reminder for auditing firms about the critical importance of adhering to federal laws and regulations concerning auditor independence.

Furthermore, the legal scrutiny extends beyond Prager Metis. A recent filing on September 21 revealed that the law firm Fenwick & West, which had previous engagements with FTX, is also under investigation. The plaintiffs argue that Fenwick & West should be held partially responsible for FTX’s downfall due to alleged over-extension in service offerings to the exchange.

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Class Action Filed Against Fenwick & West, LLP, Former Law Firm of FTX, in Connection with Largest Financial Fraud in U.S. History

A class action complaint has been filed against Fenwick & West, LLP (“Fenwick”), a prominent law firm, in the United States District Court, Northern District of California, San Francisco Division, on August 7, 2023. The complaint alleges Fenwick’s involvement in the FTX disaster, described as “the largest financial fraud in US history.”

FTX Disaster Unveiled

The complaint outlines two major schemes allegedly perpetrated by Samuel Bankman-Fried (SBF), FTX Group’s founder, and the FTX Group. The first scheme involved stealing customer deposits and using billions of dollars in customer funds for various purposes, including “to support the operations and investments of FTX and Alameda, to fund speculative venture investments, to make charitable and political contributions, and to personally enrich SBF himself” (Page 2). The second scheme accused the FTX Group of offering and selling securities without proper registration, thereby depriving investors of essential financial and risk-related disclosures (Page 3).

Fenwick’s Alleged Role

Fenwick, headquartered in Mountain View, California, served as FTX US’s principal outside law firm. The complaint alleges that Fenwick provided services to the FTX Group that went beyond legal boundaries, including crafting illegal strategies, setting up shadowy entities, structuring acquisitions to circumvent regulatory scrutiny, and advising on regulatory dodges (Page 4).

FTX’s Collapse and Misrepresentation

The FTX Group’s alleged fraudulent activities led to its implosion, with over $30 billion in value evaporating almost overnight when the FTX Group filed its emergency Chapter 11 bankruptcy petition in Delaware (Page 3). Despite portraying itself as a trustworthy and law-abiding member of the cryptocurrency industry, the complaint alleges that FTX did not segregate customer funds and used them as an interest-free source of capital for private ventures (Pages 5-6).

Potential Recovery for Victims

The class action may be the only avenue for victims to recover any of their damages, as FTX will be involved in federal bankruptcy proceedings for many years without a guarantee of recovery for the victims (Page 3).

The class action complaint against Fenwick & West, LLP sheds light on the complex legal landscape surrounding the FTX disaster. With billions of dollars at stake and allegations of significant legal violations, the case is likely to attract widespread attention in both the legal and cryptocurrency communities.

Image source: Shutterstock


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