Bridging Finance Inc.’s receiver is suing KPMG LLP for $1.4-billion, alleging the accounting firm failed to adequately audit the private debt manager before its collapse in 2021.
In a lawsuit filed with the Ontario Superior Court, PricewaterhouseCoopers Inc., the receiver, alleges that “throughout KPMG’s tenure, the Bridging funds materially misrepresented the value of their assets and financial performance. KPMG negligently failed to detect and report on these misstatements.”
Once a dominant private lender in Canada that attracted 26,000 investors, Bridging was placed under PwC’s control in April, 2021, by an Ontario court. PwC initially tried to sell the company, hoping to use the proceeds to recoup investor money, but has since decided to wind down Bridging and repay investors as its loans mature.
Early last year, PwC estimated that investors will lose $1.3-billion, meaning almost two-thirds of Bridging’s $2.09-billion in assets under management have vanished – one of the largest collapses of an investment manager in Canadian history.
PwC increased that estimate to $1.4-billion in its new lawsuit, and it blames KPMG. ”The Bridging funds are insolvent, and KPMG is liable for the liquidation deficit.” PwC argues the shortfall “would have been avoided if KPMG had conducted the audit competently and in accordance with applicable standards.”
Until now, formal court proceedings related to Bridging’s downfall have targeted other actors. The Ontario Securities Commission is currently pursuing an enforcement case against Bridging’s former chief executive officer, former chief investment officer and former chief compliance officer.
The Globe and Mail has also reported that the Royal Canadian Mounted Police have launched a criminal investigation into the private lender, but it is not clear what aspect of the scandal the RCMP is focusing on, and the investigation may not result in any charges.
Bridging’s receiver, meanwhile, is directly targeting KPMG, seeking damages for breach of contract, negligence and negligent misrepresentation. KPMG started auditing the financial statements of Bridging’s largest fund, then known as the Sprott Bridging Income Fund, in 2016, then took over the auditing role of all of Bridging’s funds by 2019.
“KPMG takes its role and responsibilities as auditor very seriously and stands behind its work as auditor of the Bridging funds. We have never been the auditor for the manager, Bridging Finance Inc.,” KPMG said in a statement.
“KPMG is not responsible for any losses that may have been caused by the decisions and actions, including any alleged fraudulent actions, of Bridging management and others. We will vigorously defend our work throughout the legal proceedings,” the auditor added.
Numerous audit firms have settled claims over the past decade for their alleged roles in scandals. In 2013 Ernst & Young paid $117-million to settle claims related to its role in the Sino-Forest Corp. fraud; in 2015 Coopers & Lybrand paid $240-million to settle legal claims tied to its alleged negligence when auditing Castor Holdings Ltd., a Montreal real estate lender that collapsed in 1992; and in 2017 Deloitte paid $122-million to settle a lawsuit over its audit of Philip Services Corp.
KPMG itself has faced several lawsuits in recent years. In February, the global accounting firm paid an undisclosed sum to settle a lawsuit in the United Kingdom for its audit work on construction giant Carillion, and in March a Dubai court ordered KPMG to pay US$231-million for its poor audit of an infrastructure fund.
The PwC lawsuit alleges multiple ways in which KPMG failed as an auditor of Bridging, such as not detecting alleged wrongdoing and mismanagement by Bridging’s senior officials. PwC alleges “numerous red flags ought to have alerted KPMG to the possibility of wrongdoing.”
The lawsuit devotes a lot of time to two central allegations: KPMG’s assessments of expected credit losses were deficient, and KPMG was far too lenient with how many loans were allowed to defer cash interest payments.
When estimating expected losses and the necessary collateral to protect investors, Bridging used a risk assessment model that allowed for significant judgment from senior management, and was often deficient.
PwC alleges, for instance, that when Bridging would estimate the value of collateral necessary to backstop a loan, senior management would use a Schedule I bank’s expected loss rates for its own loan book. The problem, PwC alleges, is that Bridging made high-risk loans to borrowers who were unable to obtain credit from traditional banks.
PwC’s lawsuit also takes issue with Bridging’s embrace of loans that did not pay cash interest. Known as PIK loans, or “payment-in-kind,” interest on these loans is deferred and added to the total loan value so that it is repaid at maturity.
PIK loans are a common feature of private debt and Bridging permitted them liberally. When the receiver took over, 62 per cent of the funds’ asset value was made up of loans with deferred interest, according to PwC.
The receiver also alleged that many borrowers had deferred cash payments “despite there being no provision in the loan agreement that permitted PIKing interest.” Allowing this, PwC alleges, meant Bridging did not have to recognize certain defaults.
The lawsuit takes particular issue with loans made to Gary Ng, a businessman who had initially borrowed money from Bridging, but then bought 50 per cent of the lender for $50-million. It was later discovered that Mr. Ng had allegedly falsified his collateral for the loans, but instead of pursuing him to recover the funds, Bridging took steps to conceal the issue from its investors.
While investors are estimated to lose $1.4-billion from Bridging’s collapse, the lender made large profits for multiple years. Between Jan. 1, 2017, and Dec. 31, 2020, Bridging earned more than $150-million in management and incentive fees.