Does Deloitte Not Understand FAS 157?

Kohlberg Capital Corp., a publicly-traded business development company, has filed an 8-K that includes a major dig at accounting firm Deloitte & Touche LLP. 

Kohlberg reported that Deloitte gave an unqualified opinion on Kohlberg’s financial statements for the 2008 fiscal year, but that the accounting firm later conducted an internal inspection process “of the methodology and procedures used to prepare the valuations” under FAS 157. As a result, Deloitte requested supplemental information.

Kohlberg says it is cooperating, but that Duff & Phelps has deemed the original information disclosure was sufficient.

The implication, of course, is that Deloitte didn’t know what it was doing, vis-à-vis FAS 157. I can’t say whether or not the implication is legit, because neither Kohlberg nor Deloitte will comment on the situation. Nor do I know what supplemental information was requested.

Odd situation, and must be causing some nervousness at other publicly-traded BDCs that relied of Deloitte for loan portfolio or valuation audits…

Here is the relevant text from Kohlberg’s filing:

Kohlberg Capital Corporation (the “Company”) previously disclosed in its Current Report on Form 8-K/A dated November 9, 2009 and Form 12b-25 dated November 9, 2009 that it was unable to timely file its Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2009 due to ongoing discussions with Deloitte & Touche LLP (“Deloitte”), the Company’s independent public accountants, of the application of certain accounting standards relating to valuation determinations under Statement of Financial Accounting Standards No. 157—Fair Value Measurements (“SFAS 157”) included in its financial statements for the fiscal year ended December 31, 2008 in the Company’s Annual Report on Form 10-K for such fiscal year and its financial statements for the interim quarterly periods ended March 31, 2009 and June 30, 2009 in the Company’s Quarterly Reports on Form 10−Q for those respective periods (collectively, the “Financial Statements”). As previously disclosed, the discussions with Deloitte commenced following an internal inspection process by Deloitte of its audit of the Company’s financial statements for the fiscal year ended December 31, 2008 as a result of which certain questions were raised by the Deloitte employees conducting the internal inspection regarding Deloitte’s documentation of the methodology and procedures used to prepare the valuations reflected in the December 31, 2008 financial statements. As a result, certain questions were then raised by Deloitte regarding the Company’s methodology and procedures for valuing its loan portfolio investments under SFAS 157. As also previously disclosed, Deloitte then requested supplemental information from the Company beyond that which was previously requested by Deloitte and provided by the Company for purposes of its prior review of each of the Financial Statements and preparation of its opinion covering the Financial Statements for the fiscal year ended December 31, 2008. The Company provided such additional information and has engaged in an ongoing dialogue with Deloitte with respect to alternative methodologies and procedures that would be acceptable to Deloitte in valuing the Company’s investments under SFAS 157.

The Company continues to provide additional information to Deloitte as it is requested by Deloitte and continues to review and discuss with Deloitte valuation methodologies and procedures that would be appropriate to meet the requirements of SFAS 157 and fairly reflect the value of the Company’s investments as of December 31, 2008, March 31, 2009 and June 30, 2009. However, after a thorough review of, and ongoing dialogue with Deloitte regarding, the valuation methodologies and procedures that the Company currently believes would be acceptable to Deloitte, to date the Company has been unable to conclude that such alternative methodologies and procedures meet the requirements of SFAS 157 and fairly reflect the value of the Company’s investments as of December 31, 2008, March 31, 2009 and June 30, 2009. Duff & Phelps, LLC, an independent valuation firm, that had provided third party valuation consulting services to the Company’s Board of Directors in connection with the Company’s Financial Statements for the fiscal year ended December 31, 2008 and for the quarterly period ended March 31, 2009, participated in certain of the discussions with Deloitte as part of the ongoing dialogue referred to above and continued to express its view in such discussions that, based upon the procedures performed by Duff & Phelps at the time of its review of the Company’s valuation methodology and procedures in connection with the preparation of such Financial Statements and its understanding of the provisions of SFAS 157, the valuation methodology and procedures used by the Company did not appear to be unreasonable.

Deloitte issued an unqualified opinion on the Company’s December 31, 2008 financial statements, which was included in the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 16, 2009. The Company is not aware of any allegation or belief by Deloitte that the information provided by the Company to Deloitte at the time of the preparation of the Financial Statements regarding the Company’s valuation methodology and procedures was incomplete or inaccurate or omitted any information requested by Deloitte at such time. On December 10, 2009, the Company and its management were advised by Deloitte that (i) the audit report issued by Deloitte accompanying the Company’s financial statements for the fiscal year ended December 31, 2008 in the Company’s Annual Report on Form 10-K for such fiscal year and (ii) Deloitte’s completed interim reviews of the Company’s financial statements for the interim periods ended March 31, 2009 and June 30, 2009 in the Company’s Quarterly Reports on Form 10−Q for those respective periods should no longer be relied upon because Deloitte had changed its position with respect to the appropriateness of the methodology and procedures used by the Company under SFAS 157 to value the Company’s investments as of the end of each of those periods and, as a result, the Company has been informed that Deloitte now believes, based upon such changed position and the additional information provided to Deloitte by the Company following Deloitte’s internal inspection process, that such Financial Statements contain material misstatements with respect to the value of the Company’s investments included therein. Accordingly, the Financial Statements should not be relied upon until the foregoing matters are resolved.

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The Company’s management, the Company’s Audit Committee and Deloitte have discussed the matters disclosed in this filing.

(c) The Company has provided Deloitte with a copy of this Current Report on Form 8−K and has requested that Deloitte furnish a letter as promptly as possible addressed to the Commission stating whether Deloitte agrees with the statements made by the Company in response to this Item 4.02 and, if not, stating the respects in which it does not agree.