The Securities and Exchange Commission has charged two auditors at KPMG for playing a role in a failed audit of a Nebraska bank that hid millions of dollars in loan losses from investors during the financial crisis and eventually filed for bankruptcy.

The SEC had previously charged three former executives at the bank, TierOne Bank, responsible for the scheme. Two executives agreed to settle the SEC’s charges, and the case continues against the other.

The new charges in the SEC’s case are against KPMG partner John J. Aesoph and senior manager Darren M. Bennett. The SEC’s investigation found that they failed to appropriately scrutinize management’s estimates of TierOne’s allowance for loan and lease losses (known as ALLL). Due to the financial crisis and problems in the real estate market, this was one of the highest risk areas of the audit, yet Aesoph and Bennett failed to obtain sufficient evidence supporting management’s estimates of fair value of the collateral underlying the bank’s troubled loans. Instead, they relied on stale information and management’s representations, and they failed to heed numerous red flags when issuing unqualified opinions on TierOne’s 2008 financial statements and the bank’s internal controls over its financial reporting.

KPMG indicated it plans to defend its executives in the case. “Our partner and senior manager look forward to presenting the facts in support of the work that was performed under the circumstances at TierOne,” said KPMG spokesman Tim Connolly in an email.

According to the SEC’s order instituting administrative proceedings against Aesoph, who lives in Omaha, and Bennett, who lives in Elkhorn, Neb., the auditors failed to comply with professional auditing standards in their substantive audit procedures over the bank’s valuation of loan losses resulting from impaired loans. They mainly relied on stale appraisals and management’s uncorroborated representations of current value despite evidence that management’s estimates were biased and inconsistent with independent market data. Aesoph and Bennett failed to exercise the appropriate professional skepticism and obtain sufficient evidence that management’s collateral value and loan loss estimates were reasonable, according to the SEC.

“Aesoph and Bennett merely rubber-stamped TierOne’s collateral value estimates and ignored the red flags surrounding the bank’s troubled real estate loans,” said SEC’s Division of Enforcement director Robert Khuzami in a statement. “Auditors must adhere to professional auditing standards and exercise due diligence rather than merely relying on management’s representations.” The SEC announced Wednesday that Khuzami will be leaving the agency after nearly four years as enforcement chief.

According to the SEC’s order, the internal controls identified and tested by the auditing engagement team did not effectively test management’s use of stale and inadequate appraisals to value the collateral underlying the bank’s troubled loan portfolio. For example, the auditors identified TierOne’s Asset Classification Committee as a key ALLL control. But there was no reference in the audit work papers to whether or how the committee assessed the value of the collateral underlying individual loans evaluated for impairment, and the committee did not generate or review written documentation to support management’s assumptions. Given the complete lack of documentation, Aesoph and Bennett had insufficient evidence from which to conclude that the bank’s internal controls for valuation of collateral were effective.

The SEC’s order alleges that Aesoph and Bennett engaged in improper professional conduct as defined in the securities laws. A hearing will be scheduled before an administrative law judge to determine whether the allegations contained in the order are true and what, if any, remedial sanctions are appropriate. The judge is expected to issue an initial decision within 300 days from the date of service of the order.