Last week, I used this space to comment on a survey that concluded audit quality in the U.S. has improved since Sarbanes-Oxley was signed into law in 2002.
I have no doubt that’s true.
However, I also had little doubt that despite the best intentions of SOX and the premium it placed on auditor diligence, that another or several) major accounting scandals would invariably surface.
Sadly, human nature rarely disappoints.
Enter Big Four firm KPMG.
Last week, a five-month independent investigation into the collapse of California subprime lender New Century Financial, alleges that the company’s “imprudent” accounting practices were allowed by KPMG auditors.
The 580-page report revealed that an e-mail from a KPMG auditor had raised a red flag about the accounting practices at New Century, and, moving up the chain of command, consulted the national office which ultimately made the decision to move ahead with the 10-K.
That has a familiar echo.
New Century Financial, based in Irvine, Calif., at one time was one of the country's biggest subprime lenders to applicants with suspect or poor credit histories. In 2006 alone, the company originated nearly $60 billion in subprime mortgages. It imploded one year later when its accounting problems were exposed.
The report chronicled how New Century accounted for the losses on troubled loans it incurred when it was forced to buy them back from Wall Street investment firms and hedge funds.
To be fair to KPMG, investigators did not find evidence to charge New Century with another all-too-familiar term of recent years, “earnings management,” but nevertheless, the accounting irregularities resulted in increased profits.
Subsequently, those increased earnings helped paint a radically rosier picture of fiscal health than actually existed and, in many cases, executive bonuses were predicated on that financial façade.
KPMG disputed the claims and was confident that the firm would be cleared pending an “objective” review of the facts.
For the firm, though, the timing of this thing basically sucks.
The New Century audit debacle comes at a time when memories remain relatively fresh regarding the firm’s tax-shelter scandal, in which 16 executives of the firm were charged with marketing shelters that the IRS claimed allowed clients to avoid paying $2.5 billion in taxes.
As a result, the firm agreed to pay $456 million in a deferred prosecution agreement and be overseen by a court appointed monitor.
Both the profession and the Justice Department have probably learned a thing or two since the demise of Arthur Andersen (I certainly wouldn’t put the total any higher than that). So I doubt we should get used to the phrase “Big Three.”
But many of us have seen this movie before. And the ending is rarely, if ever, uplifting.
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