Big Four firm KPMG could be sued for professional negligence for its audits of New Century Financial and for helping the troubled mortgage company devise accounting strategies to hide the problems that led to its collapse last April, according to a report from an examiner for the bankruptcy court.
The examiner, Michael Missal, said in his 580-page report that KPMG "failed to exercise due care in planning and carrying out its audits and reviews, failed to demonstrate appropriate professional skepticism with respect to management's judgments, and failed to obtain sufficient competent evidence to support its opinions and representations to the company's officers, directors and shareholders."
KPMG disputed the claims in the report. "We strongly disagree with the reports and allegations concerning KPMG," said Dan Ginsburg, a KPMG spokesman. "We believe that an objective review of the facts and circumstances will affirm our position."
The Justice Department is conducting a separate investigation of the case.
New Century Financial, based in Irvine, Calif., at one time was one of the country's biggest subprime mortgage lenders to applicants with suspect or poor credit histories. It imploded one year later when its accounting problems were exposed.
Missal, a partner with Kirkpatrick & Lockhart Preston Gates Ellis, criticized some of the accounting practices that New Century followed on KPMG's advice. "The biggest one by dollar magnitude is that KPMG suggested a change in the methodology that did not comply with GAAP," he said in an interview with WebCPA. "That had to with the repurchased reserves."
One of the tasks he was assigned by the bankruptcy court was identifying whether any causes of action may exist against KPMG, but he is not privy to how the Justice Department will use his report. He was not at liberty to describe his contacts with the Justice Department.
He said he was not always satisfied with the answers he received from the KPMG auditors he interviewed. "KPMG did not agree to cooperate voluntarily," he said. "I was required to get subpoena authority to compel their cooperation."
The report revealed e-mail messages in which a KPMG partner argued with an employee who was concerned about one of New Century's accounting practices as the company was about to file its 2005 annual report. "I am very disappointed we are still discussing this," he wrote. "As far as I am concerned, we are done. The client thinks we are done. All we are going to do is p--- everybody off."
There were also disagreements within New Century about its own valuations. "The investigation revealed strikingly different perceptions within New Century about the technical capabilities and accuracy of New Century's residual interest valuation models," said the report. Missal believed those models should have been replaced by better third-party tools by no later than 2006, if not before. "The examiner concludes that KPMG should not have acquiesced in the continued use of those models, particularly after a 'flaw' in one such model resulted in a $9 million overvaluation of one specific residual interest at Dec. 31, 2005," he wrote.
Missal's report contended that accounting practices at New Century allowed the company to continue to report profits through the second half of 2006, even though it was reeling from problems in the subprime market. New Century originated almost $60 billion in subprime loans in 2006 and now owes creditors approximately $35 billion. The company has said that its creditors would probably recover only about 17 cents on the dollar.
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