Big Four firm KPMG could potentially face negligence litigation stemming from its audits of New Century Financial, the troubled mortgage company that collapsed last April, according to a report from an examiner for the bankruptcy court.The examiner, Michael Missal, a partner with Washington, D.C.-based law firm Kirkpatrick & Lockhart Preston Gates Ellis, said in a 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 however, disputed the claims in the report. “We strongly disagree with the report's allegations concerning KPMG,” said Dan Ginsburg, a firm spokesman. “We believe that an objective review of the facts and circumstances will affirm our position.”
The examiner's report however also said that a negligence case would be difficult to win.
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 when its accounting problems were exposed.
Missal 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. “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.
“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 Missal believed that those models should have been replaced by better third-party tools by no later than 2006, if not before.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.
The New Century audit comes at a time when memories still remain relatively fresh regarding KPMG’s tax-shelter scandal, in which 16 firm executives 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 to be overseen by a court appointed monitor.
More recently, KPMG agreed to pay $80 million to settle a 2000 shareholder suit lodged against its client, Xerox, which charged the company with inflating its earnings.
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