An appeals court judge has affirmed that KPMG should not be held liable for malpractice under Illinois law after one of its audit clients acquired a dot-com company and subsequently went bankrupt.
The case involved IT consultancy Whittman-Hart, which acquired US Web/CKS in March 2000, and subsequently changed its name to MarchFirst. Whittman-Hart paid the owners of US Web $7 billion in an all-stock deal, but 13 months after the acquisition it declared bankruptcy.
The trustee for MarchFirst, Andrew Maxwell, claimed that while the acquisition was being negotiated, KPMG approved a statement of Whittman-Hart's fourth-quarter 1999 earnings that it should have known was false. The trustee argued that KPMG should have known that Whittman-Hart had engaged in a form of "round-tripping," in which a company makes a loan to a firm it controls with the understanding that the borrower will purchase services from the lender in an amount equal to the amount of the loan.
The trustee argued that KPMG should not have approved Whittman-Hart's classification of prepaid consulting fees that it had received in the fourth quarter of 1999 as revenue for that quarter, rather than allocating it to 2000. Maxwell contended that US Web would have lost interest in being acquired by Whittman-Hart if it had known of the revenue shortfall for that quarter, and that if the acquisition had fallen through, Whittman-Hart would not have been dragged down by the failure of US Web in the dot-com meltdown. The trustee sought more than $600 million in damages from KPMG.
However, Judge Richard Posner of the U.S. Court of Appeals for the Seventh Circuit ruled against Maxwell and in favor of KPMG. "By swallowing a larger company, and one concentrated in the dot.com business, Whittman-Hart assumed the risk of being injured, fatally as it turned out, by a downturn in that business," he wrote. "It wants to make its auditor the insurer against the folly (as it later turned out) of a business decision (the decision to try to acquire US Web) unrelated to what an auditor is hired to do. Nothing in Illinois law permits such an attempt to succeed."
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