The Securities and Exchange Commission sanctioned KPMG LLP, two former partners and a current partner and senior manager for improper professional conduct in connection with audit failures involving licensing and advertising revenue in the past audits of Gemstar-TV Guide International Inc.
Without admitting or denying the SEC's findings, KPMG was censured and agreed to pay $10 million to Gemstar shareholders - the largest payment ever made by an accounting firm in an SEC action - to settle the charges. The firm also agreed to conduct training for its partners and managers on qualitative materiality, accounting for multi-element transactions, and consideration of appropriate disclosure related to complex accounting issues, and to adopt a policy requiring more effective consultation between audit engagement teams and the firm's national office in connection with possible restatements. KPMG served as Gemstar's auditor from 1993 until October of 2002.
The order also names Kenneth B. Janeski, a partner in KPMG's Los Angeles office; David A. Hori, a manager in KPMG's Phoenix office; and former KPMG partners Brian E. Palbaum and John M. Wong. Palbaum was the KPMG co-engagement partner for the Gemstar engagement from the June 2000 review through the March 2002 review. Wong was a manager for the Gemstar audit for the fiscal years ended in March from 1993 through 1995, and the engagement partner for the audits of the fiscal years ended in March from 1996 through 2000. Janeski was the KPMG SEC reviewing partner from 1999 through the March 2002 review. Hori was a KPMG senior manager for the Gemstar engagement from late 1999 through the March 2002 review.
Under the settlement, all four agreed, without admitting or denying the charges, to be barred from practicing before the SEC, with the right to reapply after three years (Palbaum), one year (Wong and Janeski), and eighteen months (Hori).
"KPMG resolved this matter with the Securities and Exchange Commission on an amicable basis and to avoid any further distractions in achieving our goal to restore public confidence in the capital markets," KPMG spokesman George Ledwith said.
He noted, "The SEC first filed a complaint against Gemstar's CEO and CFO in June 2003, charging the executives with a widespread and complex scheme to inflate licensing and advertising revenue and to mislead investors about the company's financial performance. In its complaint, the SEC noted that the executives did, in fact, deceive the company's auditors."
Gemstar publishes TV Guide magazine and licenses and sells advertising on an interactive program guide. According to the SEC order, from September 1999 through March 2002, the auditors' conduct resulted in "repeated audit failures" in connection with KPMG's audits of the financial statements of Hollywood, Calif.-based Gemstar. The SEC said that the respondents "reasonably should have known" that Gemstar improperly recognized and reported some $212 million in licensing and ad revenue in its public filings, in violation of generally accepted accounting principles.
SEC director of enforcement Stephen M. Cutler said that the action "holds KPMG as a firm accountable for the audit failures of its partners" and should "reinforce the message that accounting firms must assume responsibility for ensuring that individual auditors properly discharge their special and critical gatekeeping duties."
"KPMG's auditors repeatedly relied on Gemstar management's representations, even when those representations were contradicted by their audit work. The auditors thus failed to abide by one of the core principles of public accounting - to exercise professional skepticism and care," added Randall R. Lee, regional director of the SEC's Pacific Regional Office.
According to the SEC order, KPMG and its auditors knew that Gemstar was recognizing material amounts of IPG licensing revenues from Scientific-Atlanta and TWC even though Gemstar didn't have a contract with the purported licensee, and hadn't received any of the recognized revenue; and Gemstar's receipt of the revenue was contingent on Gemstar's negotiating a contract with, or settling or prevailing in litigation against, the purported licensee. The SEC said KPMG and its auditors also knew that Gemstar was recognizing additional material amounts of IPG licensing revenue from AOL over a 12-month period, even though the contract had an eight-year term and Gemstar hadn't produced sufficient evidence to support its recognition of the revenue over 12 months.
The SEC alleged that KPMG and its auditors knew or reasonably should have known that Gemstar was improperly recognizing IPG ad revenue and that Gemstar was recognizing ad revenue from some transactions even though Gemstar provided insufficient evidence of the advertising's fair value as required by GAAP. Gemstar ultimately reversed the improperly recognized licensing and ad revenue.
The commission also said that KPMG and its auditors knew or should've known that Gemstar's disclosure in its filings regarding the licensing and advertising revenue didn't comply with GAAP or was inconsistent with its accounting for the revenue and the transactions.
Despite indications of improper accounting and disclosure, the SEC said that the auditors issued unqualified audit reports representing that KPMG conducted its audits in accordance with generally accepted auditing standards and that Gemstar's financial statements fairly presented its financial results in conformity with GAAP. The SEC said the auditors unreasonably relied on representations by Gemstar's management and its inside or outside legal counsel, or decided that the unsupported revenues were immaterial.
The SEC said that the auditors' reliance on those representations was unreasonable because the representations "were contradicted by other evidence and contained qualifications that called into question their reliability," and that their materiality determinations were unreasonable because they were based on a quantitative analysis and didn't consider whether the revenues were qualitatively material.
According to the SEC, during Gemstar's audit committee's investigation into potential restatements, information came to light in August 2002 that the local engagement team didn't convey to KPMG's national office, including evidence indicating that senior Gemstar management may have been involved in an intentional misreporting of IPG ad revenue and that Gemstar didn't have sufficient evidence to recognize other IPG ad revenue.
The commission said that KPMG lacked a policy that required the local engagement team to consult with the national office on all new significant issues that had come to its attention - a consultation that the commission said should have led KPMG to consider additional evidence that came to light during the investigation and could have led KPMG "to a more prompt decision" to withdraw its previously issued audit report on Gemstar's 2001 financial statements, which it didn't do until November of 2002.
The SEC has a pending lawsuit against four former Gemstar executives, including former CEO Henry C. Yuen. Back in June, Gemstar agreed to pay a $10 million civil penalty to be distributed to shareholders to settle SEC charges against it. In August, former Gemstar co-president Peter C. Boylan agreed to pay $600,000 to settle an SEC action against him.
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