New Century Trustee Sues KPMG Over Audits

By DONNA KARDOS, Wall Street Journal

April 1, 2009

NEW YORK -- A trustee of New Century Financial Corp., one of the first major casualties of the subprime mortgage mess that jump-started the credit crisis, is suing the company's auditor, KPMG LLP, and KPMG's international parent, alleging "reckless and grossly negligent audits" were conducted that hid the lender's financial problems and helped accelerate its collapse two years ago.

Legal firm Thomas, Alexander & Forrester LLP filed two suits Wednesday on behalf of the trustee -- one in California against KPMG LLP and another in New York against its parent, KPMG International. The suits allege, among other things, that KPMG LLP assisted in and certified "materially misstated financial statements," and that KPMG's international parent is responsible for "the severely reckless and grossly negligent acts of its agent."

KPMG didn't immediately respond to a request for comment.

New Century, an Irvine, Calif., mortgage lender, had been one of the country's largest mortgage lenders to people with poor credit histories. But after it disclosed accounting errors in early 2007 -- informing shareholders it was losing money rather than making it -- New Century's stock price plummeted 90%. Its outstanding repurchase requests soared to $8 billion and New Century soon collapsed as it was no longer able to finance its lending business.

Creditors, who were collectively owed more than $3 billion, have been expected to receive just pennies on the dollar unless the trustee -- standing in the shoes of the many debtors -- is successful in suing parties it considers responsible for its collapse. The complaint in California asks for no less than $1 billion in compensatory and consequential damages.

The suits filed Wednesday come a year after a court-appointed investigator filed a 550-page report with the U.S. Bankruptcy Court in Wilmington, Del., saying KPMG contributed to some of New Century's "accounting and financial reporting deficiencies by enabling them to persist and, in some instances, precipitating the company's departure from applicable accounting standards."

At the time, KPMG said it strongly disagreed with the report's conclusion.

The investigator, Michael J. Missal, had said at the time that the company might be able to recover money for its creditors by suing KPMG alleging professional negligence and negligent misrepresentation.

In the suits filed Wednesday, Thomas, Alexander & Forrester said e-mails showed specialists within KPMG had tried to point out errors in the company's financial statements, but were silenced by the KPMG partner in charge of the audits "to protect KPMG's business relationship with, and fees from, New Century." Accordingly, the trustee said KPMG lacked the independence that is required by ethical and Securities and Exchange Commission rules.

"They were cheerleaders for management when they were supposed to be cheerleaders for the public interest," Steven Thomas, counsel to the trustee, told Dow Jones Newswires.

The suits -- filed in the Superior Court of California in Los Angeles County and the U.S. District Court in the Southern District of New York -- also allege that KPMG aided and abetted New Century's directors and officers in breaches of their fiduciary duties, saying the auditing firm knew New Century's management was improperly reserving for risks and failing to implement an effective system of internal control over financial reporting.

Among the errors KPMG is alleged to have overlooked were New Century's residual interest asset in the loans it securitized as well as its loan repurchase liability. The suits note that a key component of New Century's accounting -- due to the high-risk lending it did -- "was properly reserving against the various and substantial risks its business model embraced." However, its calculations for required reserves were incorrect and violated Generally Accepted Accounting Principles, according to the suit.

If New Century had been properly reserved, Mr. Thomas said, it "couldn't have gotten into this deep mess because they literally couldn't have gotten the loans they needed to run their business."