New Century liquidators sue KPMG for $1bn

By Jennifer Hughes in London - Financial Times

April 1, 2009

KPMG is being sued for $1bn by the liquidators of New Century, the collapsed subprime lender, in the first big case against an auditor arising from the current financial crisis.

In a court filing on Wednesday, lawyers for New Century’s liquidators claimed that KPMG “assisted in the misstatements and certified the materially misleading financial statements” filed by the lender. They claim KPMG was responsible for its collapse because it allowed the lender to use inappropriate accounting that led it to underestimate the provisions it needed to cover bad loans. This made its position look better and gave it access to more funds.

“If the financial statements were accurate and its reserves correct, New Century could not have have got the loans to expand as it did,” said Steven Thomas of Thomas, Alexander and Forrester, lawyer for the liquidating trust, told the Financial Times.

A KPMG spokeswoman said the firm had not yet seen the complaint but that it would “vigorously defend” its audit work.

“Any claim that we acquiesced to client demands is unsupportable,” she said. Any implication that the collapse of New Century was related to accounting issues ignores the reality of the global credit crisis. This was a business failure not an accounting issue.”

New Century’s collapse in April 2007 was considered a harbinger of the current economic crisis. The lender, which grew rapidly in the boom years, made home loans then sold them on. It ran into trouble over a spike in problem loans which led it to struggle with funding.

Prior to its collapse, New Century warned it was investigating accounting irregularities that would result in a need to restate its 2006 earnings. It then warned in May 2007 that it might need to restate 2005 numbers too.

Wednesday’s complaint claims that KPMG “silenced” questions raised by its own experts for fear of upsetting its client. One staffer on the account queried a particular accounting treatment on the eve of the deadline for New Century’s annual filing. However, John Donovan, KPMG’s lead audit partner on New Century, responded by e-mail to his colleague and told him: “As far as I am concerned we are done. The client thinks we are done. All we are going to do is piss everybody off.”

In 2006, KPMG came under pressure from New Century management to sign off its audit and did so even though it knew it had not fully completed its work and that its staff were still waiting on documentation from the client, the complaint alleges.

Auditors are braced for a series of lawsuits arising from company collapses in the current financial crisis.

The biggest firms are still dealing with claims from the wave of accounting frauds uncovered earlier this decade. Last week, Ernst & Young paid $109m to settle claims, without admitting liability, over its audit of HealthSouth, the healthcare group charged with a $2.7bn accounting fraud in 2003.

Auditors have historically tended to settle rather than facing a full legal battle. However BDO Seidman, the US arm of the fifth biggest global accounting network, is currently appealing a $521m judgement against it for its audit of Banco Espirito Santo. It claims the award would break the firm.