SAN FRANCISCO (Reuters) - Auditor KPMG KPMG.UL either initiated accounting fraud at New Century Financial Corp NEWCQ.PK or stood idly by as the failed subprime mortgage lender committed fraud in 2005 and 2006, an independent report requested by the U.S. Department of Justice shows.
Once the second-largest U.S. subprime lender, New Century filed for Chapter 11 bankruptcy protection last April 2, and was one of the first major casualties of the current U.S. housing crisis, which has roiled global financial markets. It had been one of the largest U.S. providers of home loans to people with poor credit.
The 581-page report by court examiner Michael Missal concluded that New Century “engaged in a number of significant improper and imprudent practices related to its loan originations, operations, and financial reporting.”
KPMG contributed to some of these accounting and financial errors “by enabling them to persist and, in some instances, precipitating the company’s departures from applicable accounting standards,” Missal concluded.
New Century officials were not available to comment on Wednesday.
“We strongly disagree with the report’s allegations,” KPMG spokesman Dan Ginsburg said in a phone interview. “We believe that an objective review of the facts and circumstances will affirm our position.”
More than 450 companies and individuals who have filed claims against the Irvine, California-based New Century may be able to sue KPMG for professional negligence based on KPMG’s breach of its professional standard of care, Missal wrote.
“In the post-Enron era, one of the lessons should have been that accountants need to be skeptical, strong, and independent,” Missal told Reuters in a phone interview. “You didn’t have any of those attributes here.”
Missal added that creditors might also be entitled to remuneration from New Century officers, whose bonuses were tied to inaccurate financial statements and were sometimes three times what they should have been.
That could result in millions of dollars in recoveries, Missal said.
Missal’s report was submitted to and sealed by the U.S. Bankruptcy Court on February 29. A judge unsealed the report on Wednesday at the request of former New Century employees, who said they could not approve the company’s liquidation plan without more information.
The report details how New Century was “brazen” in increasing its loans and extending them to borrowers who were increasingly unlikely to repay.
The company also lacked internal controls that Missal said were particularly important in a company that dealt with a risky product.
Such controls might have caught “at least seven “wide-ranging, improper accounting practices”, most of which were not in accordance with generally accepted accounting principles, Missal said.
These resulted in the company reporting a profit of $63.5 million in the third quarter of 2006 when it should have reported a loss, the report said.
The company also reported an increase of 8 percent in earnings per share during the second quarter of 2006 when it should have reported at least a 40 percent decline, the report said.
“KPMG contributed to these failings in critical ways,” Missal wrote. “The KPMG engagement team acquiesced in New Century’s departures from prescribed accounting methodologies and often resisted or ignored valid recommendations from specialists.”
Missal said the accounting firm’s most obvious error was suggesting another method for calculating New Century reserves needed to cover potential defaulting loans.
New Century was already underestimating these coming payments when KPMG professionals suggested a new scheme that not only violated the accounting industry’s Generally Accepted Accounting Principles but also exacerbated the situation.
“This is really the origin of the credit crisis,” Missal concluded.
Reporting by Amanda Beck, editing by Peter Henderson & Kim Coghill