Until recently the sub-prime mortgage meltdown had left the auditors unsullied. By contrast, in 2001 Arthur Anderson, one of the then Big Five public accounting firms, was charged with aiding and abetting Enron’s fraudulently creative bookkeeping. Both firms went under in 2002.
Now a 581-page report by court-appointed investigator Michael J. Missal spotlights KPMG, one of the remaining Big Four. The charge is that KPMG was too ready to stretch the accounting rules for New Century Financial Corporation, a giant California mortgage company—whose bankruptcy on April 2, 2007 heralded the current financial crisis. 
New Century made money by originating as many mortgages as possible; its training facility was known as CloseMore University. Risk was all but ignored. As Missal put it in an interview with Reuters, “The predominant standard for loan quality was whether the loans New Century originated could be initially sold or securitized in the secondary market…[which] created a ticking time bomb that detonated in 2007.” The report focuses on how KPMG signed off on New Century’s piddling $14 million in reserves held against what turned out to be billions of dollars of “repurchases.” These were mortgage loans returned to the company by Wall Street securities firms because the borrowers (many with “option ARM” mortgages) were failing to make required payments on time, or at all. In March of 2007 an outside risk evaluator, RiskMetrics, pointed out New Century’s untenable position. In response, New Century’s creditors closed the spigot. The result: the April 2nd bankruptcy. KPMG protests the unfairness of all this. Still, there can be little question that KPMG has suffered a series of embarrassing scandals in the past decade. - In the years before 2000, Xerox engaged in deceptive accounting practices by booking multi-year leases of equipment as outright sales, thus overstating revenues by $3 billion and income by $1.5 billion. When this deception came to light, shareholders sued. KPMG, the auditor, was cited for complicity and has been assessed over $100 million in penalties.
- From 2001 to 2004, mortgage giant Fannie Mae (FNMA) used “cookie-jar” and other accounting gimmicks to smooth earnings and meet bonus-pay targets, according to the SEC. When FNMA’s officers were then fired, their replacements sued KPMG, the auditor, as a party to the scam. As to its incentives, KPMG made over 80 percent of its $53 million in 1998-2003 fees from FNMA for non-auditing services.
- In 2005 KPMG admitted to promoting tax fraud and agreed to pay penalties of $456 million. Its aggressive “loss-generating” schemes for high-income U.S. taxpayers had spawned $12 billion in bogus losses between 1996 and 2003, costing the U.S. Treasury an estimated $2.5 billion. The fraudulent tax-shelter gambits included dummy investments and artificial losses on currency swaps to the Cayman Islands.
As with the bond ratings firms (Moody’s, S&P, and Fitch), the appearance is that KPMG was earning as much or more from consulting as it was a from auditing firms per se. No wonder a partner of the firm would tell his own auditors, in e-mail cited by Missal, to lighten up with an audit because “we are at risk of being replaced.” Will KPMG now go the way of Arthur Anderson? Probably not. As one research article put it recently KPMG may be “Too Big to Fail” on antitrust grounds. In other words, the government is not likely to press for sanctions that would leave only a Big Three standing. Instead enforcement is likely to focus on misbehaving individuals within the partnerships, not the larger firms themselves. Indeed, this would seem a feasible approach, in that the Big Four are more like loose agglomerations of local accounting firms around the world than fully integrated companies. In any case, Missal suggested in his report to the U.S. Bankruptcy Court that creditors of New Century should consider suing KPMG for negligence.
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