A five-month investigation into the collapse of New Central Financial, one of the nation’s largest subprime lenders, points a finger at accounting firms as a possible new culprit in the ongoing mortgage fiasco. New Century, whose failure just a year ago came at the start of the credit crisis, engaged in “significant improper and imprudent practices” that were condoned and enabled by auditors at the accounting firm KPMG, according to an independent report commissioned by the Justice Department. E-mail messages uncovered in the investigation showed that some KPMG auditors raised red flags about the accounting practices at New Century, but that the KPMG partners overseeing the audits rejected those concerns because they were afraid of losing a client.
New Century, once one of the nation’s leading subprime lenders, was forced into bankruptcy last April because of a surge in defaults and a loss of confidence among its lenders. The report lays bare the aggressive business practices at the heart of the mortgage crisis. KPMG disputes the report’s allegations. The report zeros in on how New Century accounted for losses on troubled loans that it was forced to buy back from investors like Wall Street banks and hedge funds. Had it not changed its accounting, the company would have reported a loss rather than a profit in the second half of 2006.
According to the report, investigators “did not find sufficient evidence to conclude that New Century engaged in earnings management or manipulation, although its accounting irregularities almost always resulted in increased earnings.” Even so, the report contends the profits were the basis for significant executive bonuses and helped persuade Wall Street that the company was in fine health when in fact its business was coming apart. In bankruptcy court, creditors of New Century are claiming they are owed $35 billion. The company’s stock peaked at nearly $65.95 in late 2004, but it was trading at a penny in late March of this year.
The investigation was led by Michael J. Missal, a lawyer, who has had extensive experience in matters of this nature. He was hired by the United States trustee overseeing the case in United States Bankruptcy Court in Delaware. Missal, a former investigator in the enforcement division of the Securities and Exchange Commission, who also worked on an investigation of WorldCom’s accounting misstatements, concluded that KPMG and some former New Century executives could be liable for millions of dollars in damages because of their conduct. According to the report, KPMG auditors had deferred excessively to the lenders. It appears that KPMG was afraid it would lose New Century’s business if its auditors didn’t acquiesce to their client’s demands. New Century and its executives are the subjects of a federal investigation by the Justice Department. Investors have filed numerous civil lawsuits against the company and it appears that KPMG will be a defendant.
Source: New York Times
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