A significant lawsuit has been filed against KPMG over claims that “grossly negligent audits” by the accounting giant helped trigger the collapse of New Century Financial Corp., a top subprime mortgage lender, at the start of the U.S. housing crisis. New Century, the largest independent provider of home loans to people with poor credit, filed for bankruptcy two years ago amid mounting customer defaults. Its failure rippled across the U.S. mortgage lending industry, sparking a string of other bankruptcies that roiled financial markets as banks booked losses on billions of dollars in mortgage-linked securities at the heart of the current global financial crisis.
The lawsuit, filed on behalf of a liquidating trust formed by New Century debtors, was filed against both KPMG International and its U.S. arm, KPMG LLP. KPMG is accused of helping cover up “catastrophic” problems at New Century — including accounting and financial errors — that led to its collapse. The complaint alleges that, “as New Century’s auditor, KPMG failed its public watchdog duty.”
The suit demands at least $1 billion in damages. At one point, KPMG “did the unthinkable for a public auditor,” the lawsuit alleges. It claims that KPMG issued an audit report on New Century’s 2005 financial results before its audit was complete, “falsely enabling” New Century to file its annual report with the U.S. Securities and Exchange Commission. Many of the problems at New Century resulted from aggressive business practices that saw the company grow from originating $357 million in mortgage loans in its first year of operation in 1996 to about $60 billion in 2006.
Despite a denial of wrongdoing, a report by a court-appointed bankruptcy examiner found last year that KPMG contributed to New Century’s questionable financial reporting practices through “troubling and puzzling conduct” including its alleged negligence. It is alleged in the suit:
Despite KPMG’s promise that it would ensure that KPMG LLP audit services would comply with professional standards and regulatory requirements, KPMG LLP conducted grossly negligent audits and reviews of New Century that violated both professional standards and regulatory requirements.
Separate suits were filed in federal courts in New York and Los Angeles. It will be most interesting to see how this lawsuit develops. This appears to be a highly significant lawsuit. Other accounting firms will be closely watching what happens in this litigation.
Source: Insurance Journal
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