Two separate lawsuits were filed yesterday against Netherlands-based Big Four accounting giant, KPMG International, and its U.S. subsidiary, KPMG LLP, alleging that KPMG conducted “reckless and grossly negligent audits” that contributed to the collapse of top subprime lender New Century Financial in April 2007. If successful, these actions would mark the first time a Big Four accounting firm is held legally liable for the actions of its U.S. subsidiary.
According to the New York Times’ Deal Book Blog, the lawsuits were filed on behalf of a liquidating trust formed by New Century Debtors, and alleges that “KPMG failed in its public watchdog duty” and helped cover up “catastrophic” problems at New Century. New Century was the first major subprime lender to file for bankruptcy as a result of the housing downturn nearly two years ago, and is largely credited with triggering a wave of additional bankruptcies that turned the subprime mortgage crisis into a full-scale global credit crisis. At its peak, New Century was the second-largest subprime lender in the United States.
The two lawsuits, one filed in federal court in New York and the other in federal court in Los Angeles, target the parent company and the U.S. arm of KPMG separately. However, their allegations largely overlap. Though he hadn’t seen the complaints, KPMG spokesman Dan Ginsburg issued a statement saying:
KPMG acted in accordance with professional standards in New Century, and we will vigorously defend our audit work. Any implication that the collapse of New Century was related to accounting issues largely ignores the reality of the global credit crisis. This was a business failure, not an accounting issue.
However, the lawsuits cite emails that allegedly show that specialists within KPMG tried to point out errors in New Century’s financial statements but, as we have seen so often in the shakeout from this crisis, higher-ups in the company silenced these objections in an attempt to protect business relationships. And while it is almost certainly true that, had KPMG spoken out about these errors, New Century would have found itself a new auditor that would have gone along with its shenanigans, that loss of business would have been orders of magnitude smaller than the liability KPMG faces in these actions. If KPMG is held liable, it will mean that major financial players will no longer be able to hide behind “group-think” and an “everyone else is doing it” justification to blindly pursue financial gain, whatever the cost to others. And ultimately, realigning incentives so that actors do the “right” thing is one of the most important functions of the law.