Big Four accounting firm KPMG has been criticized for allowing mortgage company New Century Financial to change its accounting practices in a way that converted a loss into a profit:
In a sweeping accusation against one of the country’s largest accounting firms, an investigator released a report on Wednesday that said “improper and imprudent practices†by a once high-flying mortgage company were condoned and enabled by its auditors.
KPMG, one of the Big Four accounting firms, endorsed a move by New Century Financial, a failed mortgage company, to change its accounting practices in a way that allowed the lender to report a profit, rather than a loss, at the height of the housing boom, an independent report commissioned by a division of the Justice Department concluded.
The result of a five-month investigation, the report is the most comprehensive and damning document that has been released about the failings of a mortgage business. Some accusations echoed claims that surfaced about the accounting firm Arthur Andersen during the collapse of Enron, the energy giant, more than six years ago.
The 580-page report documents how New Century lowered its reserves for loans that investors were forcing it to buy back even as such repurchases were surging. Had it not changed its accounting, the company would have reported a loss rather a profit in the second half of 2006. The company first acknowledged that its accounting was wrong in February 2007 and sought bankruptcy protection less than two months later as its lenders stopped doing business with it.
Federal law requires that that certain organizations have their financial statements reviewed by an independent auditor. That’s an enormous subsidy for accountants, generally, and big accounting firms in particular. If the standards for independence allow this sort of advocacy, we need to redefine the standards for what constitutes an independent auditor.
I’ve got to admit that I’m skeptical about large auditing companies that have other lines of business. I don’t believe there’s any way to overcome the intrinsic conflicts of interest.
