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May 31, 2009

KPMG and PwC face large legal battles Down Under

Australia’s two largest audit firms are
battling huge lawsuits following recent corporate collapses.

Investors in the MFS Premium Income Fund have
launched an A$746 million ($598 million) class action against the
fund’s auditor KPMG Australia for an alleged failure to detect
unsecured loans.

Centro, once the second largest shopping
centre construction company in Australia, is attempting to drag its
auditor PricewaterhouseCoopers Australia (PwC) into an A$1 billion
class action launched against it by shareholders.

Both cases are at a relatively early stage and
are large in the context of Australian lawsuits involving
auditors.

Largest class action

In April, Sydney law firm Carneys
Lawyers filed a claim in the Federal Court on behalf of more than
10,000 unitholders against KPMG and Wellington Investment Capital
Management, the responsible entity for the MFS Premium Income Fund
at the time it ran into trouble. It is the largest class action
filed in Australia’s federal court in terms of number of claimants,
a figure that could grow.

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Two of the respondents to the claim, Andrew
Waters and Michael Andrew, are partners at KPMG, and 10 of the 15
are former directors of MFS Investment Management, including
founder Michael King.

Those managing the MFS Premium Income Fund
funnelled loans to related parties in the MFS group between 2005
and 2007. Most of the loans were unsecured and have not or will not
be repaid, costing investors hundreds of millions of dollars.

Carneys Lawyers partner Arthur Carney said the
compliance plan governing the fund legally requires all loans to be
secured and to meet the approval of unitholders in an extraordinary
meeting. The suit claimed this never happened. Loans also cannot be
made to offshore entities under conditions of the plan, which was
breached.

KPMG audited the fund from 2003 to 2007. The
firm ceased being the auditor from 30 June 2007. Carney said after
the auditor departed “it was open slather”, and directors
transferred hundreds of millions of dollars out of the fund.

“We basically say the auditors had an
obligation to ensure these transactions were in accordance with the
constitution, that they were prudent and that they were in the
investors’ best interests,” Carney told the International
Accounting Bulletin
. “If they weren’t or they had any
suspicions they had an obligation to notify the Australian
Securities and Investment Commission of the irregularities.”

Adding intrigue to this case is the fact that
senior MFS executives and employees, including former chief
financial officer David Anderson and company secretary Kim Kercher,
were formerly employed by the Big Four firm.

“It’s early days yet, and we don’t know, but
we think there is a relationship there,” Carney alleged.

KPMG declined to comment on the case but said
it always conducts audit work in compliance with Australian
auditing standards.

According to Carney, KPMG’s lawyers have
argued that the statement of claim is defective and discloses no
course of action. The firm has legally challenged the claimants to
prove otherwise and both parties will attempt to sort out the
status of the claim before the next court hearing on 30 June.

KPMG Australia is also defending an A$200
million claim for alleged negligent conduct in its audit of
property company Westpoint Group, which collapsed in 2006 with
losses of more than A$300 million.

The claim relates to the firm’s audits of
several Westpoint companies for the years ended 30 June 2002, 2003
and 2004.

A cross-claim?

Australia’s largest audit firm, PwC,
is fighting a potentially costly legal battle with its client
Centro.

On May 27, Centro’s administrators launched a
cross-claim application against PwC, attempting to rope the firm
into a ‘proportionate liability’ defence of an A$1 billion
shareholder class actions brought by the law firms Slater &
Gordon and Maurice Blackburn.

The claim relates to undisclosed short-term
liabilities, which eventually caused Centro’s stock value to
crumble and the company to collapse in late-2007.

Lawyers suing Centro told the
International Accounting Bulletin that the company failed
to account for current and non-current liabilities on its balance
sheet, failed to warn shareholders about off balance sheet
liabilities and failed to warn investors that there was a material
risk the company could not re-finance this debt.

In August 2007, Centro told shareholders it
had no interest bearing current liabilities. In its audit report,
PwC discovered the company had not disclosed A$1.1 billion in
current liabilities, forcing Centro to re-state this amount.
However, this fell well short of the A$2.6 billion of short-term
debt, which caused the construction company to collapse in December
2007.

The suit applies to investors who bought
shares in Centro between August 2007 and February 2008.

PwC was not targeted in the original suit
because lawyers could not find any evidence of wrongdoing by the
firm, according to Maurice Blackburn senior partner Martin Hyde.
This situation could change pending PwC’s defence and if new
evidence emerges.

“In terms of PwC’s liability, we knew that
Centro had got it wrong but we didn’t know the extent to which PwC
were involved,” Hyde said. “We didn’t have the info to be able to
join PwC, but Centro [allegedly] did and Centro have taken that
decision.

“Given it’s such an elementary part of an
auditor’s task to check when debts are due and what the company is
telling you is accurate, I think the liability story in this one is
a very strong one.”

Hyde said PwC has launched a counter claim
against Centro’s directors. The firm has also launched an
application for security of cost to try and force Centro to produce
upfront legal fees in the event the firm wins the case.

“Everybody couldn’t believe it because one
minute you’re the auditor and saying they’re good for this money
and earning A$8 million in fees for doing so, the next minute you
are turning up in court and saying ‘actually, we don’t think you
are good for it’,” Hyde commented.

The firm is preparing its defence for a
mediation sitting with Centro and the lawsuit claimants on 3 July.
PwC has also approached the Australian Securities and Investment
Commission to sever its audit contract with Centro.

This publication was unable to reach PwC for
comment by the time it went to press.

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