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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.

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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