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April 30, 2008

KPMG US refutes claims it contributed to collapse

KPMG US has spoken out against a report from a US Bankruptcy Court Examiner that suggested the firm contributed to accounting and financial reporting deficiencies at failed subprime lender New Century Financial. KPMG US was New Century’s external auditor from the lender’s formation in 1995 until 27 April 2007, when the Big Four firm resigned soon after New Century filed for bankruptcy protection.

In May 2007, New Century announced its audited 2005 financial statements for the year ended 31 December 2005 should no longer be relied on.

The examiner, Michael Missal, was appointed by the United States Bankruptcy Court for the District of Delaware at the request of the US Trustee Program, the component of the Department of Justice charged with protecting the integrity of the bankruptcy system.

In his 581-page report, Missal alleged the Big Four firm enabled the deficiencies to persist at New Century and, in some instances, precipitated the company’s departure from applicable accounting standards.

The examiner alleged KPMG did not perform its reviews and audits in accordance with professional standards. It is alleged KPMG’s engagement team for New Century and their relationship with the client increased the risk KPMG would not detect material financial mis-statements.

The examiner also alleged KPMG failed to exercise due care by providing erroneous advice to New Century inconsistent with US GAAP; failed to criticise New Century’s reliance through 2006 upon outdated and inadequate internally developed models to value residual interests worth hundreds of millions of dollars; and failed to plan its audits and reviews appropriately in light of the inherent and control risks of the engagement.

The examiner concluded with the allegation that had KPMG conducted its audits and reviews prudently and in accordance with professional standards, the misstatements included in New Century’s financial statements would have been detected long before February 2007. According to Missal, the earnings reported in New Century’s 2005 year-end financial statements were materially overstated in its interim financial statements for the first three quarters of 2006 by at least $7.4 million, $75.6 million and $116.4 million, respectively.

The Big Four firm has rejected the report’s criticism. A spokesperson told IAB: “We strongly disagree with the report’s allegations concerning KPMG and we believe an objective review of the facts and circumstances will affirm our position.”

Timeline of New Century’s corporate decline

• 1995 – New Century Financial is founded as a Delaware corporation and employs KPMG US as its auditor

• 8 February 2007 – New Century’s share price falls 36 percent after the company says it expects to record a net loss for the fourth quarter of 2006

• 2 March 2007 – New Century discloses further concerns about its 2006 financial statements, causing its share price to drop from $14.65 to $4.56 in 24 hours

• 13 March 2007 – New York Stock Exchange files an application with the SEC to delist New Century’s stock

• 2 April 2007 – New Century files for bankrupcy

• 27 April 2007 – KPMG resigns as New Century’s auditor

• 24 May 2007 – New Century announces its audited 2005 financial statements for the year ended 31 December 2005 should no longer be relied on

• 29 February 2008 – Michael Missal delivers his 580 page report on the New Century collapse

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