Are Auditors Worth It?

Auditing is an expensive proposition for public companies.

Sure, it's a task that must be done, but are auditors really worth the fees they charge?

The New York Times has an interesting article about this.

Draw your own conclusions after reading these excerpts...

ALTHOUGH he had been with the mortgage lender New Century Financial for only two months, Tajvinder S. Bindra had spent a good part of late 2006 and early 2007 pelting the company’s controller and a member of its auditing firm, KPMG, with questions about the company’s accounting.

Frustrated by their responses and staring down a deadline to close New Century’s year-end books, Mr. Bindra, the company’s chief financial officer, told both men that he needed written assurances from KPMG that New Century’s bookkeeping was proper, according to accounts of the discussions.

But KPMG balked. A few weeks later, on Jan. 31, 2007, KPMG and New Century’s own accountants stunned the company’s board by revealing that the lender had incorrectly calculated its reserves for troubled home loans. That mistake was likely to cost New Century $300 million, wiping out all of its profits from the second half of 2006.

Two months later, New Century, one of the largest subprime mortgage lenders in the country, would be bankrupt.

In March, Xerox and KPMG settled a securities lawsuit relating to decade-old accusations of accounting manipulations. And KPMG has been criticized for its audit of the Federal National Mortgage Association, after it was revealed that the company, known as Fannie Mae, had overstated its earnings by billions of dollars over several years.

And, finally, nearly three years ago, federal prosecutors came within an eyelash of filing criminal charges against KPMG over dubious tax shelters it set up for clients, leading to a deferred prosecution agreement and a wrenching internal investigation.

“For KPMG, this comes on the heels of all of the tax-shelter stuff, and they just got rid of having a court-appointed examiner, so this is difficult for them,” said Jack Ciesielski, editor of The Analyst’s Accounting Observer, a trade publication.

AMONG the “Big Four” auditing firms, KPMG is the smallest. Yet it is the go-to auditor for banking and financial services firms and real-estate investment trusts like New Century, according to Audit Analytics, an independent research firm. Deloitte & Touche and Ernst & Young also have many financial services clients.

KPMG is the auditor for such prominent mortgage players as Wells Fargo, Citigroup, HSBC Finance, Countrywide Financial and Thornburg Mortgage, according to an examination of annual reports.

Those relationships put KPMG in a potentially vulnerable spot as authorities increased their scrutiny of the subprime business. The Federal Bureau of Investigation has said it has 17 continuing investigations of possible corporate and accounting fraud related to subprime lending. That number, the F.B.I has said, is likely to increase.

“The Justice Department learned from its prosecution of Arthur Andersen that threatening entire firms jeopardizes our system of private auditing,” said Lawrence A. Cunningham, a professor at the George Washington University Law School. “What’s vital is that individuals be held responsible for wrongdoing.”

A MORE likely threat to auditing firms and mortgage companies could be civil, rather than criminal, lawsuits. Shareholders have already filed a raft of lawsuits against lenders that failed or whose stocks have dropped sharply. In some cases, shareholders are trying to add the auditors as defendants.

In January, New York City and New York State pension funds that are leading a class-action lawsuit against Countrywide added its auditors, KPMG and Grant Thornton, as defendants. KPMG declined to comment on the suit. A spokesman for Grant Thornton said the firm was confident it would be dropped from the suit because it had not audited Countrywide for four years.

Last week, liquidators of two hedge funds run by Bear Stearns sued the bank and its auditor, Deloitte & Touche. They contend that the firms hid the true financial risks and health of the funds, which invested in mortgage-linked securities. Bear Stearns declined to comment, and, in a statement, Deloitte said that the suit was without merit and that the firm intended to defend itself.

It is unclear whether the creditors in the New Century bankruptcy will try to recoup losses from KPMG. Even the court examiner, Mr. Missal, notes in his report that creditors of New Century could pursue negligence claims against KPMG but that such a case could be hard to win.

Even if KPMG is safe from large damages and a criminal prosecution, Lynn E. Turner, a former chief accountant at the S.E.C., said the findings were still troubling.

“The examiner cites different pieces of evidence that do raise concerns about whether or not you had an honest-to-goodness independent audit going on,” Mr. Turner said.

For its part, KPMG says that it faithfully carried out its professional duties.

“It is very easy — and totally unreasonable — to look at decisions made in 2005 or 2006 through a 2008 lens,” said Ms. Fitzgerald, the KPMG spokeswoman. “The full record shows that KPMG acted in accordance with professional standards. We will vigorously defend our audit work in the appropriate forum, which will allow for a complete hearing of the facts.”