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.
The profit was important because it allowed executives to earn bonuses and convince Wall Street that it was in fine shape financially when in fact its business was coming apart, the report contended. But the report stopped short of saying that the company “engaged in earnings management or manipulation, although its accounting irregularities almost always resulted in increased earnings.”
A spokeswoman for KPMG, Kathy Fitzgerald, denied the accusations. “We strongly disagree with the report’s conclusions concerning KPMG,” she said. “We believe an objective review of the facts and circumstances will affirm our position.”
A spokesman for New Century, which is being managed by a restructuring firm brought in early last year, said the company was looking forward to its liquidation plan.
The report is the result of a five-month investigation by Michael J. Missal, a lawyer and former investigator in the enforcement division of the Securities and Exchange Commission who was hired by the United States Trustee overseeing the New Century bankruptcy. Mr. Missal concluded that KPMG and some former New Century executives could be legally liable for millions of dollars in damages because of their conduct.
“I saw e-mails from the engaged partner saying we are at the risk of being replaced,” Mr. Missal said in a telephone interview about a KPMG partner assigned to work on the audit of New Century. “They acquiesced overly to the client which in the post-Enron era seems mind-boggling.”
New Century was the first large mortgage company to fail and its quick demise marked the beginning of the end for the heady era of cheap money that helped home prices soar. While markets improved for a few months after the company sought bankruptcy protection, they came undone last summer after the implosion of two hedge funds at Bear Stearns that invested heavily in securities backed by the kind of subprime mortgages that New Century specialized in making.