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Inquiry puts blame for New Century fall on KPMG

The Baltimore Sun

A sweeping five-month investigation into the collapse of one of the nation's largest subprime lenders points a finger at a possible new culprit in the mortgage mess: the accountants.

New Century Financial Corp., whose failure just a year ago was the start of the crisis, engaged in "significant improper and imprudent practices" that were condoned and enabled by auditors at the accounting firm KPMG, according to an independent report commissioned by the Justice Department.

In its scope and detail, the 580-page report is the most comprehensive document yet made public about the failings of a mortgage business. Some of its allegations echo charges that surfaced about the accounting firm Arthur Andersen LLP after the collapse of Enron Corp. in 2001.

E-mail uncovered in the investigation showed that some KPMG auditors raised red flags about the accounting practices at New Century but that the KPMG partners overseeing the audits rejected those concerns because they feared losing a client.

From its headquarters in Irvine, Calif., New Century ruled as one of the nation's leading subprime lenders. But its dominance ended when it was forced into bankruptcy last April because of a surge in defaults and a loss of confidence among its lenders.

The report lays bare the aggressive business practices at the heart of the mortgage crisis.

"I would call it incredibly thorough analysis," said Zach Gast, an analyst at RiskMetrics who raised concerns about accounting practices at New Century and other lenders in December 2006. "This is certainly the most in-depth review we have seen of one of the mortgage lenders that we have seen go bust."

A spokeswoman for KPMG, Kathleen Fitzgerald, took strong exception with the report's allegations. "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."

The report zeros in on how New Century accounted for losses on troubled loans that it was forced to buy back from investors such as Wall Street banks and hedge funds. Had it not changed its accounting, the company would have reported a loss rather a profit in the second half of 2006.

The report said investigators "did not find sufficient evidence to conclude that New Century engaged in earnings management or manipulation, although its accounting irregularities almost always resulted in increased earnings."

The profits were the basis for significant executive bonuses and helped persuade Wall Street that the company was in fine health when, in fact, its business was coming apart, the report contends.

In bankruptcy court, creditors of New Century claimed they are owed $35 billion. The company's stock peaked at nearly $65.95 a share in late 2004 and was trading at a penny yesterday.

A spokesman for New Century, which is being managed by a restructuring firm under the supervision of the bankruptcy court, said the company was pleased that the report had been published.

The investigation was led by Michael J. Missal, a lawyer and former investigator in the enforcement division of the Securities and Exchange Commission who was hired by the U.S. Trustee overseeing the bankruptcy.

Missal, who also worked on an investigation of WorldCom's accounting misstatements, concluded that KPMG and some former New Century executives could be legally liable for millions of dollars in damages because of their conduct.

In the aftermath of the Enron collapse, Arthur Andersen was indicted and convicted on obstruction of justice charges, but the conviction was overturned by the Supreme Court in 2005.

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