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KPMG Assessed $41 Million for Failing to Divulge Fraud Revealed in AuditA New Jersey jury has tagged KPMG with a $41 million verdict, finding the national accounting firm was negligent in auditing a ceramic collectibles company that was up for sale. The jury found that KPMG, in advising the would-be buyer, failed to mention large-scale accounting irregularities that undercut the target company's value. An attorney in the case says he believes the verdict is the largest ever against KPMG.
New Jersey Law Journal2008-10-15 12:00:00 AM
A Middlesex County jury on Oct. 10 tagged KPMG with a $31.8 million verdict, finding the national accounting firm was negligent in auditing a ceramic collectibles company that was up for sale.
With interest, the award comes to $41 million.
The jury found after a 24-day trial that KPMG, in advising the would-be buyer, failed to mention large-scale accounting irregularities that undercut the target company's value.
After the $34 million purchase in 2000, the suit charged, the acquirer discovered that the pervasive extent of the irregularities made the new acquisition "worthless or nearly so." The combined company went under 18 months later.
The jury found that KPMG committed professional negligence and negligent misrepresentation. A fraud count against KPMG was dismissed in July.
KPMG spokesman Daniel Ginsburg said, "We do not believe there is a factual basis for this verdict and are confident it will be reversed on appeal. KPMG had issued going concern audit opinions stating there was substantial doubt about the company's ability to continue as a going concern on the very financial statements that plaintiffs relied on."
In 2000, Cast Art Industries LLC of Corona, Calif., entered an agreement to purchase Papel Giftware Inc., of Monroe Township, N.J., a client of KPMG. Both companies made collectible ceramic figurines.
KPMG audited Papel's 1998 and 1999 financial statements, and said they conformed with generally accepted accounting principals. But as Cast Art later learned, Papel had cooked the books for those years: double-shipping orders to customers and booking both invoices as receivables; creating invoices for sales that never occurred and booking them as revenue; grossly understating the reserve for returns on sales; and booking obsolete inventory at full cost to materially overstate the quantity and value of assets.
KPMG maintained it fulfilled its obligation by advising Cast Art that heavy debt made Papel's future as an ongoing concern questionable. KPMG said that it was not obligated to notify Cast Art of the irregularities uncovered during the audit.
The plaintiffs disputed KPMG's narrow view of its duty to the plaintiff, saying it contradicts the accounting firm's own policies.
Cast Art's lead attorney, Michael Avenatti, says he introduced evidence of a training course for KPMG's auditors on how to uncover accounting fraud. It was given by one of KPMG's trial lawyers -- Kelly Hnatt of Wilkie, Farr & Gallagher in New York -- in August 2000, a month before the Papel audit reports were issued.
"It's remarkable, then, that they claim in trial that they don't have an obligation to find fraud," says Avenatti, of Eagan, O'Malley & Avenatti in Newport Beach, Calif.
Cast Art's local counsel, Alan Wasserman, says KPMG was also likely hurt in the jury's eyes for insisting that there was no fraud committed at Papel. "It defied logic. If you had a 10-year-old kid, they would know there was fraud at Papel," says Wasserman of Wilentz, Goldman & Spitzer.
Wasserman says KPMG's credibility was further hurt in the damages phase of the trial, when its valuation expert said comparable companies used to establish a value for Cast Art were all out of business. With his cell phone switched to speakerphone mode, Avenatti called those companies so the jury could hear a live person answer the phone, proving that the firms in question were still in business.
Avenatti says he believes the verdict is the largest ever against KPMG. His firm has made a niche of suing the accounting giant, with half a dozen other suits pending.
Neither Hnatt nor her co-counsel, Joseph Baio of Wilkie, Farr returned calls about the case, Cast Art Industries v. KPMG, MID-L-3295-03.
Superior Court Judge Phillip Paley presided at the trial.