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A 500-plus-page tome about what went wrong at New Century Financial � the second biggest subprime lender in the country until its fast descent into bankruptcy last year � has been eagerly anticipated by lawyers across a swath of practice areas. The bankruptcy examiner’s report could be unsealed as early as this week, and plaintiffs lawyers looking for a solvent defendant will be attuned to parts of the document that deal with New Century’s auditors, KPMG. New Century announced in February 2007 its need to restate earnings but didn’t detail what went wrong in the company’s finance department. According to lawyers familiar with the situation, the audit committee of New Century’s board was not told about accounting changes at the company that eventually contributed to the need to restate earnings. However, New Century’s regular auditor, KPMG, was involved in the accounting changes alongside finance department personnel, these lawyers say. That will be relevant to SEC staff attorneys, because a fraud case against former New Century CFO Patti Dodge might be harder to prove if auditors approved or even recommended the accounting changes. The soon-to-be-public document will fuel government investigators, creditors and state attorneys general � and maybe some lucky defense lawyers, if the findings break their way. But it could also prove instructive about the limits of internal investigations that companies now routinely order when faced with financial irregularities, and on which the government routinely relies. After the February restatement, New Century hired Heller Ehrman to conduct an internal probe. But the company filed for bankruptcy April 2, and the court appointed K&L Gates partner Michael Missal as bankruptcy examiner. Heller Ehrman, which had been stonewalled by KPMG, handed over its work to the government and to Missal � who wielded subpoena power. Missal and his colleagues at K&L Gates embarked on a much wider-ranging investigation of New Century, billing more than $12.4 million for its work through the end of January, according to court filings. Heller Ehrman only billed $1.1 million, not including its first few weeks on the job. “It’s like a reporter working on a story who is given an unlimited budget and 10 underlings and told to leave no stone unturned, versus a reporter told to get me everything you’ve got by Thursday,” said former SEC enforcement attorney Christopher Cooke of Cooke Kobrick & Wu, who is not involved in New Century. PRESSING KPMG Events surrounding New Century have been closely watched because of its status as one of the first subprime casualties. But before the housing market fully tanked last summer, the lender’s audit committee did what many other companies have done when faced with possible wrongdoing by their employees: It called Heller Ehrman’s Michael Shepard. Shepard was asked to investigate the events surrounding the February restatement, along with some insider trading issues among top executives. From the outset, Shepard informed the audit committee of a conflict: Heller Ehrman represents KPMG in other litigation, to the tune of half of 1 percent of its revenue, according to court documents. In his declaration, Shepard said he’d raised “the possible contention that Heller Ehrman’s relationship with KPMG would adversely affect objectivity of the investigation into issues involving KPMG, or at least the appearance of objectivity on those issues.” Based on 2006 figures, KMPG represented $2.5 million in revenue for Heller Ehrman. Though the terms of Heller Ehrman’s engagement specified that the firm wouldn’t be able to advise on any possible claims the company had against the auditors, Shepard gave the committee his personal assurance the firm’s KPMG relationship would not limit his ability to “diligently and fairly pursue” all facets of the investigation, because his own reputation would be at stake. That apparently helped close the deal. After Heller Ehrman started work, however, KPMG soon made it clear, according to Shepherd’s declaration, that it wouldn’t share any information about New Century with Heller Ehrman’s team unless issued a subpoena � which Heller Ehrman, of course, had no authority to do. But Shepard said that didn’t stop him from trying to do his job. “In addition to pressing KPMG for information to the best of our ability, we pulled no punches in gathering information about KPMG’s conduct from percipient witnesses at the company,” he said in his declaration. The U.S. bankruptcy trustee cited Heller Ehrman’s relationship with KPMG last summer in objecting to the law firm’s efforts to get paid for the internal investigation, arguing that Heller Ehrman was not the proper firm to have been hired for the assignment. But bankruptcy Judge Kevin Carey awarded the firm its fees without commenting on the conflict issue. New Century filed for bankruptcy in April � less than a month after its audit committee retained Shepard. With Missal’s appointment later that spring, Shepard and his team exited the stage. The company did not disclose whether it had fired anyone after Heller Ehrman made its report. Shepard declined to comment on the findings of his investigation. Lawyers familiar with the probe said Heller Ehrman did a good job, given the circumstances. Heller Ehrman’s caveat about not being able to plot a litigation course against KPMG became academic once New Century entered bankruptcy. One of Missal’s central tasks is to recommend possible claims to creditors. KPMG, which resigned as New Century auditor last year, is represented by Sidley Austin partner Michael Kelley. The L.A.-based attorney referred questions to a New Century spokesman. “KPMG continues to fully cooperate with all investigations regarding New Century,” said Dan Ginsburg. “We are unable to comment further due to client confidentiality.” In past disputes with Missal, KPMG cited its engagement agreement with its former client, which held that New Century’s management was “responsible for ‘adopting sound accounting policies, and for establishing and maintaining effective internal control over financial reporting.’” While shareholder claims against KPMG could be complicated by recent Supreme Court rulings on third-party liability in corporate fraud cases, the SEC will likely be interested in why KPMG personnel did not inform New Century’s audit committee about some of the accounting changes that took place at the company � and whether those accountants knew in-house finance staff hadn’t told the committee, either. Janet Moser, the SEC staff attorney in Los Angeles spearheading the government’s New Century inquiry, would not talk about the case. Nor would Vincent Marella, the Bird Marella Boxer Wolpert Nessim Drooks & Lincenberg lawyer representing CFO Dodge. He did not return several messages seeking comment. Another figure in the middle of the finance mess was New Century’s controller at the time, David Kenneally. His attorney, Los Angeles white-collar practitioner John Vandevelde, said Kenneally is cooperating with government investigators, and with Missal. “He is intent on satisfying people trying to understand what happened at New Century, and why,” Vandevelde said. This article originally appeared inThe Recorder, a publication of ALM. �

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