In its opinion issued late last week, the Commission said KPMG "acted negligently with respect to maintaining its independence" and that it found "a lack of care at senior levels," by the Big Five firm.

The matter stems from KPMG's 1995 strategic alliance with financial services company KPMG BayMark and its subsidiaries. As part of the alliance, KPMG, then known as KPMG Peat Marwick, granted each of the BayMark entities the right to use KPMG as part of their names and, in return, each BayMark entity agreed to pay Peat Marwick a license, or royalty fee of approximately 5 percent of its quarterly consolidated fee income. KPMG also agreed to lend each of BayMark's four individual owners $100,000 to be used as equity contributions to BayMark and its subsidiaries, according to the SEC.

In late 1995, KPMG audit client Porta Systems hired KPMG BayMark Strategies, a BayMark subsidiary, to provide it with turnaround management. Edward R. Olson, the executive managing director of Strategies, who was also an owner of BayMark, became Porta Systems' president and chief operating officer and directed its turnaround effort in exchange for a management fee of $250,000 and a "success fee" of certain percentages of the registrant's earnings, disposed inventory, and restructured debt. While Strategies was running Porta Systems, KPMG audited the company's 1995 year-end financial statements for inclusion in an upcoming annual report.

The Commission concluded that the relationship impaired KPMG's independence from its audit client and said that KPMG's loan to an officer of its audit client "ran afoul" of independence standards and generally accepted auditing standards that require that auditors and their firms avoid debtor/creditor relationships with officers of audit clients.

In addition, the SEC said that because the success fee arrangement between the registrant and Strategies, along with the royalty fee arrangement between Strategies and KPMG, gave KPMG the right to receive a fee attributable, in part, to Porta Systems' financial success, KPMG had violated a GAAS prohibition against receiving a contingent fee from an audit client.

The Commission also concluded that KPMG violated a rule requiring its audit report to accurately state that the audit was made in accordance with GAAS and that KPMG caused Porta Systems to violate the Commission's reporting requirements, because the financial statements included as part of the firm's annual report weren't audited by independent accountants.

According to a report by The Wall Street Journal, the SEC order overturns an earlier ruling by an administrative law judge who concluded that KPMG violated auditor-independence rules, but said the company shouldn't be sanctioned since it made a good-faith effort to be in compliance.

The Big Five firm reportedly intends to seek a review of the decision, according to The Journal.

-- SmartPros News Staff

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