Tuesday, August 30, 2005 | The auditor in charge of helping restore the city of San Diego’s financial credibility took a hit to its own reputation Monday when the U.S. Attorney’s Office for the southern district of New York announced a settlement agreement with the firm in connection with the creation and marketing of corporate tax shelters.
The settlement allowed KPMG, the entity, to detach itself from the specific behavior of a group of former executives, eight of whom were also indicted Monday for their roles in the alleged tax shelter scheme. KPMG admitted to wrongdoing as an entity, accepted a $456 million fine, and agreed to outside monitoring of its operations for years to come.
The deal was constructed to allow KPMG – one of the Big Four accounting firms – to survive. Federal officials reportedly feared that the collapse of another of the major accounting firms would leave the profession thin at the top with only three firms capable of handling audits of major corporations.
Arthur Andersen, once the fifth in what was formerly the Big Five, crumbled after being found guilty of one count of obstruction of justice in connection with the Enron accounting scandal.
In San Diego, KPMG has been working to verify the city’s fiscal year 2003 audit, which has been on hold since the discovery of errors and omissions in financial statements in connection with city bond offerings. Without the completion of the audit, the city will remain frozen from public financial markets and, therefore, locked out from the capital needed to complete basic municipal projects such as road repairs and infrastructure construction.
KPMG is expected to survive the Justice Department settlement, although ongoing state investigations and the prospect of criminal trials against its former executives will keep its name in the headlines into the future.
Arthur Levitt and Lynn Turner, two former SEC leaders brought into San Diego to rectify its ongoing legal and accounting problems, told the Wall Street Journal on Monday that they believe the settlement will, in fact, spare KPMG. Levitt and Turner’s primary duty in San Diego is to complete an investigation into alleged wrongdoing by city officials in order to satisfy KPMG’s concerns.
City Attorney Mike Aguirre doesn’t agree that KPMG will survive. In a news conference Monday, he reiterated his desire to have the audit firm working on the city’s 2004 audit work in tandem with KPMG because of “the eventuality of KPMG’s unfortunate demise.”
“Any prudent person under these circumstances that is using KPMG as an auditor, I think, would be hard pressed to say that we put all of our eggs in that basket,” he said.
Aguirre also used KPMG’s settlement as an example for what he believes the city should do in connection with ongoing federal probes into city finances and politics.
The city attorney said he believes the ongoing scandal will so sully KPMG’s reputation that its audit opinions will lose credibility. He asked Monday that the City Council move to employ the city’s long term auditors, Macias Gini & Co., to work with KPMG on the 2003 audit when it returns from recess on Sept. 6. The firm is already working on the 2004 and 2005 financial statements.
Levitt, who shared terse exchanges with Aguirre at a council meeting this month, supported KPMG.
“I think the audit clients will stand by them, because as they survey the field, the alternatives are certainly no better, and hopefully KPMG has moved strenuously to correct the problems of the past,” Levitt, a former SEC chairman, told the Journal.
City Manager Lamont Ewell dismissed Aguirre’s suggestion that Macias Gini engage in the completion of the 2003 financial statement.
“I think it’s a bad idea. I think Macias and Gini have stated repeatedly that they are not interested in coming in and taking over the 2003 audit,” Ewell said. The city manager said KPMG’s problems didn’t concern him because they were in the tax department and unrelated to its auditing practice.
Aguirre said he’s had conversations with Ken Macias, the firm’s founder and managing partner, and believes the firm would be able to step in quickly.
Macias declined to comment on whether or not his firm would want to take part in the 2003 audit.
“It is true that the city has talked to us about that possibility, but we still haven’t finalized anything,” he said in an interview.
According to an Aug. 5 memo from KPMG to the City Council, auditors and city officials have identified more than 30 errors in the city’s 2002 financial statement that will force officials to lower the city’s net assets by at least $642 million – or more than 9 percent of its net assets.
The audit remains incomplete, as KPMG officials won’t certify the city’s books until investigators have access to documents that are being protected by the pension board’s evocation of the attorney-client privilege. A reexamination of the pension system’s annual financial report and the city’s compliance with generally accepted accounting principles could also still impact the unfinished financial statements.
The city’s disclosure problems have attracted an ongoing 18-month investigation by the Securities and Exchange Commission, while officials from the FBI and U.S. Attorney’s Office are probing for possible political corruption in connection with a pension deficit that’s estimated to be at least $1.37 billion.
Aguirre also used KPMG’s settlement as an example of what he’s proposed the city do in settlement talks with the SEC: admit to guilt as an entity in order to move past the investigation, while allowing the federal government to proceed with charges against individuals.
“It is the norm rather than the unusual … in circumstances involving complex cases such as this,” said Aguirre, who reiterated his opinion that former Mayor Dick Murphy, council members and other city officials broke federal securities laws in the preparation and authorization of financial statements and bond offerings.
A separate investigation by a city-hired law firm found the city’s disclosure practices to be faulty, but didn’t find any wrongdoing by city officials. The audit committee led by Levitt and Turner has been hired to reconcile the differences between the two opinions.
They have been silent publicly about the city attorney’s suggestions to bring in Macias Gini and to begin settlement talks with the SEC. However, both were supportive of KPMG on Monday and are investigating some of the very details Aguirre wants to settle on.
The city attorney said he’s crafting a consent decree to be delivered to the SEC by early next week that will ask that the city itself not be fined for its disclosure problems and call for a city-funded remediation plan. The remediation plan, oftentimes part of a settlement with the SEC, would include the replacement of a number of top city officials and an SEC-chosen overseer.
“It’s kind of like having a parole officer on site,” Aguirre said.
The audit committee, which estimates it will complete its work by the end of the calendar year, is expected to include a remediation plan in their final investigative report as well.
Deputy Mayor Toni Atkins was unavailable for comment Monday as the council begins its last week of a three-week recess. When Aguirre first suggested a settlement last week, she dismissed it, likening it to pleading guilty before being charged with a crime.
The council would need to approve any remediation plan put forth by Aguirre. In his press conference, the city attorney said this puts the city in a situation unlike most comparable corporate investigations.
“We have a very serious problem because in most circumstances the board of directors would have resigned given what happened,” Aguirre said. “So you would be faced with a situation where the City Council wouldn’t be there anymore. You would have a City Council that didn’t have involvement in the underlying wrongdoing.”
He said this directly impacts San Diego’s situation.
“This is right now, though, why the council members are deeply conflicted. They are focused on saving themselves,” Aguirre said. “I am focused on saving the city.”
The City Council earlier this month chose to renew the audit committee’s contracts, in contrast to Aguirre’s recommendation that the $800,000-a-month contracts be terminated.
Council members said KPMG and the SEC had endorsed the work of the audit committee and would allow them to complete an independent investigation into alleged wrongdoing in connection with the disclosure issues and the pension system’s deficit.
In response to Aguirre’s securities accusations, council members have said they relied on advice of outside disclosure counsel and city officials in approving bond sales.
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