Court Denies KPMG's Appeal of Charges by SEC

In a decision dated May 14, 2002, a court of appeals denied KPMG's request for a reconsideration of an independence action brought against the firm by the Securities and Exchange Commission (SEC). The court's decision to back the SEC was especially significant because KPMG's position was supported by the American Institute of CPAs (AICPA).

The SEC charged that KPMG was not independent when it audited a client who purchased turnaround services from a KPMG affiliate in exchange for contingent fees. The turnaround services were provided by KPMG Baymark Strategies LLC in return for a management fee of $250,000 plus a "success fee." The formula for the success fee involved percentages of the client's earnings, disposed inventory and restructured debt.

AICPA testified that SEC's charges were based on a novel interpretation of Rule 302, a part of generally accepted auditing standards (GAAS). In effect, AICPA said, SEC's interpretation "morphs the Rule into something entirely different than what AICPA intended to promulgate." Reasons: (1) KPMG Baymark was not a "member in public practice" because it was not an accounting firm, and (2) SEC's interpretation was based in part on a royalty that Baymark paid KPMG in return for the right to use "KPMG" in its name. AICPA argued that the royalty did not violate GAAS because it was not dependent on the attainment of any specified finding or result of any service.

The court acknowledged that KPMG had not received "fair warning" of the new interpretation of GAAS. But it denied KPMG's request for a reconsideration because it said the SEC had properly used a negligence standard to enforce violations of its own rules. The judge said, "There is no ambiguity here that the Commission on remand would reach the same result. Accordingly, we deny the petition for review."

Another judge disagreed and wrote in a dissenting opinion, "The SEC’s contingent fee finding was clearly erroneous . . . we have no hint that Congress intended the SEC to fill in gaps left by AICPA. It would be another thing entirely if the SEC had its own rule on contingent fees, but all the agency has is its general requirement that accountants be independent."

A KPMG spokesperson was not immediately available for comment. Read the full court decision.

-Rosemary Schlank

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