(January 22 – 18:30 ET) – The U.S. Securities and Exchange Commission has found that one of the big accounting firms compromised its independence in connection with its audit of the financial statements of an unnamed commission registrant. The SEC ordered KPMG LLP to cease and desist from future violations.

This decision comes in the wake of a long-running effort by the SEC to improve auditor independence. The commission stressed that when accounting firms enter into complex relationships with other entities that in turn have relationships with audit clients, persons in charge of making independence determinations must exercise particular vigilance. In this case, the commission says it found instead a lack of care at senior levels.

The SEC’s decision is based on KPMG’s 1995 strategic alliance with a newly-formed financial services company, KPMG BayMark LLC, and its subsidiaries. As part of the alliance, KPMG 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 KPMG a royalty. KPMG also agreed to end each of BayMark’s four individual owners US$100,000 to be used as equity contributions to BayMark and its subsidiaries.

In late 1995, KPMG BayMark Strategies was hired by a commission registrant to provide it with turnaround management. The executive managing director of Strategies, who was also an owner of BayMark, assumed the positions of president and COO of the registrant 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 the registrant, KPMG also audited the registrant’s 1995 year-end financial statements for inclusion in an upcoming annual report.

The commission concluded that these relationships impaired KPMG’s independence from its audit client. Since the “success fee” and “royalty fee” arrangements gave KPMG the right to receive a fee attributable, in part, to the registrant’s financial success, the commission determined that KPMG violated generally accepted auditing standards.

The SEC determined that KPMG acted negligently with respect to maintaining its independence, and it decided that it was appropriate to issue a cease-and-desist order
-IE Staff