ORANGE COUNTY IN BANKRUPTCY : Accounting Firm Failed to Detect Fund’s Problems

KPMG Peat Marwick--one of the giant accounting firms that got into trouble for failing to flag the problems that led to the nation’s savings and loan debacle--had been asked for the past two years to pay special attention to the Orange County treasurer’s office.

But a December, 1993, letter accompanying last year’s audit said the firm detected only one problem--one that already had been spotted years earlier, involving wire transfers on behalf of county departments.

There was not a word about Treasurer Robert L. Citron’s investment practices, which a year later led the county into the nation’s biggest municipal bankruptcy filing ever.

This year’s audit, which normally would have been made public by this time, has been held up at the request of the county.

Peat Marwick spokesman Kevin Kelly said Friday that the firm stands by its work for the county. He said Peat Marwick was asked only to look at the county’s investment portfolio--not Citron’s policies.

But Kelly acknowledged that as part of the firm’s regular audit of the county, “when you conduct an overall audit, you do look for weaknesses in controls.”

The California Board of Accountancy, which regulates accountants and auditors, may look into Peat Marwick’s county audits, board executive officer Carol Sigmann said Friday.

“At this point, we’re gathering facts. If the facts indicate that it’s appropriate to investigate them, we will investigate,” Sigmann said. “I would say any firm, auditor or accountant involved in this process is going to be under scrutiny until this whole matter is resolved.”

Although none have actually filed suit, lawyers for investors in the county’s bankrupt pool and for buyers of county bonds are beginning to talk about Peat Marwick as partly responsible for the county’s financial calamity and a potential “deep pocket” defendant in a lawsuit.

In its capacity as the county’s independent auditor for the past three years, they argue, Peat Marwick should have paid greater attention to the treasurer’s investment operations, which previous internal audits had found to be marred by violations of state laws and regulations.

And by the time Peat Marwick began its latest audit, a political rival of Citron had publicly claimed that the treasurer’s investment strategies had lost $1.2 billion of taxpayers’ money.

“You can bet that we will be examining this . . . and the extent that problems were ignored,” said Mel Weiss, an attorney who has filed a class-action suit on behalf of bondholders who purchased a series of Orange County bonds sold last summer.

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Officials of the worldwide accounting firm have contributed more than $9,000 to the campaigns of incumbents and candidates for the Board of Supervisors over the last 15 years. Those donations--calculated in a review by The Times of campaign finance reports--raised questions among independent analysts about whether the auditors had kept at arm’s length from county officials whose operations they were auditing.

“Independent auditors are supposed to be independent--in fact and appearance,” said John Larsen, a USC professor of accounting. “This appears to be a monetary form of schmoozing.”

However, Herb Finkston, director of professional ethics for the American Institute of Certified Public Accountants, said there are no professional guidelines prohibiting such contributions.

“You can’t exclude an auditor from the political process simply because he’s an auditor,” Finkston said. “In any event, we’re talking about appearances. It’s really nothing more than some evidence of a relationship which is inconclusive.”

Kelly declined to say whether the firm had a critical internal audit of the treasurer’s office for 1991 in hand as it conducted its audit in 1993, the year that the internal audit was issued.

“We were not engaged to do an investigation into internal controls of the treasurer’s office,” he said. “We stand by our management letters issued for fiscal years 1992 and 1993. They’re appropriate and consistent with an independent accountant’s professional obligations.”

County Auditor Steven A. Lewis said he made a “special request” that Peat Marwick take a closer look at the investment portfolio in its 1993 and 1994 county audits. Despite the request, Lewis said, the auditors’ findings do not contain a thorough analysis of the investment pool.

“I didn’t contract with them to make a detailed analysis of the portfolio. On the other hand, because there had been concerns, you just say, ‘Look at this particular area’; then they spend a couple of extra hours on it,” he said. “For the last two audits, that has been a special request.”

Lewis said he wanted “to be fair” to Peat Marwick, but noted that independent auditors are supposed to assess internal controls.

“Just like I do in my audit, they have to assess internal controls,” he said. “. . . They have professional standards that they have to go on, just like I do.”

This is not the first time the thoroughness of Peat Marwick’s audits has been questioned in Orange County.

The firm paid $200,000 in October to settle a claim that it failed to discover a multimillion-dollar embezzlement by Stephen Wagner, the former finance director of the Newport-Mesa Unified School District. Under Peat Marwick’s watch--or that of firms it later bought--more than $1.7 million disappeared, said Michael Fine, district director of fiscal services.

“The audit wasn’t adequately planned, and the sample size wasn’t adequate” to catch the problems, Fine said. Peat Marwick--which acted as the district’s outside auditor from June, 1982, to July, 1988--settled with Newport-Mesa before a suit was filed, admitting no wrongdoing.

After discrepancies in the district’s books were discovered, Wagner was arrested and ultimately convicted of embezzling a total of $3.7 million. He is still in prison.

The New York-based firm, one of the “Big Six” accounting practices, also has repeatedly been taken to task for failing to catch problems as the nation’s savings and loan scandal unfolded.

Peat Marwick agreed to pay the federal government $185.6 million in August to settle allegations that its work played a role in the failure of several savings institutions dating back to the 1980s. Two of the failed financial institutions were in Orange County: Costa Mesa-based Pacific Savings Bank, seized by regulators in 1989, and Orange-based Ramona Savings & Loan, taken over in 1986.

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Accounting and legal experts say Peat Marwick, one of the world’s largest accounting firms, should have spotted the problems in Citron’s office in the course of normal auditing practices.

While they agree that no auditor is expected to act as an investment adviser, they say part of an auditor’s responsibility is to look at the potential risks for an organization’s major assets--in Orange County’s case, its multibillion-dollar investment pool.

Auditors should, as a matter of practice, take into account every bit of internal documentation that would point to problems, including previous internal audits, these experts said.

“You would think they would take a look at what the risks were,” said Larsen, who specializes in ethics and professional standards for accountants.

Some accounting experts said the competition for clients has caused auditors in general to go easy on their clients in hopes of keeping them happy--and getting their contracts renewed, though none had a basis for raising such allegations against Peat Marwick for its work in Orange County.

“I think that the environment hasn’t been so good,” said Don Kirk, former chairman of the Financial Accounting Standards Board and recently the chairman of a panel that looked into the independence of auditors for the American Institute of Certified Public Accountants.

“The competition for clients sometimes causes them to maybe lose sight of their public responsibility,” Kirk said.

Weiss, the securities lawyer, said that it would be unconscionable for an auditing firm not to review internal controls or violations of investment rules, regulations and policies.

“The import here is that the auditors say that they don’t have the responsibility that the rest of us think they have,” Weiss said.