Orange County Sues Outside Auditing Firm : Finance: KPMG Peat Marwick was negligent in not warning officials of problems that resulted in disastrous investment losses, court papers allege. The firm replies that the county is trying to shift blame for its own mistakes.
Opening a second front in its campaign to recover its disastrous investment losses, Orange County on Wednesday filed a $3-billion damage suit against its former outside auditors, claiming that the accounting firm failed to uncover the problems that led to the largest municipal bankruptcy in U. S. history.
The 78-page lawsuit, filed in U. S. Bankruptcy Court here, alleges that KPMG Peat Marwick either overlooked or ignored what should have been “red flags” to an auditor, including former Treasurer Robert L. Citron’s risky investment strategy, which “differed wildly from those of virtually every governmental investment officer in the United States.”
The county claimed in the lawsuit that its entire bankruptcy could have been avoided if Peat Marwick, the world’s fourth-largest accounting firm, had sounded the proper warnings. Instead, the firm’s auditors wrongly “assured the county that all legal requirements were being met,” the lawsuit states.
The suit signals a renewed legal assault on Wall Street financial houses, accounting firms and lawyers that the county blames for the $1.64 billion in losses it sustained when its investment pool crashed last December.
J. Michael Hennigan, the Los Angeles lawyer spearheading the county’s litigation efforts, said the suit against Peat Marwick was “phase two” of the county’s plan to recover its own losses and the $800 million it needs to repay the cities, schools and other governmental entities that had entrusted their reserves to the county.
“There will be other phases in the coming weeks,” Hennigan promised.
The county is already pursuing a $2-billion lawsuit in U. S. Bankruptcy Court against Merrill Lynch & Co., the Wall Street brokerage that sold billions of dollars worth of exotic securities to Citron. The former treasurer has pleaded guilty to securities fraud charges for misrepresenting the safety of his investments to other pool participants, and to embezzlement for skimming interest from their accounts into a county account. He is scheduled to be sentenced Feb. 23.
Officials with Peat Marwick released a statement in response to the lawsuit Wednesday, saying they plan to vigorously defend the suit and “will prevail.”
“It spotlights the county’s pattern of trying to find others to blame and to pay for the outcome if its own investment decisions,” the statement said.
“The California state Senate, the state auditor and the Orange County Grand Jury have all studied the events leading up to the bankruptcy of the county,” it continued. “All have blamed the county and its officials, not KPMG, for the outcome. The county’s losses are the result of its investment decisions and KPMG did not serve as an investment advisor to the county.”
John R. Miller, Peat Marwick’s director of governmental services, said he believes the county is merely trying to go after the accounting firm’s “deep pockets. It’s an abusive lawsuit.”
Merrill Lynch also weighed in on the lawsuit Wednesday. “We haven’t seen this lawsuit, but what we have seen is a pattern of Orange County officials blaming everyone but themselves for the county’s bankruptcy,” said company spokesman Tim Gilles. Merrill Lynch also vigorously denies the county’s allegations that it extended Citron credit in excess of state constitutional limits, and sold the county inappropriate securities.
The lawsuit against Peat Marwick, which had been expected for weeks, describes in great detail how the accounting firm allegedly missed the warning signs of impending disaster and “repeatedly reported to the county that [Citron’s heavily leveraged investment strategy was] legal.”
The firm, which the lawsuit states took in $6 billion from its worldwide operations in its most recent reporting year, was engaged by Orange County from 1992 to the close of 1994 to ensure that the county’s books were in order.
In bidding for the contract to become the county’s outside auditor, Peat Marwick boasted that it audited more cities and governmental agencies in Southern California “than any other firm, local or international. Our background in the audits of local government provides the county of Orange an experienced resource in such areas as investment practices,” the lawsuit quotes the firm’s proposal as saying.
County leaders relied on these promises when they asked the auditors to report “on problems of risks and internal controls that might threaten the stability of the treasurer’s office,” according to the lawsuit.
But the accounting firm failed to live up to its promises, the lawsuit adds.
The lawsuit cites Peat Marwick’s 1993 audit as evidence of the firm’s alleged professional negligence. In reviewing the county’s investment portfolio for that year, auditors excluded from the analysis any securities whose market value was described as unknown.
By failing to audit these entries, the firm “excluded about 80% of the portfolio’s book value and 100% of the trouble,” Hennigan said.
Other “litigation targets” of Orange County are said to include C. S. First Boston Corp. and Nomura Securities International, prominent firms that sold risky securities to the pool on credit. Shortly after the bankruptcy was filed, the county filed and then withdrew a lawsuit against Nomura, reserving the right to refile it at a later date.
The county is also crafting a case against the New York law firm of LeBoeuf, Lamb, Greene & McRae, the county’s legal counsel, on a controversial $600-million note offering that pumped borrowed money into the county’s fast-collapsing investment pool and left critics complaining of woefully inadequate disclosures.
