April 2 (Bloomberg) -- KPMG International, which oversees the fourth-largest U.S. accounting firm, was sued by the trustee for bankrupt subprime lender New Century Financial Corp. over claims it failed in its role as “gatekeeper.”

Negligent audits and reviews by KPMG LLP, the U.S. member firm of KPMG International, led to New Century’s collapse, according to lawsuits filed yesterday in state court in Los Angeles and federal court in New York. The suits, filed against both KPMG International and KPMG LLP, seek at least $1 billion in damages.

“Once an auditing firm lacks independence, then their audits aren’t worth the paper they’re written on,” Steven Thomas, an attorney for New Century Trustee Alan M. Jacobs, said yesterday in an interview. “KPMG had a duty directly to New Century and a duty directly to the public. It was acting as a gatekeeper for a company that was at the center of the housing boom.”

New Century, once the second-biggest U.S. subprime mortgage lender, filed for bankruptcy in April 2007 after state regulators revoked its lending licenses and federal officials started two investigations. The company won court approval of a bankruptcy liquidation plan in July that pays unsecured creditors as much as 17 cents on the dollar.

‘Business Failure’

KPMG spokesman Dan Ginsburg said the company hadn’t yet seen the complaint and denied any wrongdoing.

“Any implication that the collapse of New Century was related to accounting issues ignores the reality of the global credit crisis,” Ginsburg said yesterday. “This was a business failure, not an accounting issue.”

More than a dozen shareholder lawsuits have been consolidated in federal court in Los Angeles. The suits accuse New Century of violating securities laws by concealing the company’s deteriorating financial condition. A consolidated complaint alleges KPMG acted fraudulently as it failed to detect accounting and underwriting practices that helped the company deceive shareholders.

KPMG served as New Century’s auditor from 1995, when the company was formed, until April 27, 2007, when it resigned after issuing 12 unqualified audit opinions on the company’s financial statements, according to the New York complaint filed yesterday. The suit is the first to accuse KPMG International of wrongdoing in the New Century case.

“As New Century’s auditor, KPMG failed its public watchdog duty. The result was catastrophic,” according to the complaint.

Dissenters Silenced

KPMG’s audits of New Century violated both professional standards promoted by its international body and regulatory requirements, according to the complaint. Dissenters within the auditing firm were silenced by senior partners to protect the firm’s business relationship with New Century and KPMG LLP’s fees from the company, the complaint said.

One KPMG specialist who complained about an incorrect accounting practice on the eve of the company’s 2005 annual report filing was told by a lead KPMG audit partner “as far as I am concerned we are done. The client thinks we are done. All we are going to do is piss everybody off,” the complaint said.

Ginsburg said this e-mail was taken out of context. The next sentence, which was omitted from the examiner’s report, “indicated that the firm’s national office had already reviewed and signed off on the issue, complying with the firm’s normal procedure,” according to the KPMG spokesman.

KPMG then allowed New Century to file its annual report with the U.S. Securities and Exchange Commission before the audit work was complete, according to the complaint. Ginsburg said this claim was inaccurate.

Loan Growth

New Century increased loan originations from $14 billion in 2002 to $60 billion in 2006, selling many of those mortgages in securities underwritten by banks. In 2005, the company expanded its business and issued $56 billion in loans.

KPMG International, “as the principal, is responsible for the severely reckless and grossly negligent acts of its agent,” according to the New York complaint.

KPMG advised New Century to alter the way it calculated reserves for repurchasing mortgage loans that didn’t meet certain conditions, according to the Los Angeles complaint. New Century’s calculations for required reserves were wrong and violated generally accepted accounting principles, the complaint said.

Mistakes in calculation grew to more than $300 million and repurchase requests soared to $8 billion once New Century’s true financial condition was known, the complaint said. The company could no longer borrow money to finance its lending business and collapsed owing billions.

‘Professional Standards’

“Any claim that we acquiesced to client demands is unsupportable,” Ginsburg said. “KPMG acted in accordance with professional standards in New Century, and we will vigorously defend our audit work.”

Last year, a report by bankruptcy court examiner Michael J. Missal concluded KPMG could be accused of professional and negligent misrepresentation although the firm had possible legal defenses to such claims. The 581-page report, unsealed in March 2008, didn’t conclude that KPMG engaged in fraud.

Thomas, the trustee’s attorney, won a $521.7 million verdict in a similar lawsuit brought by a Portuguese bank against BDO Seidman, the seventh-largest U.S. accounting firm. A jury found in August 2007 that the firm failed to detect a fraud leading to the collapse of a client of Banco Espirito Santo SA, Portugal’s third-largest bank. BDO Seidman is appealing the jury award, said spokesman Jerry Walsh.

The cases are New Century Liquidating Trust and Reorganized New Century Warehouse Corp. v. KPMG LLP, BC410846, Superior Court of the State of California (Los Angeles) and New Century Liquidating Trust and Reorganized New Century Warehouse Corp. v. KPMG International, 09-3144, U.S. District Court, Southern District of New York (Manhattan).

To contact the reporter on this story: Sophia Pearson in Wilmington, Delaware, at spearson3@bloomberg.net.

Last Updated: April 2, 2009 00:36 EDT