KPMG Warned Olympus in Accounting Fraud, Then Got ‘Careless,’ Probe Finds

KPMG LLP’s Tokyo affiliate signed off on Olympus Corp.’s 2009 results five days after the auditor confronted its camera-making client over accounting irregularities, according to the findings of a month-long probe.

KPMG Azsa LLC auditors challenged President Tsuyoshi Kikukawa and other executives over more than $600 million in takeover advisory fees and payments on other acquisitions, according to the report of an independent investigation into Olympus’s accounts. KPMG approved the company’s financial statement after an outside experts’ report Olympus commissioned justified the takeover costs.

The failure to uncover the $1.7 billion fraud that took place over more than a decade has damaged Japan’s credibility and highlighted a corporate culture of “yes men,” investigators led by a former judge reported this week. KPMG and Ernst & Young ShinNihon LLC, which took over as auditors, face questions from regulators over their roles in the scandal.

“At the end of the day, it’s the company that pays the fees to auditors,” said Yuuki Sakurai, president at Fukoku Capital Management in Tokyo. “Your business would soon run into trouble if you got a reputation as a firm that goes running to regulators without solid evidence.”

On May 21, just over a week after KPMG Azsa had approved the accounts, Olympus’s Kikukawa visited the firm and told the auditors their contract would not be renewed. KPMG Azsa and Ernst & Young ShinNihon LLC failed to conduct an adequate handover, the panel said.

E&Y Committee

Ernst & Young ShinNihon LLC set up a committee to probe its auditing of Olympus, according to a statement on the accounting firm’s website yesterday. ShinNihon said it plans to release the findings as soon as the group reports.

The independent investigation into Olympus concluded there wasn’t any problem with ShinNihon’s auditing, the accounting firm said yesterday. “There were parts where our explanation fell short and we plan to follow up.”

Japan’s Financial Services Agency is looking into any role the auditors may have played in the Olympus cover-up, Minister Shozaburo Jimi said. “I’d like to see appropriate action carried out on this case,” he said today. KPMG and Ernst & Young combined audit nine of Japan’s 15 biggest companies, including NTT Docomo Inc. (9437) and Honda Motor Co.

“We will fully cooperate with regulators investigating this incident and make efforts to carry on with our business so that we can help develop Japan’s capital market,” KPMG Azsa said in a faxed statement on Dec. 7.

Don’t Publish

KPMG Azsa had told Olympus as early as April 2009 not to publish its May 12 earnings unless the two could agree on the accounting for fees awarded to Axes America LLC in the form of preference shares for the $2.1 billion takeover of Gyrus Group Plc, a U.K. medical equipment company, the independent panel’s report said. The panel vindicated Michael Woodford, who was fired as Olympus’s first foreign president and chief executive officer on Oct. 14 after he confronted the board over the fees, paid to a now-defunct Cayman Islands fund, Axam Investment Ltd.

“The auditing firm did point out that a part of the transaction was unreasonable, thus the checks-and-balances function could have possibly worked,” the report said. However, the auditor “carelessly relied on the outside experts’ report.”

Accounting Change

KPMG Audit Plc in Cardiff, Wales, questioned the preference shares in Gyrus’s 2009 accounts filed to Companies House in the U.K. in March 2010. The firm ceased being an auditor in part because of its client’s accounting for the securities, it said in a letter to directors that was filed to Companies House the following month.

By the time Ernst & Young signed off on Gyrus’s 2010 financial statement at year later, the U.K. company had revised earnings for 2009 because it “incorrectly recorded” the preference shares at nominal value. Gyrus booked the securities in its year-end accounts at $620 million, the same amount it paid to Axam.

Both KPMG and Ernst & Young’s U.K. arms said they weren’t given sufficient information about the identities of Axes or Axam to know whether the payments were to a related party.

The investigators’ report this week traced a web of offshore companies set up by Olympus and a network of mostly Japanese financial advisers that were used to hide 118 billion yen ($1.5 billion) of losses dating back to the 1990s. Olympus last month admitted the fees and more than $700 million written off the value of three other deals were part of its loss-hiding scheme.

Commerzbank, SocGen (GLE), LGT

In a meeting on May 7, 2009, KPMG Azsa told the Olympus executives, including Hideo Yamada and Hisashi Mori, that unless they gave a better explanation of the fees and payments made to offshore funds KPMG Azsa may be forced to resign as auditor, the report said. Yamada and Mori both quit from Olympus’s board last week.

The 185-page report on the investigation also said KPMG Azsa failed to verify whether Olympus’s overseas deposits at Frankfurt-based Commerzbank AG and Paris-based Societe Generale SA in Singapore, and LGT Bank AG in Liechtenstein were genuine. The three banks didn’t respond to KPMG Azsa’s requests for collateral information on the accounts, the report said.

Olympus used the deposits as collateral to extend loans to offshore vehicles that were then used to buy impaired financial assets. The outflow of money was hidden as Olympus accountants instructed the banks not to respond to the auditor’s inquiries on collateral obligations, the report said.

Full Compliance

“We have been fully cooperating with the third-party committee, said Christof Buri, a spokesman for LGT Group in Vaduz, Liechtenstein. “We contacted them in November on our own initiative.” He said the bank had no further comment on the report.

“At all times Commerzbank (CBK) was in full compliance with all relevant laws and obligations and will assist with any possible enquiries by the regulator,” said Margarita Thiel, a Singapore- based spokeswoman. SocGen’s Singapore-based spokeswoman Kate Henley declined to comment.

In 1999, auditors Asahi & Co., which became KPMG Azsa in 2004, discovered Olympus had removed a loss from its books in a practice known as “tobashi” or “to make fly away,” the report said. Olympus unwound that transaction at the auditors’ request, according to the report.

The use of at least 17 Cayman Islands and British Virgin Islands entities and the collusion of a “rotten” core of senior managers helped keep the auditors from the facts, the report said.

To contact the reporter on this story: Mariko Yasu in Tokyo at myasu@bloomberg.net

To contact the editor responsible for this story: Ben Richardson at brichardson8@bloomberg.net

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