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KPMG, LLP v. Securities and Exchange Commission

United States Court of Appeals for the District of Columbia Circuit
289 F.3d 109 (D.C. Cir. 2002)


Facts

In January 1995, KPMG, LLP (KPMG) (plaintiff), an auditing practice, entered into an agreement with KPMG Baymark, LLC (Baymark), that allowed Baymark to use KPMG in its name and provided Baymark’s four founding principals with loans of $100,000 each, all in exchange for 5 percent of Baymark’s net income, payable to KPMG. During the making of the agreement, the chief accountant of the Securities and Exchange Commission (SEC) cautioned KPMG not to provide any audit services to Baymark’s clients. Despite this warning, Leonard Sturm, KPMG’s engagement partner, introduced Baymark to PORTA, an audit client. PORTA then hired one of Baymark’s principals as PORTA’s chief operating officer. The compensation for the arrangement included a success fee based on accounting practices and profits. Several conversations about the PORTA-Baymark relationship occurred within the KPMG hierarchy, including whether the relationship violated the SEC’s independence requirements as applied to auditors. In late 1995, KPMG’s head of the Department of Professional Practices and the SEC’s chief accountant met and decided that three steps needed to be taken to resolve the independence issue: (1) Baymark had to cease using KPMG’s initials, (2) all of the $100,000 loans needed to be repaid, and (3) the licensing-fee arrangement between KPMG and Baymark needed to be eliminated. The SEC’s chief accountant was never informed about the success fee. KPMG’s chief manager misrepresented the SEC’s awareness of the PORTA situation so that the audit could continue. KPMG did not follow the steps recommended by the SEC’s accountant and proceeded to certify PORTA’s 1995 financial statements. The SEC initiated a cease-and-desist proceeding against KPMG and concluded that KPMG had violated securities rules and engaged in negligent conduct. KPMG challenged the propriety of the negligence standard, claiming that the standard was too vague.

Rule of Law

Issue

Holding and Reasoning (Rogers, J.)

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