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SEC Faults KPMG Audits

Posted on: Friday, 17 February 2006, 12:00 CST

By Andrea K. Walker, The Baltimore Sun

Feb. 17--Two outside auditors found evidence early on of the irregularities that later enveloped U.S. Foodservice Inc. in a billion-dollar accounting scandal, but ignored several red flags and didn't pass on what they uncovered, the Securities and Exchange Commission contended yester- day.

The federal regulatory agency released a report yesterday that accused Kevin M. Hall, 51, and Rosemary K. Meyer, 35, both partners at the Baltimore office of the accounting firm KPMG, of failing to report that the Columbia company recorded rebates from vendors, referred to as promotional allowances, that were either fictitious or inflated.

In some instances, according to the report, the accountants noted suspicious entries in their working papers but later covered up their concerns with liquid white out.

"These auditors had evidence in their hands that could have stopped the fraud in its tracks," Scott Friestad, associate director of the SEC's division of enforcement, told Bloomberg News. "Instead, because they failed to exercise appropriate professional skepticism, the fraud was allowed to continue."

Promotional allowances are a standard form of rebate paid in retail businesses. Food manufacturers pay them to distributors in exchange for shelf space in grocery stores.

But U.S. Foodservice managers used false and inflated payments to boost its profits, resulting in a scandal disclosed in February 2003 that forced its Dutch parent company, Royal Ahold NV, to restate earnings by $1.2 billion.

Federal regulators found that U.S. Foodservice provided auditors with false information by persuading vendors to confirm overstated rebates.

Ahold's chief executive and a number of other higher-level managers lost their jobs, and a number of executives and vendors face trial on a variety of criminal charges, including securities fraud. Ahold recently agreed to pay $1.1 billion to settle a securities fraud class action lawsuit.

The SEC enforcement staff filed yesterday's report in support of a move to start administrative disciplinary proceedings against the accountants.

Meyer couldn't be reached for comment last night. A woman who answered Hall's office phone said that he wouldn't have a comment. A second woman that answered his home phone said he wouldn't be available.

KPMG came out in support of their employees last night.

"Our partners look forward to representing the facts in support of the work that was performed under the circumstances at U.S. Foodservice in 1999," said Tom Fitzgerald, a spokesman for KPMG headquarters office in New York.

The SEC found that when Meyer and Hall raised questions about U.S. Foodservice accounting, they relied on the word of management that all was above board -- even when it contradicted the written evidence they found and statements from third parties.

"Despite these apparent misrepresentations by USF management, Hall and Meyer did not take the necessary additional steps to either clarify these inconsistencies or bring the problems to the attention of USF's audit committee or others," the SEC report said.

The SEC also said that Meyer and Hall relied on third-party brokers to confirm vendor rebates even when those brokers weren't familiar with the contracts set up between the suppliers and U.S. Foodservice.

The pair is also accused of violating professional standards by acquiescing in improper accounting that allowed U.S. Foodservice to overstate its pretax earnings by 18 percent for the six months that ended Jan. 1, 2000. U.S. Foodservice at that point was still an independent company.

U.S. Foodservice was being required to pay penalties to suppliers because they were falling below minimum purchase requirements in sales contracts.

It made $15 million in penalty payments during the first two quarters of fiscal 2000. But U.S. Foodservice did not record those payments as expenses on its income statement, and the accountants required neither that they be expensed nor that management make clear that those expenses were likely to continue, the SEC said.

Meyer and Hall will have to appear at a hearing before an administrative law judge who will determine if the allegations are true.

The judge could censure the accountants or temporarily or permanently bar them from practicing before the commission.

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AHO, AH,

Source: The Baltimore Sun, Maryland

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