KPMG Faulted on Handling of Polaroid Financial Reports

A federal bankruptcy examiner in USA has criticized KPMG for not being vigilant enough in forcing Polaroid to report bad news on its financial statements before the company filed for bankruptcy in 2001.

The examiner, Perry M. Mandarino, filed the report in Federal Bankruptcy Court in Delaware after a bankruptcy judge rejected a request by KPMG that the report be kept confidential, at least until parties to the case could review it and seek changes.

At issue were questions of when Polaroid's deteriorating financial situation should have forced it to take certain steps that would have made its financial statements look less healthy.

Those steps included writing off Polaroid's deferred tax asset, an asset that reflected the value of the tax savings it would realize from past losses when, and if, it earned taxable income in the future. The asset had to be written off once it became unlikely that such profits would materialize.

Also, there was the question of when Polaroid should have switched long-term debt to short term, reflecting the likelihood it would default, and whether KPMG should have issued a “going concern” qualification to its opinion of Polaroid in the audit of 2000 financial statements.

Mr. Mandarino said KPMG seriously considered doing that, but decided against it after Polaroid's chief executive went over the head of the audit partner and spoke to KPMG's chief executive.

A spokesman for KPMG, Tim Connolly, issued a statement saying, “KPMG remains confident that it acted appropriately at all times and stands by its actions in this matter.”

The examiner was appointed at the request of shareholders who argued that Polaroid had wrongly written down assets and reclassified debts in 2001. The company, they said, was trying to make its financial situation look worse and thereby justify the filing of a bankruptcy petition.

The examiner rejected those claims and in several cases concluded the opposite: that Polaroid should have taken steps earlier to show its perilous financial condition and that KPMG should have forced it to do so.

An important issue in early 2001, when KPMG was completing the 2000 audit, was whether Polaroid would be able to renegotiate its debt. It was then in the process of obtaining repeated short-term waivers for violations of debt covenants, but the company assured the auditors it thought it could arrange a refinancing.

It was then that Gary DiCamillo, then Polaroid's chief executive, went over the head of the KPMG partner in charge of the audit and appealed to Stephen Butler, then the chief executive of KPMG, the examiner reported. Mr. DiCamillo told the examiner that Mr. Butler told him the refinancing issue was the critical one.

The examiner said that Mr. Butler, who has since retired from KPMG, declined to speak to him about what had happened. He did not cite any evidence indicating whether Mr. Butler had intervened to influence the audit.

The examiner concluded that it would have been appropriate for the auditor to qualify the financial statements, and he criticized KPMG's stated reliance on a verbal opinion from a Polaroid adviser at its investment banking firm, Dresdner Kleinwort Wasserstein, that there was a “90 percent-plus” chance that the company's debt would be restructured.

The examiner said there was some question whether that assurance was given, quoting the man who supposedly said it as saying he did not remember any such statement. In any case, the examiner said, KPMG should have taken other steps to determine if that opinion was accurate, like interviewing prospective lenders and reviewing drafts of proposed loan documentation.

On the deferred tax issue, Mr. Mandarino said that “arguably as early as Dec. 31, 1999,” and certainly by the end of 2000, the auditors should have forced a write-down of the asset. Polaroid did not take that action until the end of the third quarter of 2001.

It is not clear what impact the conclusions will have, but a lawyer for KPMG told the bankruptcy judge, Peter J. Walsh, at a telephone hearing yesterday morning, that KPMG objected to the release of documents it felt were confidential. The examiner had told KPMG which documents were included but had not provided a copy of his report or conclusions.

Polaroid filed for bankruptcy on Oct. 12, 2001. Its assets were sold in July 2002 to a company called New Polaroid, organized by One Equity Investors, a private equity venture of Bank One, which now operates the business.

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