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December 09, 2011

Olympus Auditors Face Scrutiny

TOKYO—In May 2009, Olympus Corp.'s external auditor was so troubled by transactions it had found while going through the company's books that it asked Olympus's top executives to resign.


KPMG Azsa LLC threatened to notify Japanese authorities about the deals and warned Olympus that if the problems weren't dealt with, "it will be difficult to continue as your auditor," according to a recently released report on those transactions.

By the end of that month, Olympus had agreed to write off around ¥71 billion yen ($921 million) of the value of those transactions.

But KPMG Azsa had also agreed to sign off on Olympus's accounts, with an unqualified opinion that signaled nothing was wrong, even though the auditors had told Olympus they had doubts about the appropriateness of the deals, according to the report.

As the Olympus scandal intensifies, it isn't just the maker of cameras and medical equipment that is under fire.

The company's external auditors are also increasingly feeling the heat, as regulators and lawyers examine why KPMG Azsa and its successor, Ernst & Young ShinNihon LLC, never exposed the company's 13-year coverup of more than $1.5 billion in investment losses.

The intense scrutiny comes as the two firms wrestle with the question of whether they can sign off on scandal-ridden Olympus's latest earnings results, due next week.

Japan's Financial Services Agency, the country's top financial watchdog, is carrying out hearings to examine whether the auditors played a part in the company's false accounting.

If it finds evidence the firms deliberately or negligently overlooked false financial statements, it can levy penalties ranging from a reprimand or a business-improvement order to fines or a suspension of operation.

The auditing firms could also face lawsuits and damage to their reputations. Olympus said in a Wednesday press conference that it is investigating the auditors' roles. E&Y ShinNihon said Thursday it is setting up a panel of outside experts to look into its audit.

E&Y ShinNihon said its internal probe had found nothing wrong with its audit. KPMG Azsa declined to comment beyond a Tuesday statement that said the company conducted audits of Olympus's financial statements in line with Japanese auditing standards and that it will continue to cooperate with investigations by authorities.

A finding of improper behavior could be devastating. In 2002, Arthur Andersen LLP lost its license to practice in the U.S. after facing criminal charges for allegedly destroying evidence related to Enron Corp.'s accounting scandal.

The U.S. Supreme Court eventually overturned the criminal conviction that doomed the accounting firm.

The first body to weigh in on Olympus's coverup, as well as the role of the auditors, was an independent panel appointed by Olympus's board, which Tuesday released the report that describes KPMG Azsa's 2009 battle with company management.

The report, which has no legal authority, contains details on how close the accountants allegedly came at times to discovering the loss-hiding.

It also points out instances where the panelists, mostly lawyers, thought the auditors might have slipped up, using deliberately vague language in their report, according to a person familiar with the board's independent panel.

Both firms followed accounting procedures, but "it would go too far to say there was no problem,'' the person familiar with the panel said.

KPMG Azsa, which audited Olympus's accounts from 1974 to 2009, first raised serious questions about the books in September 1999.

That is when it came across information that Olympus executives Hisashi Mori and Hideo Yamada were hiding securities losses in a fund off the company's balance sheet, according to the panel's report.

KPMG Azsa demanded the transaction be unwound immediately and the assets brought back on the books and written down.

Messrs. Yamada and Mori protested, saying that then-president Masatoshi Kishimoto was traveling overseas and unreachable, but eventually backed down, the report said.

In fact, Olympus had set up other funds that held bad assets as well—something that KPMG Azsa failed to catch, the report said.

One reason is that some of the banks through which money passed in the coverup scheme failed to give KPMG Azsa all the information it requested about Olympus's accounts, the report said.

In 2008, KPMG Azsa became concerned about four deals that were at the center of Olympus's coverup, according to the report.

One involved nearly $700 million in payments to a financial advisor for work on the purchase of U.K. medical-technology company Gyrus Group PLC.

The others involved the purchase of three tiny Japanese venture firms for the equivalent of nearly $1 billion at current exchange rates. Olympus has since said that money was really used to clear up its decades-old investment losses.

In December 2008, KPMG Azsa warned Olympus it thought the company had spent way too much on those deals and urged Messrs.

Mori and Yamada to bring the matter up at a board meeting, according to the panel's report. The auditor followed up in late January 2009 with an on-site audit of the three firms and was soon warning Olympus it could be facing a shareholder lawsuit if it didn't correct its accounts.

In April, KPMG Azsa's auditors ramped up the pressure on Olympus, threatening to notify Japanese authorities that they had found irregularities.

By mid May, KPMG Azsa was demanding the resignation of Messrs. Mori, Yamada and then-president Tsuyoshi Kikukawa, and threatening to quit itself.

"If you just keep repeating the explanation you've given so far [that the deals were appropriate], it will be difficult to continue as your auditor,'' KPMG Azsa's auditors told Messrs.

Mori, Yamada and Kikukawa at a May 7 meeting, according to the report. "The same applies to these deals with unknown brokers and investment funds."

Olympus responded by agreeing to write down much of the value of those acquisitions and payment and convening a panel of outside experts who concluded the executives had done nothing wrong.

KPMG Azsa signed off on Olympus's accounts, and Messrs. Yamada and Kikukawa canceled its contract with the auditor soon after, the panel wrote.

When E&Y ShinNihon took over the auditing contract, the firms had only a "superficial'' exchange of information, and so "criticism is inevitable," the panel's report said.

Messrs. Mori, Yamada and Kikukawa couldn't be reached for comment. The former executives have declined to comment since Olympus said they admitted to being involved in the deals. All have now resigned from Olympus, following revelations that they were involved in the loss hiding.

wsj.com

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