Auditors and Legal Liability

This project analyzes a legal case involving KPMG and Lernout & Hauspie, exploring the auditor's legal liability and the measures auditors can take to minimize litigation risk and maintain professional integrity.

Audit Report
A case study on
KPMG

Executive Summary
KPMG is one of the leading firm providing the professional services of auditing. Lernout
& Hauspie Speech product a Belgian company was established in 1987 and became a high-flying
symbol of new technology in the last 1990's. The speech software company Lernout & Hauspie
trick almost every of its account in he books in order to sacm its investors. The issues raised
were related with he misleading financial statement presented by the executives ad officers of
Lernout & Hauspie and there subsequent auditing by KPMG. In this regard the client speech
development software company Lernout & Hauspie was also culpable for its bankruptcy. GAAS
is a legally approved and adopted by the American institute of certified public Accountants
which defines the conduct of the auditors in performing and reporting of the audit engagement.
The SEC requires that publicly-traded companies present their financial statements in accordance
with GAAP. 17 C.F.R. § 210.4-01(a)(1). GAAP are those principles recognized by the
accounting profession as the conventions, rules and necessary procedure. KPMG had settled this
case afters paying of the settlement amount in form on damage compensation to the shareholders
of the company Lernout & Hauspie a amount of $115 million.

Table of Contents
INTRODUCTION...........................................................................................................................2
MAIN BODY...................................................................................................................................2
CONCLUSION................................................................................................................................8
1

INTRODUCTION
KPMG is one of the leading firm providing the professional services of auditing and is
one of the Bid four auditors along with Deloitte, Ernst and Young and Pricewaterhuose Cooper.
For the present report the evaluation of KPMG is carried out in context of professional
negligence for a period after 2000. The report will explore the lawsuits filed over KPMG for its
negligence and misrepresentations of the facts and its professional conduct. Under many
circumstances the organisation was found to under misconduct on its professional duties and at
various points it tires to settled down the lawsuits stemming against the audit of different clients
by paying huge amounts. For the present report a lawsuit on KPMG filed by Lernout & hauspie
is analysed in depth to find out the facts, evidence, ruling and decision of the case. Over al, the
present report is all about analysis and evaluation of a lawsuit filed over KPMG in context of its
misrepresentation and professional misconduct towards its client.
MAIN BODY
1. Key events and factual issues behind the case:
Lernout & Hauspie Speech product a Belgian company was established in 1987 and
became a high-flying symbol of new technology in the last 1990's. The organisation collapse due
to bankruptcy at the end of 2000 with allegations of accounting irregularities and criminal frauds.
For this organisation the audit firm KPMG has responsible to carry out the auditing work
to prepare and present the actual financial position of this client (Baugh and et.al., 2018). After
the failure of the company Lernout & Hauspie its shareholders brougth a class action lawsuit
against KPMG in the United states District Court in Boston. In this suit KPMg was imposed with
allegation of misconduct where it failed to stop Lernout & Hauspie from filing misleading
financial statement which lead to its ultimate bankruptcy and collapse.
The speech software company Lernout & Hauspie trick almost every of its account in he
books in order to sacm its investors. There was presence of massive, complex and cleverly
conceived fraud at Lernout & Hauspie which was conducts by the executives, officers of the
company along with involvement of their party who were engaged in concerted efforts of
defrauding the investors as well as the auditors.
2. The culpability and responsibilities of the parties to case, damage imposition and
considered penalties: 88
2

As stated above the Speech software development company Lernout & Hauspie the
shareholders of the organisation who bought the inflated shares of the firm, brought a lawsuit
against KPMG (Cornut St‐Pierre, 2019) The allegation was impose on KPMG that its failed in
complying with its diligent duty to determine the exact financial position of its clients
organisation and present a true picture of the company to its internal and external stakeholder in
order to assist them in making a informed decision over the investing in respective organisation's
stock.
The issues raised were related with he misleading financial statement presented by the
executives ad officers of Lernout & Hauspie and there subsequent auditing by KPMG. The
auditer stated that those financial statements were made in accordance with GAAP (general
accepted accounting principle) and audit was conducted as per GAAS and that the audit report
on those financial statement were also filed with SEC.
In this regard the client speech development software company Lernout & Hauspie was
also culpable for its bankruptcy. As this organisation was under the allegation of presenting
materially false and misleading financial statement to its stakeholders. The revenues were over
stated in the class periods only. In this a cash restriction was imposed by transferring a
significant amount of cash to Korean bank. The account receivables were inflated and net
products were recoded before exceptional items. All this were not disclosed to the public and
significant measure were taken to defraud the auditor as well. In this client company also got
succeed leading to raise question on the the working ethics and procedure of the audit firm
KPMG.
The law suit was filed against KPMG by the aggrieve shareholders of Lernout &
Hauspie who bought the shares of L& H as inflated prices and become worthless after the
bankruptcy of the company. The allegation were imposed on KPMG as it failed in carrying out
its professional duty and detecting the misstatement and fraud of its client(KPMG Units Agree to
Pay to Settle Malpractice Suits, 2019). The shareholder's claim of KPMG was settled down as
$115 millions to pad to the aggrieved shareholders by KPMG for is professional negligence and
misconduct.
3. Investigation of the relevant issues in the Auditing and Accounting raised in the
case:
3

KPMG as an auditor firms is imposed with certain duties and responsibilities under
different laws and regulation to carry out its professional duties. The audit firms are required to
abide by this impositions and if they are violated means the audit firm has failed in diligently
comparing with the its duties and responsibility under its professional conduct. The legal
requirements which were founds to be violated by KPMG in the case of Lernout & Hauspie
were:
GASS( Generally accepted auditing standards) violation:
GAAS is a legally approved and adopted by the American institute of certified public
Accountants which defines the conduct of the auditors in performing and reporting of the audit
engagement. In context of the case Lernout & Hauspie , KPMG stated on a regular basis that it
have conducted audit consistent with GAAS. However, KPMG violated GAAS inter alia failed
to expand the proper conduct of the audit regarding revenue recognition, account receivable,
cash and related party transactions. KPMG was held to violate most fundamental rights of GASS
which stated the audit conducted by audit firm did not amounted to audit at all (Didenko and
Buckley, 2019). The key issues which were neglected and not considered while interpreting the
financial statement to check the material misstatement includes knowingly or recklessly failing
to qualify or abstain from issuing material false misleading audit opinion on the fiscal policy of
Lernout & Hauspie for 1998 and 1999. The standard which were found to be violated by KPMG
were AU 326.02: to carry out independent auditor's work to from a opinion on the financial
statement with obtaining and evaluating the evidential matters concerning the assertion of
financial statement. AU 326.21: the independent auditer use the direct personal knowledge
which is obtained through physical examination, observation, computation and inspection. AU
333.02 defines duty of auditor that representation from management are not a substitute for
application of auditing procedure. AU326.16 state that with no accurate attention and
accurately over the accounting data the financial statement would not be warranted.
Another provisions of GAAS which were also found to be under violation by KPMG in
the case of Lernout & Hauspie includes general standers 3 requiring to take due professional
care in performance, examination and report preparation. General standard 2 requires auditor to
have sufficient understanding over the internal control structure in order to plan the audit. The
standard of field work 3 was also violated as it requires sufficient competent evidences which
mist be obtained from examination and inspection on financial statement. The standard of
4

reporting 3 and 4 were also no abided with requiring informative disclosure and non expression
of whole opinion over the financial statement inspected.
The SAS No. 8: Consideration of fraud in a financial statement audit which require
KPMG to specifically assess the risk of material misstatement of the financial statement to
determine any fraud (In Re Lernout & Hauspie Securities Litigation, 230 F9). Supp. 2d 152 (D.
Mass. 2002), 2019). In this context KPMG failed to the provision of risk assessment including
the AU 316.17 to determine the excessive interest of management in maintaining the stock price
and significance presence of unusual or complex transaction and unusual rapid growth and
profitability.
Furthermore, KPMG while carrying out the audit work of the financial statement of
Inadequate Confirmation stand inconsistent as to Failure to consider fraud, determining the inters
in Related Party Transactions, improper Recognition of License Revenues and finding out
Inadequate Confirmation taken by the client organisation.
GAPP, SEC and other regulations violations:
The SEC requires that publicly-traded companies present their financial statements in
accordance with GAAP. 17 C.F.R. § 210.4-01(a)(1). GAAP are those principles recognized by
the accounting profession as the conventions, rules and necessary procedure. The material
misrepresentations made by Lernout & Hauspie were not inspected and detected by KPMG, this
includes improper revenue recognition and valuation of accounts receivables as per GAAP
revenue recognition process gets completed when an exchange takes place while the Company
Lernout & Hauspie only recognizes revenue when collection of the related receivable is
probable. Another fault was related with the related party transaction which requires the client
company to disclose the related party transaction during the class period. In violation of these
required rules and procedures, L&H's financial statements failed to disclose all such parties and
transactions.
As per the another rules of GAAP any restriction placed n the use of cash in any must be
disclosed and Lernout & Hauspie had significant amount of cash held under the restriction by
certain Korean banks. This failure in disclosure lead the public to believe the public that all the
cash held by Lernout & Hauspie was in the ordinary course of business and was available in the
company's fund. Moreover the organisation Lernout & Hauspie overstated its inventory and its
not write it of on regular time. KPMG and the Company knew or recklessly disregarded that
5

L&H also violated, and thereby misrepresented, its stated policy of accounting for its inventory
at the lower of cost or market as disclosed in its 1998 and 1999 audited financial statements
(Houser, 2019). Nonetheless, in violation of GAAP, L&H's financial statements failed to
disclose that the internal control weaknesses were reasonably likely to have a material adverse
effect on L&H's operating results.
4. Probables and mistakes on the part of defendant: KPMG
There was a serious breach of the duty and responsibilities imposed on a audit firms by
the GAAS on the part of KPMG in the case of Lernout & Hauspie. KPMG was found under
severe breach of the its professional duties where it failed to company diligently with the
carrying out the audit work over the financial statement of the Lernout & Hauspie. In this case
though the organisation stated the whole time that they have analysed and evaluated the financial
documents and statements of Lernout & Hauspie nut there were sever drawbacks in following
the provisions of GAAS.
The audit firm KPMG s suly required to abide with the generally accepted auditing
standards (GAAS) while carrying out the audits investigation of its clients. This assure the
authentication of the reports presented by KPMG (Manwaring and Hanrahan, 2018). In the case
of Lernout & Hauspie, KPMG has full and complete access to the financial and non financial
information of its client. Moreover, at the time of class period the auditors of KPMG were
present at the time of quarterly preparation of financial statements of the client. They closely
monitored the process still they missed out such as big scam. The mistake here was that some
of the auditing task of the client's company were carried out through KPMG consulting. In
particular KPMG was hired for determining the allocation of the purchase price among the
various asset acquired it got involved in the process too much as it missed out the possibility of
any misrepresentation of the financial statements by Lernout & Hauspie.
Moreover, in the process of auditing KPMG have discovered misstatement in the six nth
review fro 30th June 2000 still no corrective measures was taken by KPMG. The Audit firm
reluctantly refused the possibility of any fraudulent activity or unethical behaviours in presenting
and preparing of financial statement by Lernout & Hauspie (Nawawi and Salin, 2018). This was
the major mistake which cost KPMG an huge amount of $115 million.
Furthermore, the personnel of KPMG shows frequent presence at Lernout & Hauspie
for the first two quaters in the fiscal year 2000 in their head quarters as well as Belgian office.
6

They have continuous and unfiltered access to and knowledge of the confidential internal
corporate, financial operating and business information. They were available with ample
opportunities to observe and review the business of Lernout & Hauspie and their accounting
practises. They were having opportunities to test the internal and publicly reported financial
statements and review the internal control of the company.
With availability of ample possibilities and sufficient opportunities, the auditors of
KPMG failed in detecting a severe fraud and left the shareholders of the company on an edge
with huge losses on their investments (Smith Thompson and Lee, 2019) Also the knowledge of
Lernout & Hauspie was based on almost 10 years as the auditor of the company. As KPMG
had served as the audit of the firm since 1991 an this was the big factors that made the KPMG
rely on the financial statement made by the management of Lernout & Hauspie.
5. Judgement and awarding of damages
In this case the audit firm KPMG was imposed with a law suit over non detection of the
fraudulent activities by its client leading to cause loss to innocent people. The court have decided
this case with taking a reference from its previous litigation by the Rite Aid who was also the
client of KPMG. Also the litigation on KPMG in the present case was decided on the practical
business reasons and save the firms from litigations. This case took 4 years to get a final decision
and settlement. With the impose allegation the defence given by KPMG stated that it has been a
victim of massive, complex and cleverly conceived fraud on the part of Lernout & Hauspie 's
executives officer and their party.
With bringing in a case against KPMG the shareholder held the audit firm liable for
their loss. The litigation was filled against KPMG but after a period of 4 years from 2001-2004
on this law suit, KPMG had settled this case afters paying of the settlement amount in form on
damage compensation to the shareholders of the company Lernout & Hauspie a amount of $115
million.
In this case the settlement ends litigation against KPMG over the fact of non presenting a
clear and true picture to the shareholders over the financial position and performance of Lernout
& Hauspie. This was the default duty of KPMG in which it failed. Along with the past 10 years
judgement over the case settlement on another leading audits firms were also taken into account
before passing as decision over this case (KPMG settles with L&H investors, 2019).. In the
litigation defalcates by Lernout & Hauspie and subsequent fault of KPMG was detected. Hence
7

it was imposed to settle down the law suit by paying off $115 million to the shareholders of
Lernout & Hauspie for the losses suffered by them due to purchasing inflated shared of Lernout
& Hauspie. In this context it was stated by KPMG that a decision to settle was a practical
bushiness decision and it saves the firm from protected legal battles beyond the fours years spent
on this matter.
With settlement of this case in the 2004 the proceedings against the executives, officers
and third party was brought in for misrepresentation and misappropriation of the financial
information and presenting misleading financial document before the auditors and public to
defraud them.
6. Recommendation of possible improvements
To avoid the situation of misrepresentation and faults in the auditing the financial
documents of the client the audits firms are required it abide with certain audit strategies to
avoid such situations:
Audits strategy:
The audits strategies set the direction timing and scope of the audit. The strategy is used
as a guidelines to develop the audit plan. The audit strategy that a audit firm must apply while
carrying out the audit of a old client coming up with a new venture includes the characteristics
of the engagement and the reporting objectives. The auditors must be made clear to set aside the
relations with the clients and diligently carry out the auditing work (Werle, 2018). Moreover
the provisions of the GAAs must be clear to all the auditors and they must be stated that no
reliance on the financial documents and statements presented by the clients be made. The
separate strategies must be made to look in to certain matters including sudden rise in the frost
and sales figures, third party interest, related party transaction, restriction of the case balance and
this use, internal control system of the client company and abidance of GAAP and SEC
regulations by the client in preparation of the their financial statements.
CONCLUSION
Form the above report it can be concluded that as a audit firm KPMG owed significant
level of professional duties towards its client to provide accurate and correct information relevant
to them in this context the organisation have faced lawsuits many times. With investigation of
facts and details its law suit with Lernout & hauspie it has been detected that the company
KPMG had failed in presenting the accurate financial position due t which the company Lernout
8

& hauspie collapsed and the shareholders were left in a bizarre situation for their investment in
the company. By the end of the case the audit firm KPMG agreed to the fact that it has failed in
its audit work for Lernout & Hauspie Speech product NV. To settle down the case KPMG agreed
to pay$115 millions to the shareholders of Lernout & Hauspie who have field suit against
KPMG. Furthermore it can also be interpreted from the above report that KPMG have failed in
abidance with its professional duties in several cases where it have failed to recognised the true
and accurate financial position of its client leading to losses faced by shareholders or collapse of
company again adversely effecting shareholders. For many of them it has to pay settlement
amount to shareholders of its client company.
9

REFERENCES
Book and Journals
Baugh, M. and et.al., 2018. Did the 2018 Deferred Prosecution Agreement Adversely Impact
KPMG's Audit Practice?. Auditing: A Journal of Practice & Theory. 38(1). pp.77-102.
Cornut St‐Pierre, P., 2019. Investigating Legal Consciousness through the Technical Work of
Elite Lawyers: A Case Study on Tax Avoidance. Law & Society Review.
Didenko, A. N. and Buckley, R. P., 2019. The Evolution of Currency: Cash to Cryptos to
Sovereign Digital Currencies. Fordham International Law Journal. 42(4). p.1041.
Houser, K., 2019. Can AI solve the diversity problem in the tech industry? Mitigating noise and
bias in employment decision-making. Mitigating noise and bias in employment decision-
making (February 28, 2019). 22.
Manwaring, K. and Hanrahan, P. F., 2018. BEARing Responsibility for Cyber Security in
Australian Financial Institutions: The Rising Tide of Directors’ Personal Liability.
Journal of Banking and Finance Law and Practice, Forthcoming.
Nawawi, A. and Salin, A. S. A. P., 2018. Employee fraud and misconduct: empirical evidence
from a telecommunication company. Information & Computer Security. 26(1). pp.129-
144.
Smith, J., Thompson, S. and Lee, K., 2019. ‘Both Sides of the Argument’? A critical review of
existing evidence on the illicit trade in tobacco products in Canada. Tobacco control,
pp.tobaccocontrol-2018.
Werle, N., 2018. Prosecuting Corporate Crime When Firms Are Too Big to Jail: Investigation,
Deterrence, and Judicial Review. Yale Law Journal, Note Forthcoming.
Online
KPMG settles with L&H investors. 2019. [Online]. Available
through<https://www.theregister.co.uk/2004/10/08/lernout_hauspie_kpmg/>.
In Re Lernout & Hauspie Securities Litigation, 230 F. Supp. 2d 152 (D. Mass. 2002). 2019.
[Online]. Available
through<https://law.justia.com/cases/federal/district-courts/FSupp2/230/152/2425955/>.
KPMG Units Agree to Pay to Settle Malpractice Suits. 2019. [Online]. Available
through<https://www.nytimes.com/2004/10/08/business/kpmg-units-agree-to-pay-to-settle-
malpractice-suits.html>.
10