The SEC's administrative order finds that from September 1999 through March 2002, the respondents' conduct resulted in repeated audit failures in connection with KPMG's audits of Gemstar's financial statements. The order also finds that the respondents reasonably should have known that Gemstar improperly recognized and reported in its public filings material amounts of licensing and advertising revenue. Gemstar, based in Hollywood, Calif., publishes TV Guide magazine and licenses and sells advertising on an interactive program guide (IPG) for television that enables consumers to navigate through and select television programs.
Stephen M. Cutler, the SEC's Director of Enforcement, said, "Our action today holds KPMG as a firm accountable for the audit failures of its partners. The sanctions in this case should reinforce the message that accounting firms must assume responsibility for ensuring that individual auditors properly discharge their special and critical gatekeeping duties."
Randall R. Lee, Regional Director of the SEC's Pacific Regional Office, said, "This case illustrates the dangers of auditors who rely excessively on the honesty of management. KPMG's auditors repeatedly relied on Gemstar management's representations even when those representations were contradicted by their audit work. The auditors thus failed to abide by one of the core principles of public accounting -- to exercise professional skepticism and care."
In addition to KPMG, the order names as respondents Bryan E. Palbaum, 41, of Encino, Calif., a former KPMG partner; John M. Wong, 43, of Huntington Beach, Calif., also a former partner; Kenneth B. Janeski, 55, of Tarzana, Calif., a partner in KPMG's Los Angeles office; and David A. Hori, 35, of Scottsdale, Ariz., a manager in KPMG's Phoenix office.
The settlement provides that Palbaum, Wong, Janeski, and Hori are denied the privilege of appearing or practicing before the SEC, with the right to reapply after periods of three years (Palbaum), one year (Wong and Janeski), and eighteen months (Hori).
The SEC's order finds that the audit failures on the part of KPMG and its auditors involved both licensing and advertising revenue and included the following.
- IPG Licensing Revenue: During the relevant period, Gemstar recognized material amounts of licensing revenue, involving, among other entities, Scientific-Atlanta, Inc. ($113.5 million in revenue), America Online, Inc. ($23.5 million), and Time Warner Cable ($18.1 million). KPMG and its auditors knew that Gemstar was recognizing material amounts of IPG licensing revenues from Scientific-Atlanta and TWC even though Gemstar did not have a contract with the purported licensee; Gemstar had not received any of the recognized revenue; and Gemstar's receipt of the revenue was contingent on Gemstar's negotiating a contract with, or settling or prevailing in litigation against, the purported licensee. KPMG and its auditors also knew that Gemstar was recognizing additional material amounts of IPG licensing revenue from AOL over a 12-month period even though the contract had an eight-year term and Gemstar had not produced sufficient evidence to support its recognition of the revenue over 12 months. Gemstar ultimately reversed the improperly recognized revenue.
- IPG Advertising Revenue: During the relevant period, Gemstar recognized material amounts of IPG advertising revenue, involving, among other advertisers, Fantasy Sports, Inc. ($20 million in revenue), Motorola, Inc. ($17.5 million), and Tribune Company ($17 million). KPMG and its auditors knew or reasonably should have known that Gemstar was improperly recognizing IPG advertising revenue. They knew that Gemstar was recognizing material amounts of IPG advertising revenue from certain transactions even though Gemstar had provided insufficient evidence of the IPG advertising's fair value as required by generally accepted accounting principles (GAAP). Gemstar ultimately reversed the improperly recognized revenue.
- The order also finds that KPMG and its auditors knew or reasonably should have known that Gemstar's disclosure in its public filings regarding the IPG licensing and advertising revenue did not comply with GAAP and/or was inconsistent with its accounting for the revenue and the transactions.
- Despite these indications of Gemstar's improper accounting and disclosure, the respondents issued unqualified audit reports representing that KPMG had conducted its audits in accordance with generally accepted auditing standards (GAAS) and that Gemstar's financial statements fairly presented its financial results in conformity with GAAP. In reaching these conclusions, the auditors unreasonably relied on representations by Gemstar's management and its inside or outside legal counsel or decided that the unsupported revenues were immaterial to Gemstar's financial statements. The auditors' reliance on these representations was unreasonable because the representations were contradicted by other evidence and contained qualifications that called into question their reliability. The auditors' materiality determinations were unreasonable in that they were based on a quantitative analysis and failed to consider whether the revenues at issue were qualitatively material.
- In addition, the order finds that in mid-August 2002, as part of Gemstar's audit committee's investigation into potential restatements of Gemstar's financial statements, certain information came to light that the local engagement team did not convey to KPMG's national office. This information included evidence indicating that senior Gemstar management may have been involved in an intentional misreporting of IPG advertising revenue and that Gemstar did not have sufficient evidence to recognize other IPG advertising revenue. KPMG did not have a policy that required that a local engagement team consult with the national office on all new significant issues that had come to the local engagement team's attention. Such a consultation should have led KPMG to consider the additional evidence that came to light during the audit committee's investigation and could have led KPMG to a more prompt decision to withdraw its previously issued audit report on Gemstar's 2001 financial statements. KPMG did not take that step until Nov. 22, 2002.
In addition to the censure and the $10 million payment by KPMG, the firm has agreed to conduct training for its partners and managers on qualitative materiality, accounting for multi-element transactions, and consideration of appropriate disclosure related to complex accounting issues. KPMG will also adopt a policy that requires more effective consultation between audit engagement teams and its national office in connection with possible financial statement restatements.
The SEC has a pending lawsuit in federal court in Los Angeles against four former executives of Gemstar -- Henry C. Yuen, its former CEO; Elsie M. Leung, its former CFO; Jonathan B. Orlick, its former general counsel; and Craig Waggy, the former CFO of TV Guide. The trial of this matter is scheduled to begin on Jan. 18, 2005. On June 30, 2004, the court entered a judgment against Gemstar as part of a settlement in which the company agreed to pay a $10 million civil penalty to be distributed to harmed shareholders pursuant to Section 308 of the Sarbanes-Oxley Act. On Aug. 10, 2004, Peter C. Boylan, a former Gemstar co-president, settled the SEC's action against him by agreeing to the entry of a judgment and to the payment of $600,000 in disgorgement and penalties.
