SACRAMENTO — In 1994, California regulators began investigating the accounting firm that had audited Orange County as it slid into the largest municipal bankruptcy in U.S. history.
It took eight years and $9 million for the state Board of Accountancy to discipline KPMG. The board has an annual budget of $10 million and 56 employees; the accounting giant earned $12 billion last year and employs nearly 90,000 people. KPMG tried to block the inquiry through two lawsuits and repeated attempts to disqualify some of the state's key advisors, state records show.
"It was a bruising experience," said Gregory Newington, the state board's chief of enforcement. "When the other side is an entity the size of a major firm and they can bring legions of attorneys and expert consultants, a little agency like ours feels insignificant."
KPMG's penalty was mild: It had to repay part of the investigation's cost and was placed on probation, which ended last year.
But California's difficulties in monitoring the performance of large firms -- problems the KPMG case made apparent -- are persisting despite a major overhaul of the board that lawmakers enacted two years ago in the wake of the Enron and WorldCom scandals, board officials and outside observers say.
Those changes required accounting firms to report to the state board lawsuit settlements over $30,000; restatements of financial figures; and investigations by other regulatory bodies. Lawmakers also reduced accountants to minority membership on the 15-member board.
But the changes did not provide the board with new penalties it could levy against errant corporations.
Nor did the changes enable the board to increase its staff of four investigators, who must police 63,000 individual accountants and 4,500 firms. Those include the international corporations known as the "Big Four": Deloitte & Touche, Ernst & Young, PricewaterhouseCoopers and KPMG.
"If the board were to undertake a major case against a Big Four firm right now, it would be literally prohibitive from undertaking any other case," said Julianne D'Angelo Fellmeth, administrative director of the Center for Public Interest at the University of San Diego.
Instead, at the same time lawmakers were adding responsibilities to the board, they also were draining its finances to balance the state budget.
Since 2002, lawmakers have borrowed $6 million from the board's reserves. A hiring freeze dating back to 2001 prevented the board from adding investigators, or even replacing some who left, even though the board is wholly supported by professional licensing fees, not tax dollars.
All these factors prompted the board to tell legislators it could not follow through on its mandate, unique among states, to discipline not only individual accountants but also large firms. Board officials say they are now more likely to defer to federal regulatory agencies, such as the Securities and Exchange Commission and the Public Company Accounting Oversight Board.
However, in some cases that is not an option, because only California regulators have authority to monitor auditing of private companies, nonprofits and governmental bodies within the state's boundaries.
That was the case when Orange County lost $1.6 billion and sought federal bankruptcy court protection from creditors in 1994.
The board launched an inquiry into whether KPMG followed professional standards over the two years it signed off on the county's books without raising alarms about then-Treasurer Robert L. Citron's precarious investment strategies.
State law enforcement officials successfully prosecuted Citron for falsifying documents and misappropriating public funds, and he was sentenced to nine months of community service work.
But the accountancy board discovered there were plenty of reasons to question KPMG's commitment to aggressively auditing the county.
The firm had won Orange County's auditing account in 1992 by offering a $104,500 bid that was $41,500 less than the county's previous auditor, according to a report issued in 1998 by Stuart Harden, an outside consultant hired by the board.
KPMG had sold itself on the experience of its senior partners, but many of them ended up doing limited or no work on the account, Harden found.
KPMG's project head spent only 52 hours on the 1992 and 1993 audits -- 1.2% of the total hours KPMG auditors devoted. Another senior auditor who was supposed to review the team's work devoted only seven hours over two years to the project.
Most of the work was performed by less experienced auditors, including one KPMG employee who had graduated from college earlier that year and had not yet been licensed as a CPA. She played "a significant role" in auditing the county, Harden's report said.
