KPMG Peat Marwick finally prevails in 1991 Kansas audit case.

The U.S. Supreme Court recently decided to let stand a ruling by the Eighth U.S. Circuit Court of Appeals that dismissed a negligence claim brought by the Kansas Public Employees Retirement System (KPERS) against its former auditor, KPMG Peat Marwick. The decision ended more than six years of litigation for the firm, including seven trips to the court of appeals.

Auditor sued over investment losses

The KPERS lawsuit sought more than $100 million in alleged investment losses from the auditing firm, including a $65 million investment in 1986 in Home Savings & Loan Association, a thrift in Kansas City, Missouri, taken over by the Resolution Trust Corp. (RTC) in 1991.

KPERS also sued its former investment advisers as well as the Home Savings officers and directors and the lawyers performing legal services relating to the investment.

KPERS alleged the firm's failure to identify and write off impaired investments caused KPERS to overvalue its Home Savings investment and prevented it from discovering the wrongdoing of other defendants and from taking action to stop its losses.

KPERS filed its complaint in a Kansas court in 1991, but the RTC removed the case to the federal court in the Western District of Missouri after the retirement system became the subject of a third-party claim by Home Savings officers and directors.

KPERS warned against investments

In 1996, as the case proceeded in federal court, the judge granted the defendants' motion for summary judgment based on the statute of limitations. In May 1997, the Eighth Circuit affirmed the summary judgment ruling. In the interim, this case was appealed before the Eighth Circuit six additional times; each time the defendants prevailed.

The circuit court said the KPERS investment in Home Savings was part of its 1985 decision to allocate a small part of its portfolio to direct placement investments in companies for the purpose of stimulating the Kansas economy. KPERS' investment consultants advised that the retirement system not make such investments in Kansas companies because of the high risk of loss.

In particular, the district court and the Eighth Circuit found that the KPERS auditors had warned KPERS as early as 1987 and 1988 that its direct placement investments were partially impaired and that it needed to establish an investment allowance account to protect it against such impairments. "After learning there was a problem with the valuation of its direct placement investments, KPERS was not entitled to sit idly by waiting for [the auditing firm] to cite chapter and verse" the Eight Circuit held.

KPERS did not set up the recommended allowance, however, for another two years--until the successor auditor in 1989 told KPERS its investment losses could be as high as $75 million. Even then, KPERS decided to continue its investment program until 1991, when political pressure from the legislature caused it to discontinue the program.

The Eighth Circuit agreed with the district court that KPERS had knowledge or notice of potential losses in its direct placement investments more than two years before it filed suit against KPMG. Accordingly, KPERS' claims were barred by the statute of limitations, and summary judgment was affirmed.

Saga continues in Kansas litigation

At that time, George Ledwith, a KPMG spokesman, told the Kansas City Business Journal, "Throughout the litigation, each trustee, officer or director of KPERS who testified said he or she was satisfied with KPMG's audit work and that the firm had fulfilled its responsibilities as the retirement system's independent auditor."

When the U.S. Supreme Court received the case, it simply denied KPERS' petition for a hearing without issuing an opinion.

The lawsuit is not yet dead. The remaining defendant, Michael Russell, is the former chairman of KPERS' board and a one-time director of Home Savings. A federal judge dismissed the case against him, but an appeal by KPERS is pending. (KPERS v. Reimer & Koger Associates, Inc., 114 F3d 679 [8th Cir. 1997])

--Edited by Wayne Baliga, CPA, JD, CPCU, CFE, president of Aon Technical Insurance Services.

Editor's note. Thanks to Larry Bodine, editor of Accounting Liability Alert, for this case.