ALLEGED PLOT GAVE EARLY WORD OF AUDITS

KPMG was faring poorly in its inspections by a federal oversight board that was created in the wake of the accounting scandals at Enron and Arthur Andersen to monitor the companies that audit the nation's public corporations. Throughout 2013 and 2014, the board had found so many problems in KPMG audits that the nation's fourth-largest accounting firm was coming under pressure from its clients to improve.

The firm took several steps to beef up its performance, but federal investigators say the efforts to produce clean audits were not limited to legitimate means. Five KPMG executive-level accountants, including one in Houston, allegedly conspired with an oversight board employee to obtain advance notice of upcoming audits, allowing them time to identify and fix any potential deficiencies, according to federal indictments unsealed this week in Houston, New York and other cities.

The conspiracy, the government alleged, involved hiring people who had worked for the oversight board, including the Houston executive, Cynthia Holder, and pressuring them to use their connections to obtain advance warning of the board's inspections. The scheme also involved developing a code to pass along confidential information about upcoming inspections in texts, emails and conference calls, using phrases such as "Okay, I have the grocery list... All the things you'll need for the year," according to the indictment.

"These defendants were each meant to be the watchmen of our financial system," Manhattan U.S. Attorney Geoffrey Berman said in a statement. "But, as alleged, these defendants chose to cheat the system and to undermine the safeguards put in place to protect investors."

The elaborate plan concocted by the high-level executives could reflect the intense pressure that KPMG put on its employees to perform as it tried to hold onto and gain clients, legal specialists said. Other companies have run into serious problems after imposing hard-to-reach performance standards, including Wells Fargo, where bank employees opened thousands of fake accounts to meet quotas for bringing in new business, legal specialists said.

"This reflects poorly on KPMG because it appears to have been a concerted effort by top-level management to game the system," said Houston lawyer Philip Hilder, who represented a whistleblower in the Enron case. "It would be a good idea for KPMG to review their practices which may have contributed to the executives' feeling they need to cheat to improve their performance."

KPMG said it exerted no undue pressure on its employees. The firm said it promptly notified the authorities when it discovered the alleged conspiracy in early 2017 and has cooperated with the government in the investigation.

"This alleged activity does not represent KPMG's values - nor does it represent our commitment to the capital markets and our respect for our regulator," the firm said in a statement.

KPMG also has taken actions to assure that such conduct cannot happen again, said KPMG spokesman Manuel Goncalves.

The Public Company Accounting Oversight Board said it is also cooperating. It will conduct a review of its security and other controls, according to a prepared statement.

Federal securities law requires companies that sell stock on public exchanges to hire independent accountants to audit their financial statements to protect investors. Tighter federal protections were introduced after Enron used fraud and accounting gimmicks to overstate earnings and assets and its auditing firm, Arthur Andersen, signed off on fraudulent financial statements. Both companies went out of business early this century.

KPMG was trying hard by 2015 to improve its audit performance. Corporate clients pay close attention to how often the oversight board finds fault with audits, and positive inspection results have become an advantage in the competitive accounting industry for finding and keeping clients. Public companies are eager to avoid any hint of an accounting scandal.

The firm launched a bonus program for teams that didn't get flagged by the oversight board, hired a data analytics firm to predict which audits might be chosen for inspection, implemented an internal monitoring program and recruited oversight board employees to join the accounting firm, according to court records.

One of those hires was Brian Sweet, the associate director of the oversight board's inspections group until 2015, when he left to work at KPMG as a partner. During the first few weeks on the job, Sweet's new KPMG colleagues - including David Middendorf, KPMG's former national managing partner for audit quality and professional practice; Thomas Whittle, the former national partner for inspections; and David Britt, the former banking and capital markets group co-leader - began asking for confidential board plans about which KPMG audits would be inspected that year, the government alleged.

Middendorf, according to the indictment, told Sweet to remember where his paycheck came from.

Cynthia Holder, executive director of KPMG's department of professional practice in Houston until last year, was another hire from the oversight board. Holder, who lives in Jersey Village, joined KPMG in 2015 after working four years as an inspections leader for the board.

Federal prosecutors accuse Holder of copying confidential information before she left the oversight board and passing it on to Sweet, her new boss at KPMG. Holder continued to obtain confidential inspection plans from one of her former colleagues at the board, Jeffrey Wada, who was angry because he had been passed over for a promotion, according to court documents.

Holder turned the 2016 inspection plans over to her boss, who shared them with Middendorf, Whittle and Britt, who, in turn, launched a stealth plan to review the audits on the list before the inspections took place, the indictment alleged. The reviews allowed KPMG to double-check its work, identify potential deficiencies and undertake new audit examinations.

Holder also passed along the 2017 inspection plans to KPMG executives, according to the indictment.

Holder, who faces up to 65 years in prison, is free on $100,000 bond. Her lawyer, Norman Bloch of New York, declined to comment.

Britt's lawyer, Robert Stern, said his client has been unfairly targeted by the government and did not commit a crime.

Middendorf's lawyer, Nelson Boxer of New York, said his client is an experienced accounting professional who will defend his good name.

Sweet recently pleaded guilty to his role in the conspiracy and is cooperating with the government. His lawyer could not be reached for comment.

Wada's lawyer did not return a call for comment.