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U.S. Securities and Exchange Commission

UNITED STATES OF AMERICA
Before the
SECURITIES AND EXCHANGE COMMISSION

Securities Exchange Act of 1934
Release No. 50564 / October 20, 2004

Accounting And Auditing Enforcement
Release No. 2125 / October 20, 2004

Admin. Proc. File No. 3-11714


In the Matter of

KPMG LLP, Bryan E. Palbaum, CPA, John M. Wong, CPA, Kenneth B. Janeski, CPA, David A. Hori, CPA,

Respondent.



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ORDER INSTITUTING PUBLIC ADMINISTRATIVE PROCEEDINGS PURSUANT TO RULE 102(e) OF THE COMMISSION'S RULES OF PRACTICE, MAKING FINDINGS, AND IMPOSING REMEDIAL SANCTIONS

I.

The Securities and Exchange Commission ("Commission") deems it appropriate that public administrative proceedings be, and hereby are, instituted against KPMG LLP ("KPMG"), Bryan E. Palbaum ("Palbaum"), CPA, John M. Wong ("Wong"), CPA, Kenneth B. Janeski ("Janeski"), CPA, and David A. Hori ("Hori"), CPA, (collectively "Respondents") pursuant to Rule 102(e)(1)(ii) of the Commission's Rules of Practice.1

II.

In anticipation of the institution of these proceedings, Respondents have each submitted Offers of Settlement (the "Offers"), which the Commission has determined to accept. Solely for the purpose of these proceedings and any other proceedings brought by or on behalf of the Commission, or to which the Commission is a party, and without admitting or denying the findings herein, except as to the Commission's jurisdiction over them and the subject matter of these proceedings, Respondents consent to the entry of this Order Instituting Public Administrative Proceedings Pursuant to Rule 102(e) of the Commission's Rules of Practice, Making Findings, and Imposing Remedial Sanctions ("Order"), as set forth below.

III.

On the basis of this Order and Respondents' Offers, the Commission finds2 that:

A. SUMMARY

This matter concerns KPMG and four of its auditors who engaged in improper professional conduct in the audits and reviews of the financial statements of Gemstar-TV Guide International, Inc. ("Gemstar"). The conduct addressed in this order includes KPMG's audits and reviews of Gemstar's financial statements from the quarter ended September 30, 1999, through the quarter ended March 31, 2002.

The KPMG auditors reasonably should have known that Gemstar's recognition of material amounts of revenue was not in conformity with Generally Accepted Accounting Principles ("GAAP"). This improperly reported revenue consisted of approximately $152 million in licensing revenue and approximately $60 million in advertising revenue that was reported during the periods ended March 31, 2000 ($32 million overstatement of licensing revenue), December 31, 2000 ($38 million overstatement of licensing revenue), December 31, 2001 ($70 million and $52 million overstatement of licensing and advertising revenue, respectively) and March 31, 2002 ($12 million and $8 million overstatement of licensing and advertising revenue, respectively). The auditors also reasonably should have known that certain disclosure in Gemstar's Forms 10-K regarding its revenue recognition policies, licensing revenue, and multi-element transactions was inconsistent with Gemstar's accounting for the revenue and/or did not comply with GAAP disclosure requirements.

The KPMG auditors, however, concurred in Gemstar's accounting, did not object to Gemstar's disclosure, and issued audit reports stating 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 KPMG auditors unreasonably relied on representations by Gemstar management and/or unreasonably determined that the revenues were immaterial to Gemstar's financial statements. The KPMG auditors' materiality determinations were unreasonable in that they only considered quantitative materiality (i.e., that the amount of revenue was not a large percentage of Gemstar's consolidated financial results) and failed to also consider qualitative materiality (i.e., that the revenue related to business lines that were closely watched by securities analysts and had a material effect on the valuation of Gemstar stock).

As a result, KPMG and the auditors did not comply with GAAS by unreasonably failing to exercise due professional care and skepticism and to obtain sufficient competent evidential matter; substituting management representations for competent evidence; failing to take appropriate action to correct Gemstar's inconsistent and deficient disclosure; and issuing inaccurate audit reports.

In addition, in August 2002 as part of Gemstar's Audit Committee's investigation into potential restatements of Gemstar's financial statements, information concerning the possible improper recognition of electronic advertising revenue came to light. Such information included evidence indicating that senior Gemstar management may have been involved in that improper revenue recognition, that the evidence Gemstar had relied upon to support the recognition of electronic advertising revenue may not have been sufficient, and that the Audit Committee was recommending that certain transactions be restated or reclassified. Although KPMG did have a policy that required an engagement team involved in potential restatements of financial statements upon which KPMG had issued an audit report to consult with KPMG's Department of Professional Practice regarding the specific transaction being proposed for restatement by the issuer of the financial statements, KPMG did not have in place a policy that required consultation with the Department of Professional Practice regarding all significant issues that had come to the attention of the engagement team subsequent to the issuance of the audit report on the financial statements in question. Consultation pursuant to such a policy should have led KPMG to become aware of and 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 November 22, 2002.

B. RESPONDENTS

KPMG LLP ("KPMG") is a Delaware limited liability partnership and a national public accounting firm with its headquarters in New York, New York. KPMG was the auditor for Gemstar-TV Guide International, Inc. from 1993 until October 30, 2002, when Gemstar dismissed KPMG as its independent accountants. On November 22, 2002, KPMG advised Gemstar that its reports on Gemstar's financial statements for the periods ended March 31, 2000 through December 31, 2001, should no longer be relied upon because Gemstar's November 15, 2002 filing of a Form 10-K/A (Amendment No. 2) that restated Gemstar's consolidated financial statements, without audit, constituted an implicit withdrawal of management's representations as to the financial statements previously audited by KPMG.

Bryan E. Palbaum, CPA, 41, of Encino, California, began work on the Gemstar engagement during the audit for the fiscal year ended March 31, 2000.3 He was the KPMG co-engagement partner for the Gemstar engagement from the June 30, 2000 review through the March 31, 2002 review. Palbaum began working for KPMG in 1986 and was a KPMG partner from 1997 until he left the firm in August 2002. Palbaum has been licensed as a CPA in California since 1988. He is currently employed with a private company. While performing an in-depth review of Gemstar's March 31, 2000 financial statements, Palbaum reviewed the work papers supporting the auditors' conclusions on significant issues arising from the year-end financial statements. As the co-engagement partner for all periods following his in-depth review through the March 31, 2002 review, Palbaum shared primary responsibility for the conduct of the reviews and audits of Gemstar's financial statements.

John M. Wong, CPA, 43, of Huntington Beach, California, was the KPMG engagement partner for the Gemstar engagement for the audits of the fiscal years ended March 31, 1996 through March 31, 2000. He did not participate in any subsequent audits or reviews of Gemstar's financial statements. Wong has been a KPMG partner since July 1995 and currently works out of the firm's Costa Mesa, California office. He was a manager for the Gemstar audit for the fiscal years ended March 31, 1993 through 1995. Wong has been licensed as a CPA in California since 1985. He has worked at KPMG since January 1984. As the engagement partner, Wong had primary responsibility for the conduct of the reviews and audit of Gemstar's financial statements for the year ended March 31, 2000.

Kenneth B. Janeski, CPA, 55, of Tarzana, California, was the KPMG SEC reviewing partner for the Gemstar engagement from 1999 through the March 31, 2002 review. Janeski has been a KPMG partner since 1982, and has worked for KPMG since 1972. He is currently assigned to the firm's Los Angeles office. Janeski has been licensed as a CPA in California since 1974 and New York since 1981. As the SEC reviewing partner, Janeski participated in planning the Gemstar engagements, consulted with other members of the audit team and reviewed the company's financial statements for compliance with professional standards and SEC rules and regulations.

David A. Hori, CPA, 35, of New York, New York, was a KPMG senior manager for the Gemstar engagement from late 1999 through the March 31, 2002 review. Hori has been a KPMG senior manager since 1999, and has worked for KPMG since 1992. Hori has been licensed as a CPA in California since 1994. Hori is currently assigned to KPMG's office in Phoenix, Arizona. As senior manager, Hori supervised the reviews and audits of Gemstar's financial statements.

C. OTHER ENTITIES

Gemstar-TV Guide International, Inc. is a Delaware corporation with its principal place of business in Hollywood, California. Gemstar's common stock is registered with the Commission pursuant to Section 12(g) of the Exchange Act and listed on the Nasdaq National Market System. In August and September 2002, Gemstar announced that it would restate its financial results for the year ended December 31, 2001. In addition, from November 14, 2002 through March 31, 2003, Gemstar twice filed amended periodic reports to restate its financial results for 2001 and the first quarter of 2002 and restated its financial results for the second and third quarters of 2002. Also on March 31, 2003, Gemstar filed its 2003 Form 10-K to become current on its financial reporting obligations.

Scientific-Atlanta, Inc., a public company, provides equipment and services to the cable television industry. Gemstar and Scientific-Atlanta were parties to a License and Settlement Agreement, which expired in July 1999 and under which Scientific-Atlanta paid fees to Gemstar in connection with Scientific-Atlanta's manufacture and sale of cable television set-top boxes. Between late 1998 and early 2001, Gemstar and Scientific-Atlanta initiated seven different lawsuits against one another relating to the purported misappropriation of each other's intellectual property. From early 2000 through early 2002, Gemstar recognized and reported, but had not received, $113.5 million in licensing revenue from Scientific-Atlanta. In November 2002, Gemstar reversed the Scientific-Atlanta licensing revenue that it had recognized.

Time Warner, Inc., fka AOL Time Warner, Inc. ("AOLTW"), a public company formed in connection with the January 2001 merger of America Online, Inc. ("AOL") and Time Warner, Inc., operates various media businesses, including cable television systems through its Time Warner Cable ("TWC") subsidiary. Gemstar entered into an eight-year licensing agreement with AOL and received a $23.5 million upfront nonrefundable fee in May 1999 and recognized the $23.5 million from May 1999 through June 2000. From late 2001 through early 2002, Gemstar recognized and reported, but had not received, $18.1 million in licensing revenue from TWC. In March 2003, Gemstar restated its recognition of the $23.5 million upfront fee so that the fee would be recognized over the eight-year term of the agreement and reversed the TWC licensing revenue that it had recognized.

Fantasy Sports Properties, Inc., a privately owned company, creates and implements Internet-based fantasy sports games. In June 2001, Gemstar acquired Fantasy Sports' intellectual property by paying $750,000 in cash and agreeing to run $20 million in advertising for Fantasy Sports. During 2001, Gemstar ran advertising for Fantasy Sports and recognized and reported $20 million in advertising revenue from Fantasy Sports. In November 2002, Gemstar reversed the Fantasy Sports advertising revenue that it had recognized.

Motorola, Inc., a public company, entered into an October 2000 License and Settlement Agreement with Gemstar, under which Gemstar ran advertising for Motorola and recognized and reported a total of $17.5 million in advertising revenue in 2001 and 2002. Gemstar reversed the recognition of this revenue in March 2003.

Tribune Company, a public company, operates various media businesses, including the WGN television station. In April 2001, Tribune acquired Gemstar's WGN distribution business by paying $106 million in cash and agreeing to purchase $100 million in advertising from Gemstar. Under this agreement, Gemstar ran advertising for Tribune and recognized and reported $26 million in advertising revenue in 2001 and 2002. In March 2003, Gemstar reversed the recognition of the $26 million as advertising revenue and allocated it to the sale of the WGN distribution business and interest income.

D. BACKGROUND: THE KPMG AUDITORS' UNDERSTANDING OF GEMSTAR'S BUSINESS AND REPORTED FINANCIAL RESULTS

KPMG audited or reviewed Gemstar's annual and quarterly financial statements from the quarter ended September 30, 1999, through the quarter ended March 30, 2002. From these audits and reviews, the KPMG auditors understood that in the fiscal year ended March 31, 2000, virtually all of Gemstar's revenues were derived from licensing Gemstar technologies. During this period, Gemstar's primary technology was an interactive program guide ("IPG") that enabled consumers to navigate through, sort, obtain information on, and select television programs.

The KPMG auditors further understood that after Gemstar's July 2000 TV Guide acquisition, Gemstar divided its business into three primary sectors. The first sector was the Technology and Licensing ("Licensing") Sector, which developed and licensed Gemstar's technologies, including the IPG. Gemstar generated revenue in this sector by charging a licensing fee for the right to use the technologies. The second sector was the Interactive Platform ("Interactive") Sector, which constructed and operated the infrastructure for the delivery of IPG services and IPG and Internet advertising to consumers. Gemstar generated revenues in this sector principally by selling advertising on the IPG. The third sector was the Media and Services ("Media") Sector, which operated various media properties, including the TV Guide magazine. Gemstar generated revenues in this sector from subscription fees, advertising revenues, programming fees, and catalog sales.

The KPMG auditors also knew from their audits and reviews of Gemstar's financial statements that beginning in the quarter ended September 30, 2000, Gemstar began separately reporting sector results. They also reasonably should have known that Gemstar touted the strong performance of the Licensing and Interactive Sectors; that during 2001, the Interactive Sector's financial performance was important to the securities market and to the market's valuation of Gemstar stock, even though the Interactive Sector contributed only a small percentage to Gemstar's consolidated financial results; and that Gemstar's IPG was a new and untested advertising medium.

E. KPMG'S AUDITS AND REVIEWS OF GEMSTAR'S FINANCIAL STATEMENTS

1. Licensing Revenue

a. The Improper Accounting

The KPMG auditors knew that Gemstar was recognizing revenue from AOL, Scientific-Atlanta, and TWC, and reasonably should have known that the revenue was material to Gemstar's financial statements.4 As stated below, the KPMG auditors reasonably should have known that Gemstar's recognition of the revenue was not in accordance with GAAP.

i. AOL

Gemstar recognized and reported a $23.5 million upfront nonrefundable fee from AOL as revenue over the 12 months ended April 2000, which consisted of $21.5 million in the fiscal year ended March 31, 2000 and $2 million in the quarter ended June 30, 2000. This revenue was material to Gemstar's reported financial results.

The KPMG auditors knew or reasonably should have known that (1) AOL paid the amount as an upfront nonrefundable fee under an IPG agreement with Gemstar; and (2) Gemstar's accounting for this fee was based on management's representation that the fee was for transfer of the license and for 12 months of technical assistance and engineering support.5 The KPMG auditors also reasonably should have known, however, that (1) under the IPG agreement, the license had a term of eight years and Gemstar agreed to provide AOL with its IPG technology and certain technical assistance and engineering support for the eight-year license term; and (2) Gemstar had insufficient evidence to support its recognition of the revenue in the first 12 months.

The KPMG auditors therefore reasonably should have known that Gemstar's recognition of the AOL upfront fee did not conform to GAAP because Gemstar should have recognized the AOL upfront fee over the IPG agreement's eight-year term and not over 12 months. See Statement of Financial Accounting Concepts ("SFAC") No. 5, ¶ 84d (revenues recognized as earned as time passes if rights to use assets extend continuously over time); Staff Accounting Bulletin ("SAB") No. 101 (effective no later than the fourth fiscal quarter of fiscal year beginning after December 15, 1999) and authorities cited therein (upfront fees must be recognized over the contractual terms in which goods or services are to be provided or rights to use assets are to be extended).

ii. Scientific-Atlanta and TWC

Gemstar recognized and reported $113.5 million in Scientific-Atlanta revenue from the quarter and year ended March 31, 2000, through the quarter ended March 31, 2002. At all times, the Scientific-Atlanta revenue was material to Gemstar's consolidated and separately reported Licensing Sector financial results. Gemstar recognized a total of $18.1 million in TWC revenue in the last two quarters of 2001 and the first quarter of 2002. The TWC revenue was material to Gemstar's consolidated and separately reported Licensing Sector financial results.

The KPMG auditors knew that Gemstar based its recognition of the Scientific-Atlanta revenue on (1) Gemstar management's assertions that (a) Scientific-Atlanta was incorporating IPG technology into its cable set-top boxes; (b) Scientific-Atlanta had communicated its intention to enter into a new licensing agreement soon; and (c) Gemstar's settlement discussions with Scientific-Atlanta were consistent with the expectation that Gemstar would receive revenue from Scientific-Atlanta that was at least commensurate with the amount of revenue that had been recognized; and (2) with respect to the March 31, 2000 audit, Gemstar's receipt of a document from Scientific-Atlanta reporting the number and type of set-top boxes that Scientific-Atlanta had shipped during the last half of 1999. Gemstar based its conclusion regarding the collectibility of the revenue on the fact that Gemstar's outside legal counsel had issued an opinion that it was "probable" that Gemstar would prevail in its pending litigation against Scientific-Atlanta in which Gemstar alleged that Scientific-Atlanta used Gemstar's technology in Scientific-Atlanta's set-top boxes.

The KPMG auditors also knew that Gemstar based its recognition of the TWC revenue on Gemstar management's assertion that its IPG agreement with AOL applied to TWC and that AOLTW had acknowledged that the AOL IPG agreement applied to TWC.

The KPMG auditors, however, also knew or reasonably should have known that (1) Gemstar did not have a current contract with Scientific-Atlanta, and the AOL IPG agreement by its terms did not apply to TWC; (2) Gemstar had not received any of the recognized revenue; (3) Scientific-Atlanta was disputing that it owed Gemstar the revenue; and (4) Gemstar's receipt of the revenue was contingent on Gemstar negotiating contracts with Scientific-Atlanta and AOLTW or settling or prevailing in litigation against Scientific-Atlanta.

The KPMG auditors therefore reasonably should have known that Gemstar's recognition of the Scientific-Atlanta revenue and the TWC revenue did not conform to GAAP. Specifically, they reasonably should have known that Gemstar did not have an arrangement with Scientific-Atlanta or TWC. See SFAC No. 5, 83 (revenue generally recognized when it is both realized or realizable and earned); SAB No. 101 and authorities cited therein (revenue realized or realizable and earned when, among other things, persuasive evidence of arrangement exists).

b. The Improper Disclosure

The KPMG auditors also reasonably should have known that Gemstar's disclosed revenue recognition policies in Forms 10-K as relating to the AOL, Scientific-Atlanta, and TWC revenue did not comply with GAAP disclosure requirements and that Gemstar's disclosure of the AOL IPG agreement was inconsistent with Gemstar's accounting for the AOL upfront fee.

i. AOL

The KPMG auditors knew that Gemstar represented in its financial statement footnotes that its revenue recognition policy for upfront license fees was to recognize revenue ratably over the specified term of the particular license and that Gemstar had no disclosed revenue recognition policy for technical assistance and engineering support revenue. They also reasonably should have known that Gemstar described the AOL transaction in a Form 10-K as a "long-term licensing agreement with AOL" and did not disclose providing technical assistance or engineering support to AOL for, or recognizing the $23.5 million upfront nonrefundable fee over, 12 months. See AICPA Codification of Statements on Auditing Standards ("AU") §§550.02 & 04 (under GAAS, auditors should read company's annual report).

In light of their knowledge regarding the AOL transaction and Gemstar's accounting for the AOL upfront nonrefundable fee, the KPMG auditors reasonably should have known that Gemstar's disclosures of its recognition policies for upfront license fees and the AOL transaction and failure to disclose a revenue recognition policy for technical assistance and engineering support revenue was inconsistent with Gemstar's accounting for the AOL upfront nonrefundable fee and did not conform to GAAP. Accounting Principles Board ("APB") Opinion No. 22, ¶ 8 (GAAP requires disclosure of all significant accounting policies).

ii. Scientific-Atlanta and TWC

The KPMG auditors knew that Gemstar represented in its financial statement footnotes that its revenue recognition policy for licensing revenue was to recognize revenue when Gemstar learned that a manufacturer had shipped units incorporating Gemstar's patented technology.

In light of their knowledge regarding the Scientific-Atlanta and TWC revenue, the KPMG auditors reasonably should have known that Gemstar's disclosed licensing revenue recognition policy was inadequate under GAAP to describe Gemstar's actual recognition of the contingent Scientific-Atlanta and TWC revenue. See APB Opinion No. 22, ¶¶ 8 & 12 (company must describe all significant accounting policies, including accounting policies that involve "unusual or innovative" applications of GAAP); see SAB 101 (company should disclose information necessary to understanding of financial results, including information relating to unusual or infrequent transactions or to uncertainties that might reasonably be expected to have a material effect on financial results).

2. IPG Advertising Revenue

a. The Improper Accounting

The KPMG auditors knew or reasonably should have known that Gemstar was recognizing IPG advertising revenue from multi-element transactions with Motorola and Tribune, from a non-monetary transaction with Fantasy Sports, and from certain print advertisers, and reasonably should have known that the revenue was material to Gemstar's financial statements.6 As stated below, the KPMG auditors reasonably should have known that Gemstar's recognition of the revenue was not in accordance with GAAP.

i. Motorola and Tribune

Gemstar recognized and reported $17.5 million in IPG advertising revenue from Motorola during 2001 and the first quarter of 2002. Gemstar recognized and reported $17 million in IPG advertising revenue from Tribune during the last three quarters of 2001 and the first quarter of 2002. The Motorola and Tribune IPG advertising revenues were each material to Gemstar's separately reported Interactive Sector financial results.

The KPMG auditors knew or reasonably should have known that (1) Gemstar entered into a multi-element transaction with Motorola under which Motorola paid Gemstar $188 million for a license to use Gemstar's IPG technology, to settle pending litigation, and to purchase $17.5 million in prepaid advertising; (2) Gemstar entered into a multi-element transaction with Tribune under which Tribune agreed to purchase from Gemstar its WGN distribution business for $106 million in cash and $100 million in advertising; and (3) Gemstar was recognizing millions of dollars in IPG advertising revenue from Motorola and Tribune. They also reasonably should have known that Gemstar did not have sufficient stand-alone IPG advertising revenue (i.e., revenue from advertising that was not part of a related-party, non-monetary, or multi-element transaction) to provide a basis on which to fair value the Motorola and Tribune IPG advertising components of the multi-element transactions.

The KPMG auditors therefore reasonably should have known that Gemstar's recognition of the Motorola and Tribune IPG advertising revenue did not conform to GAAP. Specifically, they should have known that Gemstar could not reliably, verifiably, and objectively determine the fair value of the IPG advertising. See, e.g., SAB 101, Frequently Asked Questions and Answers, Question 4 (revenue from multi-element transaction should be allocated to various elements based on fair value that is reliable, verifiable, and objectively determinable; prices listed in multi-element arrangement may not be representative of fair value because prices of different components of transaction can be altered in negotiations and still result in same aggregate consideration).

ii. Fantasy Sports

Gemstar recognized and reported $20 million in IPG advertising revenue from Fantasy Sports in 2001, including $1.9 million in the quarter ended March 31, 2001. This revenue was material to Gemstar's separately reported Interactive Sector financial results.

The KPMG auditors knew that (1) in June 2001, Gemstar entered into a non-monetary transaction to purchase Fantasy Sports' intellectual property for $750,000 in cash and $20 million in Gemstar advertising; (2) in the first quarter of 2001 and before consummating the non-monetary transaction with, or receiving any payment from, Fantasy Sports, Gemstar ran IPG advertising for Fantasy Sports and recognized and reported $1.9 million in IPG advertising revenue; and (3) in 2001, Gemstar ran IPG advertising for Fantasy Sports and recognized $20 million in IPG advertising revenue.

They also reasonably should have known that (1) Fantasy Sports did not have the financial ability to pay for the $1.9 million in IPG advertising if the non-monetary transaction was not consummated; and (2) Gemstar did not have sufficient stand-alone IPG advertising revenue (i.e., revenue from advertising that was not part of a related-party, non-monetary, or multi-element transaction) to provide a basis on which to fair value the Fantasy Sports IPG advertising.

The KPMG auditors therefore reasonably should have known that Gemstar's recognition of the Fantasy Sports IPG advertising revenue in the first quarter of 2001 did not conform to GAAP. Specifically, they should have known that Gemstar did not have an arrangement with Fantasy Sports and there was no assurance of collectibility, in that Gemstar had not consummated the non-monetary transaction with Fantasy Sports and Fantasy Sports did not otherwise have the financial ability to pay for the advertising. See SFAC No. 5, ¶ 83 (revenue generally recognized when it is both realized or realizable and earned); SAB No. 101 and authorities cited therein (revenue realized or realizable and earned when persuasive evidence of arrangement exists, delivery has occurred or services have been rendered, price is fixed or determinable, and collectibility is reasonably assured).

The KPMG auditors also reasonably should have known that Gemstar's recognition of the Fantasy Sports IPG advertising revenue for all of 2001 did not conform to GAAP. Specifically, they should have known that Gemstar could not reliably, verifiably, and objectively determine the fair value of the IPG advertising. See APB Opinion No. 29 (revenue from non-monetary transactions must be based on fair value of assets involved; fair value to be used is that of asset surrendered unless fair value of asset received is more clearly evident; fair value defined as estimated realizable values in cash transactions of same or similar assets, quoted market prices, independent appraisals, estimated fair values of assets or services received in exchange, and other available evidence). 7

iii. Print Advertisers

In the last two quarters of 2001, Gemstar gave advertisers that had already committed to purchase a total of $5.6 million in print advertising an equal amount of IPG advertising for free. Gemstar, however, recognized and reported the $5.6 million in revenue from these advertisers as IPG advertising revenue in the Interactive Sector and not as print advertising revenue in the Media Sector. This revenue was material to Gemstar's separately reported Interactive Sector financial results.

During the September 30, 2001 review, the KPMG auditors received information from a TV Guide controller concerning the allocation of IPG revenue, specifically that Gemstar was allocating print advertising revenue from TV Guide to other Gemstar sectors. Despite this information, the KPMG auditors relied on an assurance from a Gemstar accountant that the amount of such multi-platform advertising revenue was not significant in 2001 and that Gemstar was developing a policy for proper recognition of such revenue in the future. Had the KPMG auditors looked into this issue, they would likely have determined that Gemstar was improperly recognizing Media Sector print advertising revenue as Interactive Sector IPG advertising revenue.

b. The Improper Disclosure of the Motorola and Tribune Revenue and Transactions

The KPMG auditors reasonably should have known that Gemstar's disclosure in Forms 10-K regarding its Interactive Sector revenue and the Motorola and Tribune revenue and transactions was inconsistent with Gemstar's accounting for those transactions. The KPMG auditors knew that Gemstar, in its 2001 financial statement footnotes, separately reported its Interactive Sector financial results. They also should have known that Gemstar, in its 2001 Form 10-K, touted the substantial growth in Interactive Sector revenues and attributed that growth to the successful launch of IPG advertising but did not disclose that a material amount of Interactive Sector revenue resulted from the multi-element Motorola and Tribune transactions. See AU §§550.02 & 04 (auditors should read company's annual report).

The KPMG auditors also knew that Gemstar, in its 2000 and 2001 financial statement footnotes, stated that Gemstar had settled a pending arbitration and lawsuit with, and provided for a long-term license to, Motorola but omitted to disclose the $17.5 million advertising component of the transaction.

The KPMG auditors also reasonably should have known that Gemstar, in its 2001 financial statement footnotes, stated that Gemstar had sold its WGN distribution business to Tribune but omitted to disclose the $100 million advertising component of the transaction.

In light of their knowledge regarding the Motorola and Tribune transactions, the KPMG auditors reasonably should have known that Gemstar's disclosure regarding its Interactive Sector revenue and the Motorola and Tribune transactions and IPG advertising revenue was inconsistent with Gemstar's accounting for the transactions.

3. KPMG's Policy Regarding Possible Restatements

From April to September 2002, Gemstar's Audit Committee conducted a review of Gemstar's accounting policies and procedures relating to Gemstar's 2001 financial statements. In mid-August 2002, KPMG learned that Gemstar was considering restating its recognition of IPG advertising revenue from the Fantasy Sports transaction and that the Audit Committee was continuing to review Gemstar's recognition practices for certain additional transactions. Also in mid-August 2002, as part of the Gemstar's Audit Committee's investigation into potential restatements of Gemstar's financial statements, certain additional information came to light that was not conveyed to KPMG's Department of Professional Practice. This information included evidence indicating that senior Gemstar management may have been involved in an intentional misallocation of print advertising revenue to the Interactive Sector and that Gemstar's evidence to support the fair value of its IPG advertising may not have been sufficient.

Although KPMG did have in place a policy that required an engagement team involved in potential restatements of financial statements upon which the firm had issued an audit report to consult with KPMG's Department of Professional Practice regarding the specific transaction being proposed for restatement by the issuer of the financial statements, it did not have in place a policy that required that such consultation with the Department of Professional Practice encompass all significant issues that had come to the attention of the engagement team subsequent to the issuance of the audit report on the financial statements in question. Consultation pursuant to such a policy should have led KPMG to become aware of and 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 November 22, 2002.8

F. RESPONDENTS ENGAGED IN IMPROPER PROFESSIONAL CONDUCT WITHIN THE MEANING OF COMMISSION'S RULE OF PRACTICE 102(e)

Rule 102(e)(1)(ii) of the Commission's Rules of Practice provides, in part, that the Commission may censure or deny, temporarily or permanently, the privilege of appearing or practicing before the Commission to any person who is found by the Commission to have engaged in improper professional conduct. Rule 102(e)(1)(iv) defines improper professional conduct with respect to persons licensed to practice as accountants.

As applicable here, improper professional conduct means a violation of applicable professional standards that resulted from "repeated instances of unreasonable conduct … that indicate a lack of competence to practice before the Commission." Rule 102(e)(1)(iii)(B)(2). As stated below, KPMG and its auditors acted unreasonably in failing to require its client to comply with GAAP and in failing to comply with GAAS during its audits and reviews of Gemstar's financial statements.

1. Failure to Exercise Professional Care and Skepticism, Failure to Obtain Sufficient Competent Evidential Matter, and Over-Reliance on Management Representations

GAAS requires that auditors exercise due professional care in performing an audit or review and in preparing the audit report. AU §230.01. Due professional care requires that the auditor exercise professional skepticism in performing audit and review procedures and gathering and analyzing audit evidence. AU §230.07-.08. "In exercising professional skepticism, the auditor should not be satisfied with less than persuasive evidence because of a belief that management is honest." AU §230.09. Exercise of professional skepticism requires auditors to demonstrate a questioning mind and to critically assess audit evidence. AU §316.27.

GAAS also requires that auditors obtain sufficient competent evidential matter through inspection, observation, inquiries, and confirmations to afford a reasonable basis for an audit opinion. AU §326.01. Evidence obtained from independent sources outside the company provides greater assurance of reliability than that secured solely within the company. AU §326.21a. Auditors may not substitute management's representations for the application of auditing procedures necessary to afford a reasonable basis for an audit opinion. AU §333.02.

In auditing and reviewing Gemstar's financial statements, the KPMG auditors acted unreasonably in failing to exercise due professional care and skepticism, failing to obtain sufficient competent evidential matter, and substituting management's representations for competent evidential matter.

With respect to the AOL revenue, Wong, Palbaum, Hori, and KPMG unreasonably failed to exercise professional care and skepticism in reviewing the AOL IPG agreement and in testing Gemstar's representations regarding the purpose of the upfront nonrefundable fee. They also unreasonably failed to obtain sufficient competent evidential matter and substituted management's representations for such competent evidential matter regarding Gemstar's recognition of the AOL upfront nonrefundable fee. Had they reasonably complied with GAAS, they would have concluded that Gemstar had improperly recognized the revenue.

With respect to the Scientific-Atlanta and TWC revenue, Wong (as to Scientific-Atlanta), Palbaum, Janeski, Hori, and KPMG unreasonably failed to exercise professional care and skepticism, failed to obtain sufficient competent evidence, and substituted management's representations for such competent evidential matter in determining that there was a final arrangement. Had they reasonably complied with GAAS, they would have concluded that Gemstar had improperly recognized the revenue.

With respect to the first quarter 2001 Fantasy Sports revenue, Palbaum, Janeski, Hori, and KPMG unreasonably failed to exercise professional care and skepticism in determining that there was a final arrangement and that collectibility was reasonably assured. Had they reasonably exercised professional care and skepticism, they would have concluded that Gemstar had improperly recognized the revenue.

With respect to the Motorola, Tribune and Fantasy Sports revenue, Palbaum, Janeski (as to Motorola and Fantasy Sports), Hori, and KPMG unreasonably failed to exercise professional care and skepticism, failed to obtain sufficient competent evidence as to the fair value of the IPG advertising, and substituted management's representations for such competent evidential matter in ensuring that Gemstar's recognition of the Interactive Sector revenue from these transactions was based on the advertising's fair value. Had they reasonably complied with GAAS, they would have concluded that Gemstar had improperly recognized the revenue.

With respect to the print advertising Interactive Sector revenue, Palbaum, Hori, and KPMG unreasonably failed to exercise professional care and skepticism, failed to obtain sufficient competent evidence, and substituted management's representations for such competent evidential matter in ensuring that Gemstar properly allocated the print advertising revenue to the Media Sector and not the Interactive Sector. Had they reasonably complied with GAAS, they would have concluded that Gemstar had improperly allocated the print advertising revenue to the Interactive Sector instead of the Media Sector.

2. Failure to Take Appropriate Action to Correct Disclosure that Did Not Comply with GAAP and/or Was Inconsistent with Gemstar's Financial Statements

GAAS provides that if a company omits from its financial statements, including the accompanying notes, information that is required by GAAP, the auditor should express a qualified or adverse audit opinion and should provide the information in the auditor's report. AU §431.03. GAAS further requires auditors to read the other information in a company's annual reports and to consider whether this other information is materially inconsistent with information in the financial statements and whether the auditors should take appropriate action to correct the inconsistency. AU §§550.02 & .04.

With respect to the AOL revenue, Wong, Palbaum, and Hori knew that Gemstar was recognizing the AOL upfront nonrefundable fee as compensation for providing technical assistance and engineering support and the transfer of a license; they also reasonably should have known that Gemstar had no stated policy for the recognition of revenue for technical assistance and engineering support, and that Gemstar's accounting for the AOL upfront fee was inconsistent with its disclosure of the AOL transaction. Wong, Palbaum, Hori, and KPMG, however, unreasonably failed to take appropriate action.

With respect to the Scientific-Atlanta and TWC revenue, Wong (as to Scientific-Atlanta), Palbaum, Janeski, and Hori reasonably should have known that Gemstar's disclosed licensing revenue recognition policy was inadequate under GAAP to support the recognition of the contingent Scientific-Atlanta and TWC revenue. Wong (as to Scientific-Atlanta), Palbaum, Janeski, Hori, and KPMG unreasonably failed to take appropriate action.

With respect to the Motorola and Tribune revenue, Palbaum, Janeski (as to Motorola), and Hori reasonably should have known that Gemstar's disclosure regarding the Interactive Sector financial results and the reasons for those results was inconsistent with Gemstar's recognition of IPG revenue from the multi-element Motorola and Tribune transactions. They also reasonably should have known that Gemstar's disclosure regarding the fair value of the Motorola and Tribune IPG advertising and the terms of the Motorola and Tribune transactions was inconsistent with Gemstar's recognition of IPG revenue from these transactions. Palbaum, Janeski (as to Motorola), Hori, and KPMG unreasonably failed to take appropriate action.

3. Failure to Render Accurate Audit Reports

GAAS requires that the auditor's report express an opinion on the financial statements taken as a whole and must contain a clear indication of the character of the auditor's work. AU § 508.04. The auditor can determine that he is able to issue an audit report containing an unqualified opinion only if he has conducted his audit in accordance with GAAS. AU § 508.07.

In auditing Gemstar's financial statements, Wong, Palbaum, Janeski, and Hori acted unreasonably in causing KPMG to render its audit reports containing unqualified opinions. As stated above, they reasonably should have known that Gemstar's financial statements did not conform to GAAP and that they did not conduct their audits in accordance with GAAS. KPMG, however, issued audit reports containing unqualified opinions that inaccurately stated that Gemstar's financial statements conformed to GAAP and that they had conducted their audits in accordance with GAAS.

G. CONCLUSION AND UNDERTAKINGS

Based on the foregoing, the Commission finds that KPMG engaged in improper professional conduct within the meaning of Rule 102(e)(1)(ii) of the Commission's Rules of Practice. Specifically, KPMG engaged in repeated instances of unreasonable conduct, each resulting in a violation of applicable professional standards.

KPMG undertakes:

  1. Within 10 days of the date of this Order, to pay $10,000,000 to the Clerk of the United States District Court for the Central District of California, Western Division, together with a cover letter identifying KPMG as a respondent in a Commission administrative proceeding related to SEC v. Gemstar-TV Guide International, Inc., Civil Action No. 04-4506 (C.D. Cal.) and specifying that the payment is made in connection with the Commission's administrative proceeding. KPMG shall simultaneously transmit photocopies of such payment and letter to Kelly Bowers, Securities and Exchange Commission, 5670 Wilshire Blvd., 11th Floor, Los Angeles, California 90036. By making this payment, KPMG relinquishes all legal and equitable right, title, and interest in such funds, and no part of the funds shall be returned to KPMG. The Clerk shall deposit the funds into an interest bearing account. These funds, together with any interest and income earned thereon (collectively, the "Fund"), shall be held until further order of the Court. In accordance with the guidelines set by the Director of the Administrative Office of the United States District Courts, the Clerk is directed, without further order of the Court, to deduct from the income earned on the money in the Fund a fee equal to ten percent of the income earned on the Fund. Such fee shall not exceed that authorized by the Judicial Conference of the United States. The Commission will by motion propose a plan to distribute the Fund subject to the Court's approval. Such a plan will provide that the Fund shall be distributed pursuant to the Fair Fund provisions of Section 308(a) of the Sarbanes-Oxley Act of 2002. KPMG acknowledges that such funds will not be used to pay attorneys' fees in any private damages action brought against KPMG by or on behalf of one or more Gemstar investors.
     
  2. To provide (a) training to its partners and managers with respect to (i) qualitative materiality; (ii) accounting for multi-element transactions; and (iii) consideration of appropriate disclosure related to complex accounting issues, which are defined as accounting issues about which an engagement team specifically consulted with the Department of Professional Practice, local Professional Practice Partner, or the SEC Reviewing Partner; by June 30, 2005, KPMG shall certify in writing to the Commission that such training has occurred; and (b) continuing training to its audit personnel on such topics, as appropriate.
     
  3. To adopt a policy that (1) requires engagement teams to (a) consult with the Department of Professional Practice whenever (i) a registrant informs the engagement team that it is considering restating previously issued financial statements (for reasons other than due to the adoption of new accounting pronouncements, a change in accounting principle or the application of an accounting principle that requires or permits retroactive application) or (ii) the engagement team independently is considering whether to advise the registrant that previously issued financial statements should be restated (for reasons other than due to the adoption of new accounting pronouncements, a change in accounting principle or the application of an accounting principle that requires or permits retroactive application); (b) to include in such consultation all significant new information related to the previously issued financial statements not known by the engagement team at the time the audit report was issued and not limit its consultation to the initial issue or issues which may have led to a consideration of a possible restatement; and (c) document its communication and consultation with the Department of Professional Practice, which documentation shall be included by the engagement team in KPMG's work papers for the client and a copy sent to the Department of Professional Practice; and (2) requires the Department of Professional Practice, upon a determination, either by the issuer of the financial statements or by KPMG, that there is a likely material error in the previously issued financial statements, to review the memorandum previously prepared by the engagement team documenting significant issues that arose during the audits of the financial statements that may be restated (currently the Significant Issues and Decisions Document, or its functional equivalent). By January 31, 2005, KPMG shall certify in writing to the Commission that such a policy has been established and implemented.
     

In determining whether to accept KPMG's Offer, the Commission has considered the undertakings set forth in paragraphs 1 through 3, above.

Based on the foregoing, the Commission finds that Palbaum, Wong, Janeski and Hori engaged in improper professional conduct pursuant to Rule 102(e)(1)(ii) of the Commission's Rules of Practice. Specifically, Palbaum, Hori, Wong, and Janeski engaged in repeated instances of unreasonable conduct, each resulting in a violation of applicable professional standards.

IV.

On the basis of the foregoing, the Commission deems it appropriate to impose the sanctions agreed to in Respondents KPMG's, Palbaum's, Hori's, Wong's, and Janeski's Offers.

Accordingly, it is hereby ORDERED, effective immediately, that:

  1. KPMG is censured pursuant to Rule 102(e)(1)(ii) of the Commission's Rules of Practice.
     
  2. Palbaum, Hori, Wong, and Janeski are each denied the privilege of appearing or practicing before the Commission as an accountant.
     
  3. After three years (Palbaum), eighteen months (Hori), and one year (Wong and Janeski), respectively, from the date of this Order, Palbaum, Hori, Wong, and Janeski may each request that the Commission consider his reinstatement by submitting an application (attention: Office of the Chief Accountant) to resume appearing or practicing before the Commission as:
     
    1. a preparer or reviewer, or a person responsible for the preparation or review, of any public company's financial statements that are filed with the Commission. Such an application must satisfy the Commission that such Respondent's work in his practice before the Commission will be reviewed either by the independent audit committee of the public company for which he works or in some other acceptable manner, as long as he practices before the Commission in this capacity; and/or
       
    2. an independent accountant. Such an application must satisfy the Commission that:
       
      1. such Respondent, or the public accounting firm with which he is associated, is registered with the Public Company Accounting Oversight Board ("Board") in accordance with the Sarbanes-Oxley Act of 2002, and such registration continues to be effective;
         
      2. such Respondent, or the registered accounting firm with which he is associated, has been inspected by the Board and that inspection did not identify any criticisms of or potential defects in such Respondent's or the firm's quality control system that would indicate that such Respondent will not receive appropriate supervision or, if the Board has not conducted an inspection, has received an unqualified report relating to his, or the firm's, most recent peer review conducted in accordance with the guidelines adopted by the former SEC Practice Section of the American Institute of Certified Public Accountants Division for CPA Firms or an organization providing equivalent oversight and quality control functions;
         
      3. such Respondent has resolved all disciplinary issues with the Board, and has complied with all terms and conditions of any sanctions imposed by the Board (other than reinstatement by the Commission); and
         
      4. such Respondent acknowledges his responsibility, as long as such Respondent appears or practices before the Commission as an independent accountant, to comply with all requirements of the Commission and the Board, including, but not limited to, all requirements relating to registration, inspections, concurring partner reviews and quality control standards.
         
    3. The Commission will consider an application by each such Respondent to resume appearing or practicing before the Commission provided that his state CPA license is current and he has resolved all other disciplinary issues with the applicable state boards of accountancy. However, if state licensure is dependent on reinstatement by the Commission, the Commission will consider an application on its other merits. The Commission's review may include consideration of, in addition to the matters referenced above, any other matters relating to such Respondent's character, integrity, professional conduct, or qualifications to appear or practice before the Commission.
       

    By the Commission.

    Jonathan G. Katz
    Secretary


    Endnotes


    http://www.sec.gov/litigation/admin/34-50564.htm


    Modified: 10/20/2004