Three accountants who worked at auditing giant ChuoAoyama Pricewaterhouse Coopers pleaded guilty Thursday before the Tokyo District Court to charges of falsifying Kanebo Ltd.’s earnings in fiscal 2001 and 2002 and hiding over 160 billion yen in liabilities.

The case is the first in which certified public accountants from a top auditing firm are being tried for allegedly falsifying a client’s financial statements.

Kuniaki Sato, 63, Kazutoshi Kanda, 56, and Seiichiro Tokumi, 58, bowed, apologized and owned up to the charges, acknowledging they violated the Securities and Exchange Law by helping Kanebo hide a consolidated deficit of 81.9 billion yen in fiscal 2001 and 80.6 billion yen in fiscal 2002.

Former Kanebo President Takashi Hoashi and Vice President Takashi Miyahara told the auditors in April 2002 it was necessary to report a net profit for the previous business year, the court said. The two were found guilty Monday and handed suspended prison terms.

Although the three men knew the firm was in the red, with its liabilities far exceeding assets, they told the two Kanebo executives they would let the false numbers pass if the net profit figure was under 100 million yen, prosecutors said.

ChuoAoyama auditors signed Kanebo’s earnings reports boasting a profit of 70 million yen and consolidated net assets of 926 million yen in June that year.

The three also approved a fiscal 2002 earnings report that put Kanebo’s consolidated net assets at 510 million yen, when the firm had a deficit.

The Kanebo falsifications, along with alleged window-dressing at Internet firm Livedoor Co., has shaken investor faith in corporate auditing. Both cases have been compared with the U.S. accounting fraud linked to Enron Corp.’s fall in 2001.

Auditors have said privately that auditing can be difficult. With long-term clients, auditors are there for a good part of the year, often with their own desks at the firm. They claim they often find it difficult to push for information or to charge for more time to investigate questionable practices.

It can also be difficult for an individual to blow the whistle on a client engaging in illegal practices, if the preceding auditor was complicit, they say.

That is what happened at Kanebo, where the window-dressing went on for decades.

Prosecutors told the court that Sato, who oversaw the Kanebo account for 30 years, and Kanda and Tokumi, who joined him 15 years later, first let the cosmetics and households goods firm remove subsidiaries’ losses from its consolidated balance sheet, contrary to accounting rules.

Then when the fiscal 2001 financial statements were being compiled and Tokumi and another ChuoAoyama colleague, Kazuya Miyamura, began raising questions about the figures, Kanebo executives threatened to expose the years of falsifications and bring ChuoAoyama down, the Tokyo District Court said Monday in its conviction of Kanebo’s Hoashi and Miyahara.

The three accountants also were afraid of having their past wrongdoings discovered if Kanebo went under, the prosecutors said Thursday.

The Kanebo and Livedoor cases have prompted additional regulations to deter collusion between auditors and the firms they are supposed to check.

The Japanese Institute of Certified Public Accountants last fall set up a review panel that includes outside experts, and has published stricter penalties for auditors who help companies falsify their financial statements.

The Financial Services Agency has also drafted its own version of the U.S. Sarbanes-Oxley Act (SOX), which requires firms to have strict internal controls, to follow compliance rules and to use outside auditors.

The U.S. Congress passed SOX in 2002 in response to the Enron debacle.

The FSA will submit its version, known as J-SOX, during the current Diet session.

ChuoAoyama got FSA warnings in 2000 and 2005 for failing to catch the false earnings reports of now-defunct Yaohan Japan and for poor checks on Ashikaga Bank.

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