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TOKYO/LONDON (Reuters) - Japan's Olympus Corp replaced its auditor in 2009 after a disagreement over how to account for several acquisitions, but it decided not to reveal the dispute to investors, an internal document shows.
Olympus has lost 55 percent of its market value since its former chief executive blew the whistle on a series of strange deals over the past five years, including the payment of a massive $687 million advisory fee.
In May 2009, Tsuyoshi Kikukawa, the then president of the camera-maker and medical equipment firm, announced that the contract for its then auditor, KPMG, had ended and that another global accounting firm, Ernst & Young, would take over.
Kikukawa made no mention of any row with KPMG, although Japanese disclosure rules require companies to notify investors of "any matters concerning the opinions" of an outgoing auditor.
In a confidential internal document, Kikukawa wrote to executives in the United States and Europe, revealing that there had been a disagreement with KPMG which he did not plan to disclose to the stock market.
"The release to be published today says that the reason of this termination is due simply to expiry of accounting auditors' terms of office," Kikukawa said in the letter dated May 25, 2009, which was written in English.
"I, however, would like to personally tell both of you about the circumstances behind this decision for your understanding."
Kikukawa outlined a rift between management and KPMG over the goodwill impairment of some consolidated firms and over its $2.2 billion purchase of UK medical device firm Gyrus in 2008.
That acquisition is central to the scandal engulfing Olympus because of the huge advisory fee, the biggest in M&A history.
"There are the substantial difference of views on the below mentioned issues between us including the (internal) company auditors and KPMG AZSA; the view of impairment test on goodwill of some consolidated companies, the view of purchase price allocations and impairment test of Gyrus acquisition."
The discovery of incomplete or improper disclosure about a changing of auditors would prompt disciplinary action from the Tokyo Stock Exchange, such as being placed on a watchlist or being required to submit an improvement plan.
But that infraction alone would not trigger a delisting, said bourse spokesman Naoya Takahashi.
It would likely draw the attention of Japan's securities industry regulator, which has started looking into past Olympus acquisitions, and has made disclosure a key focus of the probe, sources have told Reuters.
Yoshiaki Yamada, manager of Olympus' public and investor relations department, said he could not comment on the letter because it was not something that had been disclosed by the company. He reiterated that Olympus changed auditors because KPMG's term had ended.
KPMG's Japan practice, KPMG AZSA LLC, declined to comment, as did Ernst & Young ShinNihon LLC, citing its duty of confidentiality as auditor.
The confidential letter was given to Reuters by former Olympus CEO Michael Woodford who was ousted after just two weeks in the job on October 14 for what he says was his persistent questioning over the Gyrus advisory fee and other odd-looking acquisitions.
Woodford says the letter was addressed to him in his role as head of Olympus Europe at the time and to Mark Gumz, then head of Olympus Corp America.
"I want you to understand our decision and cooperate for smooth transition of accounting auditor," Kikukawa concluded in the letter.
Woodford, a Briton who spent most of his 31-year Olympus career outside Japan, went on to replace Kikukawa as group president in April this year, a rare foreigner in charge of a Japanese blue chip, and Kikukawa became executive chairman.
But last week, after Woodford's sacking had sparked a firestorm and led to a meltdown in the shares of the 92-year-old Japanese firm, Kikukawa quit as chairman and Olympus launched its own independent inquiry into the affair.
The scandal has highlighted money trails that lead in several cases from Olympus to obscure Cayman Islands firms, including one that pocketed the bulk of the Gyrus advisory fee, and has led to hundreds of millions of dollars in writedowns.
It has also shined a light on the way Olympus accounted for the fee, which was roughly a third of the Gyrus purchase price compared with investment banking norms of around 1-2 percent.
Japan accounting does not always follow international accounting standards, and KPMG AZSA had signed off on Olympus's group accounts without qualification only a few weeks after its removal as auditor was announced.
Under KMPG AZSA's watch, Olympus was prompted to write-off most of the value of three obscure domestic companies that it bought for $773 million in a series of transactions that are also at the heart of the widening scandal.
It is not rare for an auditor to qualify the accounts of a subsidiary while not mentioning that issue in signing off on the parent firm's books, accounting experts said.
"It would come down to whether that issue was deemed materially important for the consolidated books from a holistic perspective," said a Tokyo-based university professor and research analyst who spoke on condition of anonymity because his firm has had dealings with Olympus.
"If the numbers add up that is the most important thing."
Those Japanese accounts made no mention of the eye-watering fee Olympus had agreed to pay, nor raised any questions about the Cayman Islands firm to which it was due.
But KPMG's UK arm, which audited the subsidiary accounts of Gyrus under tougher international accounting rules, raised a big red flag over both issues.
After their termination as Olympus auditor, KPMG in the UK wrote to Gyrus in Cardiff, Wales, that there were circumstances "connected with our ceasing to hold office that should be brought to the attention of the company's members or creditors," a document filed with the UK corporate registry shows.
In the last set of Gyrus accounts KPMG handled, the auditor voiced concerns over the accounting treatment of a big portion of the advisory fee, which was awarded to Cayman Islands-based AXAM Investments Ltd in the form of Gyrus preference shares.
KPMG's British auditors said they felt the preference shares, more akin to bonds than ordinary shares, amounted to a liability that should have been recorded at fair value. Instead, Gyrus directors valued them at a face value of $177 million.
Around the same time KPMG Audit Plc noted its objection about this, Olympus repurchased the shares for $620 million from AXAM, more than three times their face value, according to other internal documents obtained by Reuters.
KPMG Audit Plc also questioned whether AXAM was a related party to Olympus, noting that it had not been given enough information from the company to clarify this issue. It said proper accounting records had not been maintained.
Since the Olympus scandal erupted last month, the company has faced a barrage of questions over the circumstances behind KPMG's removal as auditor.
On October 17, Olympus Executive Vice President Hisashi Mori told analysts and investors that it had simply "switched to the number one auditor in Japan."
But the accounting followed a similar pattern under the new auditor, Ernst & Young, which gave Olympus group a clean bill of health under Japanese accounting but raised concerns in auditing the Gyrus unit under international standards. In the Gyrus audit, it too questioned whether AXAM was a related party.
Asked if Kikukawa's 2009 letter had raised any red flags to him at the time, Woodford said: "I thought it was interesting that there had been heated discussions about the treatment of the goodwill in relation to the Gyrus acquisition ... But knowing that Ernst & Young, I thought, were a superb professional firm, I didn't think there was anything improper."
Editing by Mark Bendeich and Dean Yates