An independent report commissioned by the Justice Department concluded that the "improper and imprudent practices" of now-bankrupt subprime lender New Century Financial were condoned and enabled by the company's independent auditor, KPMG.

The accounting firm allowed New Century to change its accounting to report strong profits during the housing boom, when a more conservative treatment would have shown losses. The company lowered its reserves for bad loans that investors were forcing it to buy back, even as the number of bad loans increased.

The New York Times reports that this may pave the way for New Century to sue KPMG. Seven years after the collapse of Enron, conflicts of interest involving "independent" auditors and their clients who pay them are still costing shareholders billions. Back in October, I posed 2 ideas for ways that issues of auditor independence might be fixed:

• Shouldn't companies be required to change accounting firms (rather than just employees within the same firm) every few years to avoid entrenchment and cozy relationships. When accountants see colleagues leaving for lucrative gigs at the company they once audited, can that lead to a conflict of interest?

• Should companies be allowed to choose their own auditors, or should the SEC consider implementing a system where auditors are appointed by a third-party? Allowing companies to hire and fire their own independent auditing firms raises questions about whether they are really independent.

With a recent -- and idiotic, I would say -- Supreme Court decision making it tougher for defrauded investors to sue investment banks and auditors who aided and abetted in fraud, auditor independence may be more important than ever.

In what could be a a key ruling for those of us hoping to learn more about shady subprime lending practices, a bankruptcy judge has given New Century Financial until February 6 to turn over a report of an investigation into the firm's cash handling practices to bankruptcy monitors.

Michael Missal was appointed by judge Kevin Carey to look into the accounting mistakes and/or fraud that led the firm to file false financial statement with the SEC in 2005 and 2006. According to the AP, "That report has yet to be filed. Missal said that continued foot-dragging by the defunct lender, former leaders and accounting firm KPMG will hold it up until March."

However, he has filed the report on possible cash mishandling, but it has not been made public at the request of New Century.

MAJOR PAPERS:

• The Wall Street Journal reported that New Century Financial Corporation (OTC: NEWC) is expected to announce as soon as today that it is filing for bankruptcy projection.
• The Wall Street Journal reported that EMI Group plc (OTC: EMIPY) will hold a special media event on Monday with Apple Inc's (NASDAQ: AAPL) CEO Steve Jobs as its special guest, fueling speculation that EMI will sell music without anti-piracy software.
• The Financial Times reported that the U.S. and South Korea said they had agreed on the terms of a landmark free trade deal which will boost trade by as much as $20B a year.
• The Financial Times reported that French stock market regulators are looking into unusual share price movements in France Telecom ADS (NYSE: FTE) and a few other CAC40 stocks, as there is concern that unknown forces could be profiting from false rumors and speculation in the stocks.

OTHER PAPERS:

• The U.K. Times has learned that GlaxoSmithKline plc ADR (NYSE: GSK) is in talks with the World Health Organization, or WHO, over a proposal for a subsidized mass avian flu vaccine for developing countries.

WEBSITES:

• According to an internal memo obtained by SUSE-IRC.org, Microsoft Corporation (NASDAQ: MSFT) is in talks to acquire Novell Inc (NASDAQ: NOVL).

New Century Financial Corporation (OTC: NEWC) is a stock to stay away from. However, looking into what is going on at this mortgage provider can teach investors how the industry works and possibly how to play an industry upturn when it occurs.

New Century is a subprime mortgage loan originator, meaning New Century underwrites mortgages that are provided to home buyers.

In 2006, New Century underwrote $60 billion in mortgages, a large number. To buy these mortgages and package them to be securitized, New Century needs large lines of credits from big banks. However, last week, their bankers withdrew their lines of credit, so they cannot underwrite any new mortgages. Which is fine as long as they can profitable sell the mortgages they still have to place.

However, there is one more catch. These subprime mortgages all have contracts which forces New Century to take back mortgages that go into early default. With short-term interest rates having shot up the past few years, more mortgages are going into early default and are being pushed back to New Century, creating a problem for this company.

New Century's creditors currently want $8.4 billion in cash back for loans provided due in part because of early prepayment defaults. This $8.4 billion loan is collateralized by $9.0 billion in mortgages. So there is serious collateral. However, traders are using the current tight liquidity conditions and concerns about higher early prepayment defaults to place New Century in a difficult liquidity situation.

But, at the end of day, there are real assets collateralizing these bank loans. The questions are how bad the early prepayment default rates are, how much and how quickly do the banks want their loans back and how much pressure traders will place on mortgage pricing in the market.

In the collapse of the subprime credit card and the subprime auto businesses, companies stayed afloat by large investors willing to put up a lot of cash to recapitalize the company. When this happened, investors who purchased the stocks of these companies post-recap made a lot of money.

Wait for these companies to complete large equity recaps as a sign to start looking at these stocks. Then there might be some money to be made without taking a lot of risk.

It's hard to believe that not so very long ago, Arthur Andersen was the accounting firm. But, of course, Enron destroyed that and the company has since gone bust.

But, even dead companies still need to fight legal battles. And today, Andersen agreed to shell-out $72.5 million to settle claims on the Enron debacle. In light of the loss of jobs, pensions and shareholder value, it's a pittance.

It's also an indication that Corporate America is still vulnerable to financial shenanigans. Despite new laws like Sarbanes-Oxley, there are still companies that try to push the envelope -- or even commit crimes.

It seems ironic that on the day that Andersen announces its settlement is also the day that New Century Financial Corp. (NYSE: NEW) had its stock halted. In fact, it looks like the company is facing the same type of liquidity crisis that Enron did.

Yes, it's a bit of déjà vu all over again.

So over the next few years, we can expect some tantalizing books on New Century and perhaps a movie.

As for learning lessons? I'm not sure about that.

Tom Taulli is the author of various books, including the Complete M&A Handbook and the EDGAR-Online Guide to Decoding Financial Statements.

What is up is the theme of this week's merger talk, because there is lots of chatter, but no bold moves. Yet.


NEW CENTURY FINANCIAL CORPORATION (NYSE: NEW)

Down the tubes, and then what? With bankruptcy imminent, what next happens to the nation's second largest sub prime mortgage banker? Shares continue to fall today, recently at $3.18, a 69 cent fall, equal to almost 18%. Just two months ago the share price was over $30. The real estate investment trust isn't getting any help from lenders. Maybe reorganization is just what they need.

PALM INC (NASDAQ: PALM), DELL INC (NASDAQ: DELL)

Or should it be Dell, Palm? Either way, Palm is looking to sell, and Dell is looking to buy. Palm knows Apple Inc's (NASDAQ: AAPL) iPhone can really hit them with a number of body blows, hence, get out while the getting's good, or at least okay, seems to be the Palm plan. For Dell, they're looking at smart phones as a part of their consumer products future. And lord knows they have the cash to buy a Palm. It's a brand with international contacts and a retail distribution network. Let the bidding begin, say at $2B?

NOBLE DRILLING CORP (NYSE: NE)

A noble "no" to an LBO was sent out from high atop the corporate structure several weeks ago, but rumors keep a coming. Yes, they said they'd use their extra dough to buy their own stock, just like they did before, in 2006. And that's what they've been doing. Who knows, maybe there's nothing to it.


CLAIRE'S STORES INC (NYSE: CLE)

Private equity firm Apax seems to be in the lead to take the 3,000 stores-strong Claire's. Get this: Apax is said to be so anxious to get going that it's said they have new management "in waiting." Wow. Claire's has said it's exploring "strategic alternatives", including a sale. Goldman Sachs is helping. Must be serious stuff. By the way, same store sales were up but down recently. Up 1%, but 2.3% was expected. What do you think Apax feeds that management team in waiting, anyway?

ALLTEL CORPORATION (NYSE: AT)

Buy me, please. That's what the nation's fifth largest wireless operator (subscribers) has been saying. AT&T is kicking the tires, but because of antitrust and other issues, it may only be doing just that. Verizon Communications Inc (NYSE: VZ) may have a look-see, as well as private equity firms. Tepid seems to have been the response so far, but that can change quickly. Management says the rumors are nothing new. Is that a bad thing?

MOST NOTEWORTHY: EchoStar Communications Corp (DISH), PeopleSupport, Inc (PSPT), and Quicksilver, Inc (ZQK) were today's most notable downgrades:

• Credit Suisse downgraded EchoStar Communications Corp (NASDAQ: DISH) to Underperform from Neutral based on valuation and lower probability of an acquisition by AT&T (NYSE: T).

• PeopleSupport Inc (NASDAQ: PSPT) was downgraded to Market Perform from Outperform at both Piper Jaffray and Freidman Billings following disappointing Q4 earnings and guidance; JMP Securities cut PeopleSupport to Market Outperform from Strong Buy.

• Quicksilver (NYSE: ZQK) was downgraded by a host of firms: to Market Performer from Outperformer at Piper Jaffray, to Sector Performer from Outperformer at CIBC, to Hold from Buy at W.R. Hambrecht, to Neutral from Accumulate at Buckingham and to Sell from Hold at Wedbush.

OTHER DOWNGRADES:

• Freidman Billings downgraded Tercica, Inc (NASDAQ: TRCA) to Underperform from Market Perform on valuation.

• Prudential cut Cheesecake Factory Inc (NASDAQ: CAKE) to Underweight from Neutral citing soft industry sales trends which will impact Q1 and Q2 results.

• Raymond James downgraded Goldcorp Inc (NYSE: GG) to Outperform from Strong Buy.

• Lehman cut Sprint Nextel Corp (NYSE: S) to Equal-Weight from Overweight.

• UBS downgraded New Century Financial Corp (NYSE: NEW) to Reduce from Neutral.

• Stifel downgraded C.H. Robinson Worldwide, Inc (NASDAQ: CHRW) to Sell from Hold.

Analyst summaries provided by TheFlyOnTheWall.com (subscription required).

Two providers of excess liquidity to the international and U.S. economy are going away.

The yen-carry trade, where an investor borrows at very low Japanese interest rates and invests the proceeds in higher yielding credit or equity instruments around the world, is unwinding.

The only way this trade works is if the investor does not hedge the currency, or against appreciation of the yen. If the investor hedges his yen position, the cost of the hedge means the investor will not make any money. Therefore, as the yen begins to appreciate, a vicious cycle begins to emerge: less and less yen-carry trades make money so more and more investors need to liquidate their position and convert their money back into yen to repay the loan. While predicted for years, it finally appears to be happening.

The second big area of excess liquidity also took a shot to the head yesterday. New Century Financial (NYSE: NEW), a subprime mortgage lender, collapsed over 70% as reports hit the news wires that it's financial backer was pulling the plug on the company. New Century closed at $4.65 yesterday, down from a 2005 high of around $65.

With two areas of excess liquidity coming to an end, this should reduce concerns of too much speculative money floating around the global economy. This means world's central bankers, especially in the U.S., can feel more comfortable about not raising rates anymore. This will bode well for the U.S. market once this correction is over.

MOST NOTEWORTHY: Palm, Inc (PALM), New Century Financial Corp (NEW), Yahoo! (YHOO) and Sirius Satellite Radio Inc (SIRI) were some of today's more notable downgrades.

• JP Morgan downgraded Palm, Inc (NASDAQ: PALM) to Underweight from Neutral citing product line, execution and competition concerns.

• New Century Financial Corp (NYSE: NEW) was downgraded to Underperform from Hold at Jefferies and suspended their estimates as they believe the 10-K filing delay indicates that the company's financial and operating situation continues to deteriorate.

• Matrix USA cut Yahoo! (NASDAQ: YHOO) to Sell from Hold, providing an intrinsic value of $25. They believe strong competition, as well as rising popularity and accessibility of free social and entertainment content, is negatively impacting the company.

• Barrington downgraded Sirius Satellite Radio inc (NASDAQ: SIRI) to Market Perform from Outperform. The firm believes 2007 sub-growth target will lag previous forecasts.

OTHER DOWNGRADES:

• JP Morgan downgraded shares of The Scotts Miracle-Gro Co (NYSE: SMG) to Neutral from Overweight based on SMG's lower fundamental visibility with recent increases in raw materials and the company's underperformance during its peak-season.

• JP Morgan also downgraded Marvell Technology Group Ltd (NASDAQ: MRVL) to reflect dilution concerns from the XScale acquisition, slow end-market growth and stock option uncertainty.

• Jefferies downgraded Humana Inc (NYSE: HUM) to Hold from Buy with a $60 target after checks confirmed concerns that recent budgetary analysis in Washington has heightened the risk for legislation to curb Medicare Advantage program growth.

• RBC cut Mediacomm Communications Corp (NASDAQ: MCCC) to Underperform from Sector Perform based on valuation.

• Wachovia downgraded Atlas Pipeline Partners (NYSE: APL) to Market Perform from Outperform following the company's Q4 shortfall.

Analyst summaries provided by TheFlyOnTheWall.com (subscription required).

MOST NOTEWORTHY: Bristol Myers Squibb Co (BMY), Krispy Kreme Doughnuts Inc (KKD), Martha Stewart Living Omnimedia Inc (MSO) and New Century Financial Corp (NEW) were some of today's more notable upgrades:

• UBS upgraded shares of Bristol Myers Squibb Co (NYSE: BMY) to Buy from Neutral. The firm finds the recent pullback an attractive buying opportunity given the possibility of a takeover approach. The broker also believes BMY will likely win its Plavix patent case.

• CIBC resumed coverage of Krispy Kreme Doughnuts Inc (NYSE: KKD) with a Sector Performer rating, up from its recent Underperformer rating, citing resolutions to numerous accounting and legal issues for the upgrade.

• Morgan Stanley upgraded Martha Stewart Living Omnimedia Inc (NYSE: MSO) to Equal Weight from Underweight.

• Bear Stearns upgraded New Century Financial Corp (NYSE: NEW) to Peer Perform from Underperform saying downside risk is limited to $10-$11, but sees upside if business stabilizes and liquidity improves...

OTHER UPGRADES:

• JP Morgan raised Eaton Vance Corp (NYSE: EV) to Neutral from Underweight to reflect the company's strong fund sales and continued capital returns to shareholders.

• AG Edwards replaced Exxon Mobil Corp (NYSE: XOM) on its Focus Portfolio, adding Chevron Corp (CVX) to reflect the company's improved financial strength and attractive valuation.

• Lehman Brothers upgraded Apple Inc (NASDAQ: AAPL) to Overweight from Equal-Weight with a $105 target based on the recent pullback in shares.

• Friedman Billings raised Hess Corp's (NYSE: HES) rating to Outperform from Market Perform, based on growth reserves and an improving outlook.

• Merrill Lynch upgraded Logitech International SA (NASDAQ: LOGI) to Buy from Neutral.

• Matrix upgraded Abbott Laboratories (NYSE: ABT) to Buy from Hold on valuation.

Analyst summaries provided by TheFlyOnTheWall.com (subscription required).

MOST NOTEWORTHY:

• Hard-disk drive makers Western Digital Corporation (NYSE: WDC) and Xyratex Ltd (NASDAQ: XRTX) were upgraded by Citigroup to Buy from Hold to reflect improving fundamentals; namely easing concerns related to inventory levels and pricing.
• New Century Financial Corporation (NYSE: NEW) was upgraded by UBS to Neutral from Reduce. UBS said New Century's credit outlook is reflected in the shares and its liquidity risk is ok near-term.
  
• The Coca-Cola Company (NYSE: KO) was upgraded by Morgan Stanley to Overweight from Equal Weight on valuation and improving fundamentals, with a price target of $56.

OTHER UPGRADES:

• Sony Corporation (NYSE: SNE) was upgraded by Merrill Lynch to Buy from Sell.

HSBC Holdings PLC (NYSE: HBC) said late last night that its loan impairment charges and other credit risk provisions in 2006 are now expected to be 20% above the consensus estimate of $8.8 billion made by analysts, due to higher-than-earlier expected provisions for its US mortgage business.

HSBC now expects their mortgage loss to be $10 billion.

New Century Financial Corporation (NYSE: NEW), a large subprime mortgage lender, projected a fourth-quarter loss, and said it expects to restate each of the previous three quarters' earnings lower because it did not set aside enough money to buy back subprime loans that went bad.

This unwinding of the mortgage market is just beginning. Large financial institutions have been reporting spectacular results due to gains in fixed income and credit related trading. It appears this era is over. While investors often refer to equity bubbles bursting, credit bubbles are equally as ugly. Watch out for more blow ups.