Refco Execs’ Pleas May Ease Auditors’ Worries

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Although the Refco story is a global one, it is also a local one for us in Chicago. These guys were the quintessential “big swinging dicks.”

As I’ve mentioned before, Grant Thornton and PwC stand to lose big if the lawsuits naming them ever come to trial. They may still lose big when, not if, they settle.

But they may have been given a gift with these guilty pleas. Having the principal actors admit as part of their plea that they “deceived” everyone is a potentially useful tool for the auditors’ defense attorneys.

However, whether this “We were deceived” crap works from a purely legal defense perspective or not, I don’t buy it. One of the first things they teach you in “auditor school” is the concept of professional skepticism.

Beginning with the codification of its first professional auditing standards (see SAS 1) the accounting profession has recognized the importance of skepticism in performing audits. Early audit standards defined skepticism as an attitude that includes a questioning mind and a critical assessment of audit evidence, which was often interpreted as neither assuming managerial honesty nor dishonesty. Recent audit failures have caused the profession to reassess and emphasize the importance of skepticism during an audit engagement, requiring auditors to “increase” their level of skepticism. Auditors are now asked to expand their skeptical perspective to the level used by forensic experts, which assumes that management is dishonest unless there is evidence to the contrary (POB 2000 p. 88; SAS 99, 2002).

This is a much higher standard than, “Trust but verify.” But does anyone believe that the Big 4 view their “clients” with professional skepticism, assuming management is dishonest until it’s proven otherwise? The problem is that the client is management instead of the shareholders, the party to whom they really owe this higher duty.

From Bloomberg:

Refco Inc. ex-finance chief Robert Trosten admitted he helped hide hundreds of millions of dollars in debt, becoming the third person to plead guilty in a fraud at the futures trader that cost investors more than $2.4 billion. Trosten, 38, entered his guilty plea to fraud and conspiracy charges today in Manhattan federal court, a month before he was to go on trial for deceiving banks, auditors and investors, including Boston-based buyout firm Thomas H. Lee Partners LP. He agreed to cooperate with the government in exchange for leniency at sentencing and to forfeit $2.4 billion plus property he owns….

Refco former Chairman and Chief Executive Officer Phillip Bennett pleaded guilty Feb. 15 to helping run the scheme and faces life in prison when he’s sentenced in May. Trosten’s plea leaves two men who face trial for their roles in the fraud. Former Refco President Tone Grant goes on trial March 17, and ex-Refco outside lawyer Joseph Collins faces a separate fraud and conspiracy trial. Both deny wrongdoing. Another ex-Refco executive, Santo Maggio, former CEO of the firm’s offshore unit, pleaded guilty to fraud in December and agreed to cooperate with prosecutors…

Trosten said he helped make it appear as if the funds were owed to Refco from “third-party customers,” and not from a “related-party entity.”

“I agreed with other Refco executives to hide the true nature of Refco’s finances,” Trosten said today in court.