Every one of the Big 4 (and the next tier) has a handful of lawsuits on their desk related to their audits of the banks and other financial institutions that failed, were taken over in the dead of night, or bailed out by their respective central banks. That’s in addition to the various fraud and Madoff related suits. It may or may not have been better for them to have warned us with “going concern” opinions earlier. We’ll let the judges and juries decide, if any of the cases are actually tried. Most often they settle and the audit firm pays, but not as much as you would think.
Deloitte has been party to settlements, left and right, lately, but they’re no more prone to settlements. After all, per Adam Savett of Risk Metrics (by way of Kevin La Croix of D&O Diary), “jury trials in securities class action lawsuits are extremely rare” :
“As reported on the Securities Litigation Watch blog (here), only 21 cases (prior to Vivendi) have gone trial since the 1995 enactment of the PSLRA. Only seven of the 21 cases (including the Household International case) that have gone to a verdict involved conduct that occurred after the PSLRA was enacted.”
Jury trials in accounting malpractice cases are even rarer. It’s just that Deloitte has more than the average share of subprime-related litigation and as a result is suffering from the double whammy of both losing clients due to the crisis and having those former clients sue them.
What’s interesting about the current flood of lawsuits is the heightened probability Deloitte – and the rest of the Big 4 – will end up on both sides of lawsuits with their former and current audit clients.
Take the Merrill Lynch litigation.
Deloitte is a co-defendant with Bank of America (in place of Merrill Lynch) on lawsuits stemming from Bank of America’s “Deal From Hell” to buy Merrill Lynch for $50 billion, arranged in 48 hours, and agreed to on September 15 of last year. In January of this year, Merrill Lynch announced settlement of a suit filed in October 2007 related to the earlier period where Merrill Lynch experienced significant losses due to write downs of CDOs and other subprime related assets. Deloitte was a defendant and may also have to contribute to that $475 million settlement. Kevin La Croix described it as,
“…unquestionably the largest subprime subprime securities lawsuit settlements so far, and [ ] certainly suggest[s] the enormous stakes that may be involved in the mass of subprime and credit crisis-related litigation cases that remain pending.”
There’s a hearing tomorrow, October 13th, in the case of Bank of America NA (as successor by merger to Fleet National Bank) v. Deloitte & Touche LLP in Boston’s Suffolk County Courthouse. It will be taped by Courtroom View Network and available exclusively to re: The Auditors subscribers on Wednesday.
It must be quite uncomfortable, I’m sure, for Deloitte to be sued by Bank of America when generally they have been taking the same side in things, standing up for each other, not tearing each other down, or making each other cry.
This case tells the story of DVI, a now bankrupt “specialty” finance firm in Pennsylvania:
“DVI’s inaccurate and often illegal accounting practices hid its financial troubles long enough to land $150 million in loans with Fleet National Bank, which was acquired by Bank of America during its $47 billion acquisition of FleetBoston Financial Corp. in 2004.
In a 187-page report reviewing the fraud that took place at DVI between 1995 and 2003, the examiner also raised questions about Deloitte’s role as DVI’s auditor. Specifically, the report claims Deloitte was partly aware of DVI’s issues well before the firm imploded in 2003 and that Deloitte “aggravated the circumstances surrounding and leading to DVI’s” demise.”
This case is interesting to me for a couple of reasons:
1) The strange bedfellows situation I described earlier. Deloitte has also been on the same side as Bank of America in Parmalat litigation, for example. I think we will see more and more of these potential conflicts and compromises in independence for the Big 4+ firms because of the flood of subprime/financial crisis/bankruptcy suits. Although this is only a $50 million dollar suit, one that the firms would have brushed off as immaterial in the past, how many does it take to add up to a real problem when the Big 4 firm is still the auditor of a co-defendant bank, and then is placed in an adversarial relationship with their client or former client?
2) The language around this case reminds me of the one I wrote about recently with regard to the deepening insolvency theory. Although the news reports consider this case a potential bellwether for the firms in terms of responsibility for identifying fraud risk at their clients and acting on it, I see it as bigger than that. The audit firms already have a responsibility to identify risk of fraud and adjust their audit procedures accordingly, assuming those procedures will uncover the fraud if it exists. What we really need are judges who understand and acknowledge this responsibility and requirement and also hold audit firms accountable when they keep their clients on life support for the sake of their fees. That’s an unconscionable fraud that’s being perpetrated by the auditors on the company’s shareholders, creditors, employees, vendors, and customers.