Suing Audit Firms re: Madoff: The Iguana In The Room

From Kevin LaCroix’s blog, D&O Diary:

“When I first started tracking the Madoff-related litigation last December, it seemed like a relatively straightforward undertaking. But now the list of Madoff-related lawsuits (which can be accessed here) runs to some 18 pages, and the lawsuits continue to pour in…the most striking thing is what a varied assortment of lawsuits the Madoff scandal has produced. Even though there is a great deal of duplication among the claims, the list encompasses a spread and scope of lawsuits that defied brief summarization.”

Kevin likens the morass of Madoff litigation as reminiscent of one of his favorite films, It’s A Mad, Mad, Mad, Mad World.”

I’d very much like to assess the depth and breadth of claims, especially as they relate to the auditors. Which firms have the most claims?  Which firm locations are named most often?  Which filings do not name an audit firm and why?

How many name the international audit network umbrella “coordinating” firm?  Shouldn’t they all?

But trying to sort it all out is like trying to kiss a bumblebee.

Most of the Madoff feeder funds claims are organized this way:

(I’m going to use the Optimal Strategic US Equity fund claims to illustrate.)

Plaintiffs are an individual or individual representing a class of investors in a particular hedge fund or fund of funds.

Defendants named are one or more of the following actors:

  • The feeder fund, such as Optimal, which is the ostensible investment manager and may provide other support services to the investors such as selection and review of third-party investment managers.
  • A bank, such as Santander with regard to the Optimal funds, and/or fund of funds group that sponsors the funds and manages sales of the funds through its global network.
  • An administrator/custodian, theoretically to provide back office operations to the fund. In the Optimal case, HSBC provided no more than Net Asset Value (NAV) calculations for production of customer statements and was supposed to provide monitoring of custody of assets that had been delegated to Madoff’s firm.
  • Audit firm. Typically the auditor of the feeder fund is named. In the Optimal case, the auditor is PwC Ireland. However, PwC International  – because of its role as an umbrella coordinating organization of the PwC member firms – is named, as well as PwC US and PwC Bermuda because of their involvement in supporting the PwC Ireland audit opinion.
I’m interested in the role of the audit firms in Madoff feeder fund litigation and, in particular, the claims made against the audit firms’ international umbrella “coordinating” organizations.  Why do plaintiffs sue the audit firms’ international umbrella “coordinating” organizations?  There are several recent cases, adjudicated, pending, and prospective that may help us understand the legal strategies.
On January 28, 2009, Jennifer Hughes of the Financial Times quoted the attorney who brought the case against BDO International to sum up the issues of the Big 4 global networks:
“It makes sense that they want to have a brand just like IBM or Mercedes. But when they get sued, they say ‘that’s not us, it’s someone else’. No-one else gets to do that, why should accounting firms be able to?” says Steven Thomas, the lawyer leading the case against BDO. He claims there is an agency relationship between the international unit and the local, meaning BDOI was responsible.  If this is proven, it could be bad news for PwC.  Satyam was registered in the US, meaning US investors are likely to look to sue there, not in India.

I put this to Mr Thomas, who pauses, then says carefully: “I believe that there will be direct liability in the US for PwC – and PwC International.”

Later that day, the Wall Street Journal Law Blog reported on an important ruling in the Parmalat fraud case:

New York Judge Puts Possible Bulls-eye on Deloitte Touche

New York federal judge Lewis Kaplan issued a ruling yesterday in the Parmalat securities litigation which could have accountants quaking, and plaintiffs’ lawyers licking their chops.
Parmalat, an Italian dairy conglomerate, collapsed in 2003 following the discovery of a massive fraud in which the company allegedly overstated its assets by $16 billion.

At issue in yesterday’s ruling was whether Deloitte Touche Tohmatsu potentially could be held liable for an allegedly defective Parmalat audit by its Italian member firm, Deloitte & Touche, S.p.a. Yes, Kaplan held, in denying a Deloitte Touche Tohmatsu’s motion for summary judgment.

A settlement was recently reached in the above dispute.  Grant Thornton International will pay, also.  Grant & Eisenhofer, Stuart Grant’s firm, is happy with it, although the dollars awarded are less than I expected.

The class of securities holders will net $15 million if the settlement is approved by U.S. District Judge Lewis A. Kaplan. Deloitte Touche Tohmatsu and its U.S.-based unit Deloitte Touche have agreed to pay $8.5 million to settle allegations of fraud by Italian auditors connected to Parmalat’s 2003 spiral into bankruptcy. Grant Thornton International has agreed to a $6.5 million settlement… “We think it’s a noteworthy settlement because the settlement involves the worldwide coordinating organizations — Deloitte Touche Tohmatsu and Grant Thornton International — who were sued not directly for anything they did, but for audits by their affiliate firms in Italy,” James Sabella of Grant & Eisenhofer PA, lead counsel for the plaintiffs[…] “It’s very rare that any settlements have been achieved involving those organizations rather than the actual member firms who practice in the various jurisdictions,” Sabella said.

In the case of Banco Espirito Santo v BDO International, attorney Steven Thomas was disappointed in June of this year by the judge’s ruling and jury’s decision.

The jury’s finding that BDO International bore no responsibility for the $170 million compensatory damages verdict against BDO Seidman followed Tuesday’s directed verdict for BDO International, which cleared the international of liability for $351 million in punitive damages against BDO Seidman.

“The jury got the case at 3:01 [P.M.] and they returned a verdict at approximately two minutes of four,” said BDO International lawyer Mark Raymond of Broad and Cassel. “The evidence is just overwhelming that there is no control by BDO International of its member firms…”

However, since BDO Seidman, the US firm, is now responsible for the record verdict alone, the wrangling over the money continues.

Espirito Santo Bank may be permitted to perform limited discovery to determine if BDO Seidman is shrinking to make itself poorer while appealing a $522 million award against the accounting firm, Florida’s 3rd District Court of Appeal ruled Wednesday.

The court said Miami-Dade Circuit Judge John Schlesinger misinterpreted state law and a previous ruling, reopening the door to discovery on the narrow issue of whether BDO is dissipating its assets. Schlesinger was ordered to carefully review the discovery question again…The accounting firm asserts the $352 million punitive damages portion of the verdict could bankrupt it, and state law bans court awards that would drive a company out of business. Bank attorney Steven Thomas rejects BDO’s position on its finances.

“BDO Seidman has been making money hand over fist, and they’ve been trying to conceal that from the court,” said Thomas, a partner with Thomas Alexander & Forrester in Venice, Calif. “Their claims of poverty to the court are just false, and you’re not allowed to claim to the court one thing and to the public another.

Mr. Thomas included BDO International as a defendant in the original case because Florida state law bans a verdict that could bankrupt a defendant.  BDO International was an original defendant and then left out of decision, which was later reversed on appeal. But Mr. Thomas also feels strongly about the principles. He told me that night after the BDO International verdict:

“We believe the global audit firms should be held responsible for their advertising, marketing and branding not only as truth in advertising but as a public duty and obligation to deliver quality and standards to their clients across borders.”

Including the international firms as defendants in the large scale claims against the global audit firms that cross borders and involve multiple member firms is a way to bring in member firms as possible funding sources for a judgement in the event the primary defendant can not, will not, or is prohibited from paying. However, there doesn’t need to be an international component or multiple member firm defendants to bring in the “control”and “global brand” arguments. Mr. Thomas is applying his principles in the case against KPMG on behalf of the New Century Trustee.  They’ve filed against the US firm in California and against KPMG International in New York.

There’s another case with EY and Akai where the international firm entered into the settlement negotiations for their Hong Kong firm that is said to be more than they can pay alone. EY theoretically would like to maintain a brand presence in that location, albeit not at “any” cost.

Grant & Eisenhofer, who settled the Parmalat litigation, is one of four law firms leading the plaintiff‘s litigation in the consolidated claims filed so far in the Pricewaterhouse Satyam fraud.  PricewaterhouseCoopers, Satyam and the Indian Directors are currently trying to get the cases filed in New York dismissed on forum non conveniens grounds. In addition, Pricewaterhouse International is trying to wiggle off the hook.

“PricewaterhouseCoopers International Ltd. said it should be dropped from the case because the investors failed to show it had control over its Indian member, Price Waterhouse, as is required by U.S. securities law.”

Issues of control and the issues of the “agency” relationship between the auditors’ international umbrella “coordinating” firms and their member firms figure prominently in the Madoff feeder funds filings that include the international firms as defendants.  The plaintiffs attorneys are learning from each experience and there is plenty of learning material out there. They are looking for the strategies, hooks, information and documents that will make these cases better. The language of the filings improves with each filing including amended complaints.  The lawyers are attempting to explain to sometimes stubborn or intransigent judges, and the eventual juries, what really goes on behind closed doors in the global audit firms.

The “global brand” reference and an indictment of the “have your cake and eat it too” attitude of the firms last highlighted by Mr. Thomas in the FT…

“It makes sense that they want to have a brand just like IBM or Mercedes. But when they get sued, they say ‘that’s not us, it’s someone else’.

…also appear in the Optimal Strategic US Equity fund claims filing. Let’s look at how the Optimal feeder fund Madoff-related securities litigation brings in PwC International.


(Filed in US District Court, Southern District of Florida entered on the docket October 21, 2009.) pgs 71-74

These four governance bodies (the Network Leadership Team, Network Executive Team, Global Board, and Strategy Council) provide a global governance structure that is housed within PwC International.  In effect, the PwC member firms (including PwC Ireland, PwC Bermuda, and PwC U.S.) act as agents of PwC International.  PwC International controls its agents through a series of agreements that govern and enforce standards across PwC member firms…The Global Annual Review of PwC is, thus, no different than the annual report of McDonalds, Exxon, Microsoft, or Santander.

When trouble comes, the global audit firms claim to be separate legal entities with global “coordinating” firms that have no control over member firms. But successful branding and seamless delivery of services to multinationals depends on the members firms acting together and upholding certain standards. This was the argument Steve Thomas was making in the BDO International case.

Thomas argued the “agency” argument.  BDO International was found not liable for punitive damages because there was no separate tort for gross negligence proved.  That was required.  For joint liability on the shared damages for the negligence claim, the jury had to find that BDO International exerted control. They did not. They believed the testimony of the BDO International Secretary.
“Why do they have poor Paul Van Elten sitting in the hot seat?  He’s only the custodian of the global-size binder clips.”
From a summary of the BDO International trial by Mayer Brown:

The trial [turned] on whether BDO Seidman LLP was an agent of BDO International and whether the Member Firm’s alleged negligence occurred within the scope of the agency relationship.

At closing argument, plaintiff focused on the element of “control.” In particular, plaintiff argued that:

  • BDO Seidman LLP was required to follow the international audit manual and, thus, its work was controlled by BDO International.
  • BDO International controlled branding and therefore could “police the brand.”
  • BDO International had the “right to fire” BDO Seidman LLP by terminating its Member Firm Agreement.
The jury deliberated for about one hour before returning a verdict in favor of BDO International. The first question on the verdict form asked: “Was BDO Seidman an actual agent of BDO International, B.V.?” The jury answered “No.” As a result, the jury did not have to reach the second question, which asked whether BDO Seidman LLP’s actions were within the scope of the agency relationship.
I think the questions of “agency” and “control” are being framed incorrectly in these filings.
The member firm is not the agent of the international firm.  The international firm should more effectively be construed, in my opinion, as an agent of the member firms, controlled by a Board of Partners created by the consent and vote of the member firms, that represents the interests of the member firms with regard to the network and “controls” the member firms.
That’s why Steven Thomas should have put the head of the BDO International Board of Partners, Cecil Fleming (1998-2002) and the head of the BDO Seidman firm (who was on the Board of Partners)  at the time, not the Executive Director flunky, on the stand. Unfortunately, Mr. Fleming passed away in April of 2009.

Global board

The board is the body responsible for the governance of the PwC network and oversight of the network leadership team. The board is accountable to the PwC member firms and does not have an external role. Board members are elected by all partners in all PwC member firms every four years, with the current board taking up office in April 2009.

A new organisational model for the PwC network was introduced in the last 12 months which has enabled PwC member firms to align more closely their strategy around the world and improve  the integrated service offered to clients. As part of that new network structure we have introduced a set of standards and policies with which all PwC member firms are expected to comply. These standards cover existing key areas such as independence and risk management as well as wider areas such as people management and brand and communications. PwC member firms agree to follow this wide range of standards (including quality reviews) in exchange for the right to use  the PwC name. The use of the PwC name is very carefully monitored.

We should be judged, not just on the  quality and extent of the standards that are applied to all PwC member firms, but on the actions that are taken to maintain these standards and the consequences for member firms that do not live up to them.

PricewaterhouseCoopers International Limited (PwCIL) is a UK private company limited by guarantee in which the various PwC firms are members. PwCIL does not provide services to clients. Its primary activities are to: identify broad market opportunities and develop associated strategies; strengthen PwC’s internal product, skill and knowledge networks; promote the PwC brand; and develop and work for the consistent application  of common risk and quality standards by PwC member firms, including compliance with independence policies.

Main Page Photo Credit: Movie Still from Bad Lieutenant: Port of Call, New Orleans

Interior Page Photo Credit

13 replies
  1. David
    David says:

    In certain circumstances, an auditor can accept a confirmation. Could an auditor have properly accepted a confirmation from BLMIS (Madoff’s firm)? The answer is very likely going to be No.

    Off the subject, one time a prospective client asked Madoff if they could perform an audit to verify his returns. Bernie’s answer was No, it would compromise the secrecy of his trading strategy.

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