Send Lawyers, Guns And Money… The Big 4 And Their Litigation
Following the big lawsuits against the audit firms is fairly easy. Updates on subprime and financial crisis suits typically hit my Google Alerts. There are a few more like the Banco Espirito Santo v. BDO Seidman case and the case against PwC re: Satyam that have their very own customized alerts. And Kevin LaCroix can be counted on to pick up the odd securities class action suit naming an auditor for sport and he also tracks all of the Madoff related filings. Every once and a while I depend on the kindness of handsome strangers to catch the latest update like when Francis Pileggi told us what happened in Delaware Chancery Court with Deloitte’s suit against accused inside trader and their own ex-Vice Chairman Tom Flanagan.
The big lawsuits – the ones that accuse the firms of accounting malpractice or various federal securities law violations – have been chronicled on this site and by fellow writers such as James Peterson ad infinitum. The accounting industry’s response to these threats is to ask for liability caps. As if we don’t have enough moral hazard in the financial system with “too big to fail,” the auditors want to institutionalize their insulation from accountability to their clients, the shareholders, with a policy of “too few to pay for their mistakes.”
If only the lawsuits claiming lack of audit prowess were the only ones they had to worry about. Unfortunately for them, and for their “partners” who go along for the ride leaving the management of “matters” up to senior leadership acting as caretakers for the 5-10 years they are at the top of the heap, there are many more suits that just show what lousy managers they are.
Here are some of the more interesting lawsuits and legal matters facing each of the Big 4.
DOJ Defends Document Request Targeting Deloitte
The U.S. Department of Justice has turned to a federal appeals court in Washington, D.C., in the hope of forcing the accounting firm Deloitte LLC to turn over tax-related documents that government lawyers say are not protected by the work product privilege…As part of a civil tax suit in federal district court in Louisiana, the government is seeking certain documents that Dow turned over to Deloitte during the firm’s audit of the company.
[DOJ Tax Division lawyer Judith] Hagley on Friday argued that the work product privilege does not apply to the documents Dow turned over to Deloitte because the documents were prepared during what Hagley said was the ordinary course of business – and not prepared for litigation purposes.
Ex-Deloitte Exec Settles Insider Trading Charges
A former Deloitte tax professional has agreed to pay approximately $144,000 to settle insider trading charges with the Securities and Exchange Commission.
The SEC filed settled insider trading charges against four individuals, including John A. Foley, who served as an employee benefits specialist at Deloitte between July 2005 and May 2007. The others who settled the SEC charges were Aaron M. Grassian, Timothy L. Vernier, and Bradley S. Hale. They were accused of participating in insider trading in the securities of four public companies — Crocs, Inc., YRC Worldwide, Inc., Spectralink Corporation and SigmaTel, Inc. — over a 22-month period, yielding illegal profits totaling $210,580.62.
As GoingConcern.com told us:
Despite the high standard that Deloitte holds you to — higher than the SEC, PCAOB, and the AICPA, we might add — this happened, “Based on our own reviews and that of the PCAOB, we believe compliance with our independence policies is not what it should be, and the PCAOB has, in fact, questioned our commitment to adhere to our own policies. This is clearly not acceptable.”
Our contributor Francine McKenna reminded us that Deloitte didn’t think too much of the PCAOB’s report from last year, “They [are] the same firm that famously responded to the PCAOB’s latest inspection report, ‘How dare you second guess us?‘”
Although Deloitte won a preliminary victory against Flanagan, they obviously still have a lot of work to do to improve their independence compliance function and are still subject to PCAOB and SEC enforcement actions and potential sanctions.
In the meantime, they did settle Parmalat, but now they’re named in several suits related to the Merrill Lynch acquisition by Bank of America and the Bear Stearns failure. Deloitte is the only Big 4 firm to have escaped any Madoff feeder fund exposure even though they are supposedly the number one choice of hedge funds.
Ernst & Young
Ernst & Young has its own inside trader case to go along with the ones we saw a few months ago and the rest of the SEC sanctions they’re collecting.
A former Ernst & Young LLP partner was sentenced to a year and a day in prison on Monday after he was convicted last year of fraud charges in an insider-trading scheme where he allegedly tipped a Pennsylvania broker about pending corporate takeovers.
At a hearing, U.S. District Judge Miriam Goldman Cedarbaum in Manhattan sentenced James Gansman, a lawyer who resigned from Ernst & Young in October 2007. He was convicted of six counts of securities fraud, but acquitted of conspiracy and three securities fraud counts in May 2009.
Ernst & Young Auditors Accused in Investment Case
The Securities and Exchange Commission has instituted public administrative proceedings against two former Ernst & Young auditors who failed to uncover the misappropriation of client funds by an investment advisor they were auditing.
The proceedings were instituted against two CPAs: Gerard A.M. Oprins, 50, who had been a partner in Ernst & Young’s financial services practices group since 1995; and Wendy McNeely, 33, a former audit manager in E&Y’s financial services group who now works for another firm.
In addition to the myriad of suits relating to the Lehman collapse and their Madoff feeder fund exposure, Ernst and Young recently went through a terrible phase focused on their Bally’s sanctions, the Akai scandal and another fraud in Hong Kong.
The EY list includes the usual employment discrimination lawsuits that all of the firms face, in particular given the significant cuts they have all made to their ranks during the last two years. Ernst & Young also has several filings related to writedowns at Regions Financial Corporation. Regions is the largest audit client of Ernst & Young LLP’s Birmingham office. Back in 2003, that office’s largest client had been HealthSouth Corp., which turned out to be a massive fraud. Tough luck…
The Regions board and management team, as well as Ernst and Young, are accused of “continued reporting of a grossly inflated value of the goodwill attributable to the AmSouth acquisition,” which later caused a large $6 billion write-down equal to more than 60 percent of the total acquisition, according to the lawsuit.
Bankruptcy cases are some of the biggest moneymakers for the firms now but they can become contentious.
MP calls for probe into Nortel jobs
A MP has written to the insolvency regulator calling for an investigation into the actions of Nortel’s administrator Ernst & Young (E&Y).
“Ernst & Young’s handling of this insolvency case has been woeful and it would appear that they may have failed to pay appropriate regard to redundancy and employment legislation,” he said.
Next I’ll summarize which cases KPMG and PricewaterhouseCoopers are spending their legal dollars on.
The Big 4 is not going to be put out of business by these lawsuits. They have the ultimate liability protection. What is the ultimate liability protection? The fact that most of their value is in goodwill. If the accounting firm doesn’t stay in business, the plaintiffs can’t get anything from them. Consider how little investors and creditors got from AA as a result of the Enron, Worldcom, Global Crossing and Qwest audit failures. AA’s business evaporated, all the partners left and there was nothing remaining. A plaintiff’s lawyer doesn’t want that to happen. The plaintiff’s lawyers have no choice. They have to settle or risk not getting paid at all.
I hope you realize that of the five items in “blue boxes” above exactly zero involve a suit against a big 4 firm.
Sadly I have to agree with David. To build on his point, there are two major expenses that an accounting firm (esp. a large firm) incurs. One is payroll expense. The other (as you might have guessed) is litigation. Accounting firms, especially the Big 4, continuosly build litigation reserves to weather lawsuits like the ones mentioned in this post. It practically serves as an emergency fund account for these firms. As long the firms diligently keep adding to their litigation reserves, they are going to be well-insulated from the hits of these suits…that is, of course, unless they commit some catastrophic illegal act that warrants a complete shut-down of their business.
The front page cover rocks!!!
I would agree that these suits won’t put the firms completely out of business, but that isn’t the point necessarily. These cases will likely lead to changes in the Big 4. We’re reaching a critical mass here – increased lawsuits (and corresponding ’emergency’ reserves); regulators going after partners and (gulp) audit managers; and most important, in my opinion, the questioning of our ability to keep our own people compliant in both personal ethics and competency.
This may lead to more regulation from a grandstanding congress, not all of which results in higher audit fees like Sarbanes. But even if it doesn’t hit the public radar, it will make life harder for the majority of accountants doing these audits, because making partners wealthy becomes even more difficult, with growing legal bills for our foul-ups. Add to this the reluctancy to pay seniors and managers, and the addition of more “check in the box” crap for the audit file that gives a perception, but not necessarily the reality of a better audit, and I think audit quality overall is bound to suffer.
Staying in business is great, but if our product deteriorates, that should concern everyone.
What’s the answer? Eliminate the requirement for an independent audit? Or, require the auditors to be 100% independent; that is, prohibit them from doing any other work with a company other than the independent audit? Companies look at the independent audit as a necessary nuisance, similar to a colonoscopy for a middle-aged male, and price it like that. If we expect the auditors to find every problem, then there needs to be a huge change in how things are done. I don’t think it’s likely.
Three difficulties the CPA firms will face with the Madoff feeder fund cases are:
(1) The CPA firms can’t argue that the feeder funds failed because of business conditions and subsequent events that couldn’t have been anticipated by the auditors.
(2) Markapolous’ book makes it clear that a lot of people on Wall Street who never even looked at Madoff’s books did not believe his returns. In other words, his consistent performance should have raised red flags to anyone who knew anything about the business of securities trading. There is no way any trader makes a profit month after month. Markapolous reveals that a lot of Wall Streeters thought that Madoff’s consistent performance resulted from earnings smoothing and that he was subsidizing his bad periods by taking funds he earned in his good periods.
(3) The investors might not have believed the returns if the CPA firms hadn’t signed off on their statements.
That being said, I think the feeder fund investors will have to settle for pennies on the dollar from the CPA firms.
Of course you are only going to get what you pay for. The Firms work by the hour. The client pays for a certain number of hours and if the client is a cheapskate then you arent going to get many hours for your bucks. I imagine a lot of the cases in your article involve cheapskate clients not willing to pay the going rate hence the audit firms arent going to push the barrel out and search every nook and cranny especially relevant when people who are committing fraud generally try and hide it.
Thinking about all the comments on litigation, the firms of course are going to try and protect their people because these are Partnerships not limited companies !!
Jack Reacher —
Being a CPA is supposed to mean something more than being a hired gun, where the level of assurance depends on the fees the client is paying. There are some professional standards involved, as well as at least one Supreme Court case that opined that auditors of public companies have a higher duty than simply giving the kind of opinion the client deserves, based on engagement fees. In fact, that same Supreme Court opinion (U.S. v. Arthur Young) stated that the real client was the shareholders, not management.
Sorry the Army Military Police thing didn’t work out for you.
— Tenacious T.