anderson faces the wrath of god
February 19, 2002
PAGE ONE
Arthur Andersen Faces Court Trial
Over Baptist Investment Foundation
By JONATHAN WEIL
Staff Reporter of THE WALL STREET JOURNAL
Looming losses hidden in off-balance-sheet affiliates. Insiders' warnings about accounting fraud dismissed. A sudden bankruptcy. Investors all but wiped out. Arthur Andersen LLP auditors taking the Fifth.
Sound like the Enron Corp. saga? To many investors who lost money in the collapse of the Baptist Foundation of Arizona, the resemblance is eerie.
The foundation's Chapter 11 bankruptcy filing in late 1999 marked the largest by a nonprofit group in U.S. history. Some 13,000 investors lost an estimated $590 million. Many were elderly churchgoers attracted by the foundation's offer of above-market returns and its mission of using its earnings for good deeds such as building churches and nursing homes for the poor.
Arizona's attorney general says the foundation had become a Ponzi scheme, needing to raise tens of millions of dollars to pay the high returns it had promised to earlier investors. Three former foundation officials have pleaded guilty to felonies in the case and five others face fraud and racketeering charges. One reason the scheme lasted as long as it did, a suit by the attorney general alleges, is that Andersen gave clean bills of health to the foundation's financial statements.
Looming Trial
For all the speculation the Enron case has spurred concerning Andersen's future, the Baptist foundation matter poses a more immediate threat. A trial is set to begin March 4 in a case in which the foundation's bankruptcy trust seeks $300 million in compensatory damages from Andersen, plus much more in punitive damages. In another civil suit, the state attorney general is pursuing restitution for investors plus civil penalties for alleged violations of securities- and consumer-fraud laws.
Foundation investors seek damages in a third suit against Andersen. In addition, the state Board of Accountancy has asked an administrative-law judge to put Andersen on probation in Arizona. It's seeking to revoke the licenses of three accountants, including Andersen's lead auditor assigned to the foundation, Jay Ozer.
The suit nearing trial in Maricopa County superior court contends Andersen "turned a blind eye when it performed audit testing" of the Baptist foundation. The suit says Andersen auditors "ignored glaring red flags that, if investigated as required by professional standards and Arizona law, would have revealed the truth."
Andersen replies that it was duped by the Baptist foundation just as investors were, and is being sued because of its "size and solvency." It describes most warnings it received as vague and general. Citing investor complaints to state authorities as early as 1992, which spurred little action, Andersen also says in court that "others, in far better positions than Andersen to discover and/or disclose [the foundation's] fraud, failed to act."
With suits pending, Andersen won't comment on specifics. In a prepared statement, it says, "There's no question that investors were the victims of a massive fraud" at the Baptist foundation. "To the extent that we may bear responsibility, we are willing to do our share to arrive at a fair resolution of this case."
Founded in 1948 by the Arizona Southern Baptist Convention to fund religious causes, the foundation sold promissory notes to churches and individuals nationwide. It often marketed them as retirement investments that paid better than bank deposits, while enabling the investor to do something for Christianity as well. They weren't federally insured, but the foundation stressed that no investor had ever lost a cent in them.
In the 1980s, the foundation invested heavily in Arizona real estate, which then was surging. But property values tanked in 1988, threatening to force the foundation to take big asset write-downs, which would hurt its income statement. Instead, according to the lawsuits, the foundation began hiding losses by selling depressed assets to other entities, while taking back IOUs. The IOUs were sometimes for far more than the properties' true value, the suits say. The plaintiffs add that some of the IOUs were from entities that had few assets. And they say some of these entities were controlled by foundation executives and directors, using the same addresses as the foundation and having no staffs of their own.
In spring 1996, several foundation employees confronted management over what they said were losses hidden at a company called ALO Inc., according to the lawsuits. Unsatisfied with the response, the suits say, a staff attorney quit in April. He warned in a resignation letter that the foundation couldn't expect ALO to cover its debts and wasn't fully disclosing the problem to its auditor. He also warned of potential criminal liability.
Four months later, an in-house accountant also quit the foundation. His resignation letter described ALO and another entity related to the foundation as "bad banks" used to take losses to make the foundation look like a "good bank."
By the end of 1996, the lawsuits say, five staff professionals had resigned over accounting issues. One of them, foundation accountant Karen Paetz, took her concerns to Andersen the following February during its audit of the 1996 books.
Ms. Paetz had lunch at a T.G.I. Friday's with Ann McGrath, an Andersen auditor. In depositions, Ms. Paetz says she warned Ms. McGrath that ALO had a $100 million deficit, was losing $2.5 million a month and could make the interest payments it owed the foundation only if it obtained the money from the foundation itself. She said she provided the names of former employees who could corroborate this and urged the Andersen auditor to obtain copies of ALO's financial statements.
Ms. Paetz said she described how foundation executives had structured the relationship with ALO and another firm, New Church Ventures, to create the appearance that the foundation didn't control them. Ms. Paetz said she told Ms. McGrath that several employees who left had confronted foundation officials about such matters. And she added in her deposition that the Andersen accountant took notes.
Plaintiffs' attorneys say Andersen has told them it can't produce any notes because Ms. McGrath didn't take any. Andersen says in court filings that its auditors took Ms. Paetz's information into consideration, even though it was "very general and unsupported" and even though Ms. Paetz "was unable to, or refused to, provide a specific example of an improper transaction." Ms. Paetz said this was because she had steered the auditor to the related entities' financial statements. "I knew that she could actually get this information if they wanted it," Ms. Paetz said in her deposition.
Andersen asked the foundation for financial statements of ALO and New Church Ventures, but the foundation said it couldn't release them, according to the lawsuits. "The auditors should have demanded the documents be produced, and when they were not, they should have withdrawn from the engagement and warned that their prior opinions were not reliable," the bankruptcy trust's suit states. This, it says, would have brought "the fraud to an end." The suit also says Andersen didn't try to contact any of the employees Ms. Paetz named or otherwise try to verify what she said.
Douglas Carmichael, an accounting professor at Baruch College in New York, says if a tipster directs an auditor to obtain specific documents or information about an audit client, "then that becomes the one piece of information that you have to see." If this isn't possible, he adds -- and especially if the client refuses to provide it -- the auditor should withhold any future opinions on the client's financial statements.
The attorney general's suit says that Andersen concluded through "alternative testing" that the IOUs on the foundation's balance sheet weren't adequately collateralized. But Andersen issued a clean audit opinion for 1996, after which the foundation raised more than $200 million in new investor money.
Ms. McGrath is scheduled to give a deposition in the trust's suit Wednesday. In a previous one, she invoked her Fifth Amendment protection against self-incrimination. This time, she will testify that the foundation's "top managers misled her just as they misled ... investors," says her attorney, Carolyn Kubota. The lawyer says her client's work "met the applicable professional standards," and any suggestion that she "engaged in impropriety ... is completely unfounded."
Andersen's next warning came circuitously. A former foundation chief operating officer, David Jakes, sought a position at Buckner Baptist Benevolences in Dallas. According to that group's chief financial officer, Allen Jordan, Mr. Jakes in a May 1997 job interview expressed serious concerns about the foundation. He said it had hidden $68 million of real-estate losses in a "bad bank" and needed to raise about $10 million a month just to meet the interest payments owed to existing investors, according to Mr. Jordan.
Mr. Jordan says he saw this as a Ponzi scheme and was especially alarmed at what Mr. Jakes said was the foundation's newest strategy: encouraging elderly people to borrow against their homes and invest the proceeds with the foundation. "That's just a crime, knowing good and well that these people probably would never get their money back," Mr. Jordan says in an interview.
Mr. Jordan's own group in Dallas was audited by Andersen as well. He met with his Andersen auditor, Roger Pickett, as well as the CFO of another Texas Baptist group that Mr. Pickett audited. The three met for breakfast at a Ramada Inn south of downtown Dallas in June 1997. Mr. Jordan says he handed over copies of documents obtained from Mr. Jakes, including the foundation's financial statements, organizational chart and holdings. Mr. Pickett turned white and appeared "very shaken by what he was seeing," Mr. Jordan says in an interview.
Mr. Pickett contacted Richard Howell, a senior partner in Andersen's Dallas office, who in turn contacted an attorney at Andersen's Chicago headquarters, Donald Dreyfus, according to court filings by the bankruptcy trust. The trust says Mr. Dreyfus then got in touch with the director of Andersen's regional audit practice at the time, Richard Corgel. Handwritten notes taken by Mr. Corgel in July 1997, filed in court, say Mr. Dreyfus told him the firm had received a "credible inquiry" from an "anon. source" concerning the foundation. "Is this a ponzi scheme?" the notes say.
Andersen's Messrs. Pickett, Howell, Dreyfus and Corgel all decline to comment on what the firm labeled "the Chicago call." In court filings, Andersen describes what it was told as "vague and unconfirmed reports that [the foundation] might be engaged in some kind of improper financial activities." It says the information "did not trigger alarm for some very good reasons," namely, it was "in the abstract."
Andersen filings repeatedly refer to the call as anonymous. Mr. Jordan says neither he, the other CFO at the breakfast meeting nor Mr. Jakes asked for anonymity. When plaintiffs' attorneys questioned Andersen's Mr. Howell on this point during a deposition, an Andersen attorney acknowledged that the call to Chicago was from a partner and not anonymous.
Discounted by Partner
As Andersen was auditing the foundation again in February 1998, it raised Mr. Jordan's concerns with foundation Chief Executive William Crotts. Mr. Crotts's notes of the meeting say Andersen's legal department in Chicago had received a call raising concerns that the foundation was a Ponzi scheme. Mr. Crotts wrote that the Andersen partner in charge of the audit, Mr. Ozer, "discounted the Ponzi scheme" as well as other concerns. An attorney for Mr. Ozer declined to comment.
Mr. Crotts faces state criminal charges of theft, fraud and racketeering. He has pleaded not guilty. His attorney describes Mr. Crotts, whose father set up the foundation 54 years go, as an innocent victim who himself lost more than $800,000. "There was not fraud at the foundation," just a "difference of opinion as to valuation of properties," his attorney says.
Later in February 1998, an Andersen associate in Phoenix drafted a file memo assessing "fraud risk" at the foundation. It said that someone had raised "allegations regarding misappropriation of assets" with the legal department in Chicago, but Andersen's risk managers found no evidence to support them. Mr. Jordan in Dallas says he never said anything about misappropriation of assets.
Ms. McGrath wrote two memos of her own about fraud risk. One said the foundation's in-house counsel "considers it unlikely that fraudulent activities are occurring and that, if such activities were occurring, that they would not be detected." Andersen included this memo in its working papers, the written evidence of work done in an audit.
Her other memo -- written the same day, March 24, 1998 -- spoke of an "anonymous" call "placed to the firm's Legal Group in Chicago alleging a Ponzi scheme and the illegal sale of securities." Andersen didn't include this memo in its working papers. In court filings, the state attorney general points to the omission as evidence that Andersen "engaged in a full cover-up of the fraud." Andersen says in court filings that it didn't cover anything up but was "a victim of the [foundation's] fraud."
Newspaper Article
Andersen received still another alert before it certified the 1997 financial statements, an extremely detailed one. On April 16, 1998, the New Times, a Phoenix newspaper, published the first in a series of articles called "The Money Changers." The first long article contained extensive allegations of fraud and insider dealings at the foundation, citing specific transactions and names of directors and other people it said were involved.
Andersen responded by reviewing each allegation and asking the foundation if it was true. In a court filing, the firm said the foundation denied each allegation "and repeatedly assured Andersen ... of its financial stability."
Not good enough, says the attorney general's complaint: "Had Arthur Andersen performed any new independent audit work on the transactions discussed in the New Times, it would have determined that ... its prior clean opinions should be questioned and withdrawn," the complaint says.
Prof. Carmichael says when such questions are raised, "you can't rely on discussions with management ... because they're the ones whose conduct is at issue."
Eleven days after the allegations appeared in print, Andersen issued a clean audit opinion for the foundation's 1997 financial statements. They showed $402 million in liabilities and $421 million in assets -- 44% of the assets being IOUs. Nearly half were from debtors with ties to the foundation. The financial statement said these related parties that owed money were "associated with Southern Baptist causes," but it didn't identify them.
Financial Planner's Inquiry
Regulators say Andersen got one more reason to doubt the foundation's books before the end of 1998. Deeann Griebel, a financial planner and CPA in nearby Mesa, says she looked into the foundation's finances in 1998 at the request of a client who had invested there. After seeing the large IOUs on the balance sheet, Ms. Griebel has told state investigators, she met with foundation executives to find out who the principal note issuer was. Upon learning it was ALO, she had a friend drive to the Arizona Corporation Commission to get copies of ALO's public records. Its unaudited 1996 balance sheet filed listed liabilities at $109.7 million, and assets at minus $6.9 million.
Ms. Griebel says she left messages at Andersen's Phoenix office twice in October 1998 warning that the foundation was broke, demanding that Andersen withdraw its audit opinion and asking for the managing partner on the job to call her. When the calls weren't returned, she says, she left a similar message at Andersen headquarters in Chicago. Again, no call back, she says.
"The thing that outraged me was that I could figure out this thing was broke that quick," Ms. Griebel says in an interview. "It was that easy." Over the next few months, she says, she contacted nearly 100 clients who were foundation investors, warning them to get out.
In 1999, Andersen never completed its audit of the foundation's books. In July of that year, more than a year after the first New Times article, the Corporation Commission informed the foundation and several related entities that it appeared they were operating a fraud. The next month the foundation signed a consent degree agreeing to stop soliciting investments. Its board fired Mr. Crotts and two other executives.
The foundation also suspended all withdrawals by its investors. Forrest Bomar remembers that day well. He and his wife, Lee, had invested $236,166 with the foundation, some of it in accounts paying as much as 12% annually. "That represented the best of two worlds, a competitive interest rate and doing the work of the Lord," says Mr. Bomar, a retired AT&T Corp. middle manager in Palestine, Texas, who is 73 years old.
The money was about 90% of their savings. Mr. Bomar says that when the accounts were frozen, he suffered a bout of depression, from which he eventually recovered.
McGrath Promoted
The foundation filed for Chapter 11 bankruptcy in November 1999, listing assets of $220 million and liabilities of $640 million. The bankruptcy trust is in the process of selling the foundation's assets and will give what it recovers to investors. But it wants Andersen to make them whole. The firm "had years to do the right thing ... and has fought tooth and nail to avoid doing so," says John P. Coffey, lead trial counsel for the trust.
The same month the foundation filed for bankruptcy, Andersen promoted Ms. McGrath to principal from senior manager. Mr. Ozer took early retirement the following year.
The Arizona Board of Accountancy has asked an administrative-law judge to revoke the state licenses of Mr. Ozer, Ms. McGrath and another Andersen accountant. Mr. Ozer and Ms. McGrath are now targets of a criminal investigation by the attorney general, according to court filings by Andersen and the attorney general's office. Ms. McGrath's attorney declines to comment on that, as does Mr. Ozer's. The lawyer for Mr. Ozer adds that his client denies all of the allegations against him and says he acted appropriately throughout the course of his work.
Mr. Ozer in 1985 was the partner responsible for auditing the failing thrift Lincoln Savings & Loan, whose chief, Charles Keating, went to prison. Andersen paid a fine while denying wrongdoing. The Board of Accountancy didn't seek to discipline Mr. Ozer then. But now, the board is saying Mr. Ozer made some of the same kinds of mistakes in the Baptist foundation case as in the Lincoln case.
Mr. Ozer also was the partner on Andersen's audit of Styling Technology Corp. The Scottsdale, Ariz., beauty-products maker filed for bankruptcy protection in 2000 and later said its financial statements going back to 1997 were unreliable. Mutual funds that owned its bonds are suing two former Styling executives and Andersen, alleging fraud. Mr. Ozer isn't a defendant.
Mr. Ozer, who like Ms. McGrath invoked the Fifth Amendment in an earlier deposition, was scheduled to give a new deposition Monday. His attorney said last week he "looks forward to testifying" about "his reliance on [foundation] management." |
