HealthSouth auditors could be next in firing line
Wednesday March 26, 3:40 pm ET
By Deepa Babington
biz.yahoo.com
NEW YORK, March 26 (Reuters) - Ernst & Young has been spared accusations of wrongdoing in the unfolding scandal at HealthSouth Corp.(NYSE:HRC - News), but legal experts warn the accounting firm could find it hard to escape legal claims stemming from its role as the company's auditor.
In a complaint filed last week, regulators accused HealthSouth of overstating earnings by at least $1.4 billion but stressed the fraud was designed to fool its auditors. HealthSouth executives carefully manipulated estimates that left a limited paper trail and made sure the tampered numbers fell below the minimum threshold that arouses suspicion from auditors, the Securities and Exchange Commission (News - Websites) said.
But experts in accountants' liability say Ernst & Young can take little comfort from the defense that it was also a victim of the fraud.
"Juries -- they're almost universal on this topic -- ask the question, 'Well if they weren't there to detect fraud, what were they there to do?'" said Mark Cheffers, an accounting consultant who tracks lawsuits against auditors.
As a result, accounting firms rarely let lawsuits against them end up in court, choosing instead to settle and fork over millions in the process, Cheffers said.
"Courts in general often will take the attitude that an accountant should have detected the fraud," said John Eickemeyer, a lawyer at Vedder, Price, Kaufman & Kammholz who defends accounting firms against liability claims. "Now that may or may not be fair, particularly given that some of these frauds are exceedingly sophisticated and designed with the idea to fool auditors."
NOT AWARE OF LAWSUITS
Ernst & Young says it isn't aware of any class action lawsuits filed against HealthSouth that have included the accounting firm as a defendant.
But that could change.
An attorney for Cauley Geller Bowman Coates & Rudman, a law firm that filed a suit in Alabama on behalf of shareholders after the fraud charges came to light, for example, said there is a good chance Ernst & Young will also be named as a defendant in the suit.
"In all likelihood, when we amend the complaint, we probably will include the accountants," David Rosenfeld in the New York office of the law firm told Reuters. "They make a lot money in fees, they should do something to earn it."
Ernst & Young said it is not aware of any case where the jury has found accountants liable because it felt the auditors should have gone beyond the standards of normal auditing.
"If, and that's a very big if, we were to find ourselves engaged in a case that was before a jury, the firm has utter and total confidence in the ability of jurors to, once they are sworn in, differentiate what the realities are," an Ernst & Young spokesman said. "We're just as outraged about what happened at HealthSouth as any juror or investor would be."
LONG-TIME FRAUD
Particularly troublesome for Ernst & Young is that the alleged accounting fraud at HealthSouth stretched over more than a decade and a half, begging the question of how auditors could be fooled for so long, experts say.
Often, warning signs pop up over several years, ranging anywhere from a remark made by an executive leaving a company to a document that seemed out of place, Cheffers said.
"The longer the fraud goes on, the greater the number of red flags that, in retrospect, appear," said Cheffers. "Often times when plaintiffs go back they find all these red flags waving around that were missed."
Plus, complicating matters is that if HealthSouth slides into bankruptcy, then the bankruptcy trustee would have an easier task filing and sustaining a lawsuit against the auditor, Cheffers said.
The central question before shareholders and regulators is whether the auditor should have found the fraud or was reckless in not finding it, said Walter Schuetze, a former chief accountant at the Securities and Exchange Commission.
As a general rule, just arguing that they were fooled by management is not a good enough defense for an accounting firm, he said.
"Auditors should find fraud," said Schuetze. "If auditors do a proper job, they should find fraud." (Additional Reporting by Jed Seltzer) |
