>>currently i'm on sidelines
Sounds like a safe place to be until you can find a company to invest in that you can trust again.
This fraud happened in my own backyard well before Enron.
>>February 17, 2002
As the aura of scandal builds around Enron and the Andersen auditing firm, a multimillion-dollar lawsuit involving another Big Five auditor is wending through San Diego's federal courts.
In a long-running dispute that may go to trial later this year, Deloitte & Touche is accused of letting San Diego's FPA Medical Management keep $200 million in liabilities off its books, allowing the firm to appear flush with profits even as it was on the verge of bankruptcy.
FPA has been embroiled in lawsuits since it went belly up in 1998. Just last week, former Chief Financial Officer Steven M. Lash was slapped with a criminal indictment alleging 28 counts of fraud. The indictment includes charges that Lash reported fictitious earnings to the public, ordered employees to create false financial statements and misled federal regulators.
But in a civil suit that echoes of the Enron case, FPA shareholders say Deloitte did nothing to stop its client's questionable accounting practices. And the local case against the Big Five firm has withstood the requirements of a 1995 law designed to make it harder for investors in troubled companies to sue auditors.
Although Deloitte hotly contests the charges, U.S. District Court Judge Thomas Whelan says he is "deeply concerned with the breadth and severity" of FPA's accounting flaws, adding that the suit raises legitimate questions about Deloitte's role.
"The allegations suggest a pattern and practice of deception which this court has rarely encountered," Whelan wrote last year, rejecting a motion to dismiss the case. He said a final judgment in the case could easily top $200 million.
The Deloitte case could be a harbinger of things to come.
After seven years of being shielded from most class-action lawsuits, accounting firms are under fire in the wake of the Enron case. And the veneer of their legal protection is rapidly disintegrating.
On Wall Street and Capitol Hill, regulators are probing the auditing of such firms as Global Crossing, Tyco International, Critical Path and Enterasys Networks. Courtroom watchers predict an explosion of lawsuits.
"In the current atmosphere, these cases are going to be lay-downs for the plaintiffs," says E. Robert Wallach, a San Francisco lawyer. "For many defendants, the climate of panic is going to make it more tempting to back away and settle some of these cases."
Accountants, of course, have long been the targets of lawsuits.
After the savings and loan crisis of the late 1980s, for instance, banking regulators sued most of the then-Big Eight firms, saying they should have warned the public about problems at the institutions they were auditing.
But in other cases, auditors sometimes were added to lawsuits mainly for their "deep pockets," which assured that the plaintiffs could collect money from somebody if the primary defendants went bankrupt.
In 1995, under heavy lobbying from the Big Five firms, Congress passed a law that was supposed to prevent auditors from being dragged into such lawsuits.
Among other things, the law blocked plaintiffs from conducting "discovery" against auditors – such as seeking in-house documents or setting depositions – until the suit had survived a motion for dismissal.
"That's a very high hurdle," said Philip Borowsky, the San Francisco attorney who filed the current case against FPA. "In any other kind of litigation, plaintiffs can engage in discovery before they face a motion to dismiss. The information you collect is often crucial to helping you survive the dismissal motion."
Besides the hurdles set by Congress, federal judges have often given the benefit of the doubt to accounting firms, under the belief that auditors have little reason to be untrustworthy.
"A large independent accountant will rarely, if ever, have any rational economic incentive to participate in its client's fraud," Judge Whelan wrote in September 2000, as he dismissed a case against PricewaterhouseCoopers for its audit of San Diego's Altris Software.
The case was filed in 1998 after Altris announced it had overstated its sales and profits in the previous two years. Altris had been listing sales on its books even when the products had never been delivered or when the company doubted it could collect the bills.
When Altris restated its earnings, its $2.4 million annual profit turned into a $2.5 million loss. Altris shareholders sued the firm and its auditors, charging that PricewaterhouseCoopers had ignored the losses when reviewing Altris' books.
But Whelan dismissed the case.
"Unlike the officers and directors of the companies it represents, an independent accountant has no ability to line its pockets through insider trading, and no incentive to cover up corporate mismanagement," Whelan wrote.
He added that it would be "irrational" for an accounting firm "to risk its professional reputation to participate in the fraud of a single client."
Today, Whelan stands by his ruling in the Altris case. But he says Enron may change his mind about what accountants are capable of.
"If Arthur Andersen did what they're accused of doing – shredding documents and inflating balance sheets – that would change a lot of people's opinions," Whelan said.
Even before Enron splashed into the news, Whelan was casting a more skeptical eye toward accountants, as he showed by rejecting the motion to dismiss the FPA case.
From 1994 to 1997, FPA grew from a small medical-practice management firm with less than $20 million in revenue per year to a far-reaching public company with $1 billion in annual revenue.
FPA's chief engine for growth was the stock market, using its shares to buy competing firms. But to maintain a high stock price, FPA needed to produce glowing financial statements. To do that, critics allege, FPA hid its mounting debts and manufactured false profits.
Among other things, FPA in 1997 inflated its good will by $125 million, overestimated its receivables by $40 million and kept $35 million in liabilities off the books.
Deloitte, which earned $2 million from FPA from 1995 to 1997, audited the financial statements and reported nothing wrong. According to the suit, Deloitte auditors sat in on meetings where FPA officials assured investors about the financial statements' accuracy.
Deborah Harrington, Deloitte's national public relations director, defends the firm, saying its work was "in compliance with all applicable professional standards."
But attorney Borowsky says Deloitte's work was complicated by the fact that it was serving as FPA's consultant as well as auditor, just as Andersen did at Enron.
"It's hard to be objective when you're getting lucrative compensation to tell a company how to become successful at the same time as you're being paid to tell the public whether the company is successful or not," Borowsky said.
In an unrelated development, Deloitte this month announced it is spinning off its consulting division in light of the Enron scandal.
The discrepancies at FPA came to light in May 1998, when the company announced it had to restate its financial statements by $200 million. FPA executives revealed they only had enough cash to keep the company running for seven weeks.
That announcement came 11 days too late for two groups of Southern California doctors, who had just sold their practices to FPA in a stock swap.
The doctors – Borowsky's clients – say FPA's executives and accountants must have known at the time of the deal that FPA was about to collapse. Instead of warning them, FPA loaded the doctors with soon-to-be worthless stock.
Because of federal securities laws, the doctors were barred from selling the stock for 30 days. By the time the freeze was lifted, FPA stock was selling for pennies on the dollar.
In contrast, FPA executives sold their stock shortly before the company collapsed. Chief financial officer Lash, for example, sold $1.4 million in stock.
Although FPA officially remains in business, with a stock price of 1/100 of a penny, its phones have been disconnected and it has not filed a statement with the Securities and Exchange Commission in more than a year.
In the indictment handed down last week, the federal grand jury in San Diego pinned much of the blame for the collapse on Lash, who, among other things, was charged with concealing "material facts" from Deloitte.
The accusation echoes the Enron case, in which Andersen says it was misled by Enron's top officials.
But Borowsky said that even if Lash purposely misled Deloitte, the auditors still share culpability.
"Auditors are supposed to verify representations made by their clients," he said. "If an auditor simply believes what the client says, what's the purpose of having an audit?"
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