Deloitte has settled a shareholder case against the firm stemming from their role as
auditor of Bear Stearns, one of the early financial services firms to fail,
be force sold or nationalized during the financial crisis of 2008-2009.
Deloitte was dangerously close to having to answer for its actions - or rather
inactions - at a trial. For the Big 4 audit firms in the United States, trials
over auditor liability are unheard of.
Rare birds in modern times.
Deloitte's audits "were so deficient that the audit
amounted to no audit at all," the [Bear Stearns investors] plaintiffs argued in
That was Reuters
describing the rationale behind the decision of US District Judge Robert
Sweet back on January 23, 2011 to allow a case against executives of Bear
Stearns and its outside auditor, Deloitte, to go forward. I wrote in Forbes:
& Ernst v. Hochfelder, the Supreme Court held that actions under
Section 10(b) of the Exchange Act and Rule 10b-5 require an allegation of
"'scienter'-intent to deceive, manipulate, or defraud." The "scienter"
requirement, necessary to sustain allegations against the auditors in a
securities claim under Section 10(b), is notoriously difficult to meet in an
auditor liability case.
If there's anything of substance in a claim against
auditors the case usually settles before the facts are made public. New
Century Trustee v. KPMG is an early crisis mortgage originator case, cited
several times in the Bear Stearns decision. However, those facts will
never be heard in open court. In spite of - or perhaps because of - very
particular examples of reckless behavior by the auditor documented by the
bankruptcy examiner, the
case was settled...since Ernst, most courts have concluded that recklessness
can satisfy the requirement of "scienter" in a securities fraud action against
That standard requires more than a misapplication of
accounting principles. Plaintiffs must prove that the accounting practices
were so deficient that the audit amounted to no audit at all, or "an
egregious refusal to see the obvious, or to investigate the doubtful," or that
the accounting judgments which were made were such that no reasonable
accountant would have made the same decisions if confronted with the same
The plaintiffs' attorneys In
Re: Bear Stearns Companies, Inc. Securities Litigation successfully pled
recklessness equivalent to "scienter" and more. They knocked the requirements
for recklessness to prove "scienter" out of the park. The Complaint
identified as a red flag the fact that Deloitte knew or should have known,
absent recklessness, the risk factors inherent in the industry, such as
declining housing prices, relaxation of credit standards, excessive
concentration of lending, and increasing default rates.
The Securities Complaint has alleged that JPMorgan
discovered in the course of one weekend the overvaluation of assets and
underestimation of risk exposure in Bear Stearns' financial statements. JC
Flowers & Co., a leverage-buyout company, had also reviewed Bear Stearns'
books the same weekend and made an unsuccessful proposal to buy 90% of the
Company at a similar price between $2 and $2.60 per share. These allegations
support an inference of Deloitte's scienter.
They're specific enough about who, what, why, and when to
nail "particularity". The misstatements with respect to valuation and risk
were adequately alleged with sufficient specificity and established as
material. They showed how Deloitte, like the Bear Stearns executives,
But there will be no trial. Investors led by the State of
Michigan Retirement Systems settled with Bear Stearns executives for
$275 million - which will be covered by insurance - and auditor Deloitte
will pay, in cash, an additional $19.9 million.
To put Deloitte's settlement in perspective, I looked at
the firm's audit fees for Bear Stearns from 2003-2006. (Fee information for
2007 is not available since the firm was bought, under duress, by JP Morgan in
2008 and the proxy focuses on that transaction, not the typical disclosures.)
Deloitte earned $110 million dollars, more than 5X this settlement amount, in
just the last four years at Bear.
Read this article in its entirety at the re: The Auditors, a blog
by Francine McKenna.
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