• BDO International: “Manage and Control” Means Slam Dunk For BES

    By • Jun 6th, 2009 • Category: Latest, Pure Content, The Case Against The Auditors

    After a week’s delay, the Banco Espirito Santo (aka ES Bankest ) vs. BDO International trial finally started in Miami on June 2. I was approached by Courtroom View Network and given access to the full trial tapes and select clips in exchange for this mention.  The first day of the trial was quite a long, arduous combination of jury instructions, opening statements by both attorneys, and testimony from the BDO International Secretary Paul Van Elten.  (BDO International is now known as  BDO Global Coordination B.V., a recent name change.)  But it all was worth the price of the ticket.

    Go here for better longer clips of both opening statements and the testimony of BDO Secretary Paul Van Elten. There will be more, including hopefully some custom excerpts, as the trial progresses.

    Some general impressions first.

    I’ve been following Steven Thomas of Thomas Alexander & Forrester in the BDO International case and in his new initiative regarding KPMG International and New Century.  He’s on a roll. And I personally believe he’s got a slam dunk case against BDO International.  But watching him give his opening statements and question International Secretary Van Elten sort of burst my admiration bubble.  Maybe he has to be slow, ponderous, repetitive, folksy, and borderline condescending to the jury to help them comprehend what is, to even accounting industry professionals, a very complex case.  

    But the proceedings made my head hurt.  Even when questioning Van Elten, who is probably an otherwise intelligent international executive, I felt he was being very tedious.  Maybe this approach is a result of the same frustration I have sometimes with seemingly intelligent folks who find accounting and these issues boring, too hard to follow.  To me, they are pretty straightforward and critically important.  My bias. Yes.  But I try not to dumb-down the writing on this site, even while attempting to make it interesting, entertaining, and hopefully enticing.  The facts are the facts and they can’t be made much simpler without dangerously distorting or diluting their meaning.  

    Well, Thomas is the professional and he will win.  So I hope it’s all part of the grand strategy.  But the issues are so simple and the evidence, in my mind, so compelling that I could have tried the case. 

    The attorney for the defense, Mark Raymond who is Managing Partner of Broad and Cassel, is even more boring and lame. His opening argument was pathetic, characterizing BDO International as a “wedding planner,” an insult to his client.

    ”Like a wedding planner, they coordinate, they facilitate,” Raymond said. “Does a bride give the wedding planner all of these rights to run and control everything? Of course not.”

    Is there a defense that’s more embarrassing for the accounting firms than “We were duped?”  Yes.  It will now be called the “Wedding Planner”  defense, intended to excuse senior leadership and a global network of member firms for the sins of their business partners based on turning the principal/agent relationship upside down. Raymond is stretching, but in this case he’s pulled a major muscle. I don’t think he’s going to recover.

    I did like how Thomas began his opening argument. He told the jury that the case is all about relationships and that relationships come in all shapes and sizes, but they all carry responsibilities and obligations. He then, during several stops and starts, rambles, meanderings, and roundabouts eventually gets the meat of his case on the table:

    BDO International has the contractual right to manage and control every aspect of their member firms conduct of the professional services typical of a public accounting firm. However, in the case of BDO Seidman, their US firm, and ES Bankest, the client who sued and won a huge gross negligence claim against them, BDO International did not exercise this right.

    Thomas posits in his opening statement and then solicits testimony from Van Elten, the BDO International Secretary, to prove that BDO International has the contractual right, based on the contracts each member firm signs with BDO International when they join the network, to:

    1. Decide which firms are allowed into the BDO network of firms;
    2. Tell member firms how to look via rules about use of the name, acronyms, logo, use of style sheets for correspondence and other marketing standards;
    3. Tell member firms how to do their work via methodologies, software, technical manuals including audit manuals, and mandatory quality assurance inspections; and 
    4. Enforce these contractual obligations, as a final step, by expelling a member firm if they can not or will not comply.

    Later, he gets the BDO International Secretary to testify that the three main objectives of the International entity, as defined in their articles of Association at the time of the ES Bankest audits (1998-2002) were:

    1. To promote high standards of accountancy, audit, and financial and business advice throughout the world;
    2. To acquire, own, grant licenses or other rights, and authorize the use of the name BDO, logos, and styles to accounting firms of repute all over the world; and
    3. To participate and cooperate with other companies, partnerships, and entities which form the network as well as to manage and control the member firms.
    Interestingly, Van Elten then testified that a portion of the third objective, the “manage and control” part, was excised from the articles of Association after the ES Bankest lawsuit was filed. In addition, Van Elten testified that, although BDO International had “managed and controlled” other member firms in the past, he did not recall them doing so for BDO Seidman during the period of the ES Bankest audits.
      
    For me, this exchange was the money shot. It plays completely into the contention by Banco Espirito Santo that BDO International had the contractual right and the public service obligation to manage and control the quality of BDO Seidman’s audits and the behavior of its partners and employees. But they didn’t exercise that right.  
    The issue of “public duty” makes an early appearance in this trial and I am gratified by that.  Thomas tells the jury in his opening that performing an audit of a company is a public duty of accounting firms.  
    That’s why they are called “public accounting firms.”  The public relies on the certification of financial statements by auditors for investment purposes, but also as creditors, employees, customers, vendors, and the community.  This is an important point that often gets lost.  Audit firms are part of the regulatory infrastructure, the global capital markets system by virtue of their government-sponsored franchise to perform audits of public and private companies. 
    Fortunately for the plaintiff’s case, BDO International’s attorney Raymond put his Florida foot in his mouth and told the jury that the discussion of a “public duty” for BDO International is a “sideshow.” There’s an exchange that I hope to be able to show you on a longer clip where Raymond tells the jury that the judge will not instruct them to consider “public duty” and that this duty does not belong to BDO International.  Attorney Thomas objects and the judge tells the jury he will instruct them on the law, not the lawyers.  I think Raymond stupidly overreached here.
    Raymond’s defense of BDO International boils down to a desperate plea to the jury to believe that BDO International is not the ‘boss” of BDO Seidman by focusing on the size and lack of accounting/audit prowess of its nominal administrative head.  However, all anyone has to do look at the BDO International website or its Annual Report to know that BDO International is a vehicle set up by the member firms to control themselves and that the people who should be on the witness stand are the members of its Policy Board (the Board of Directors) not Mr. Van Elten.  The Policy Board consists of representatives of its largest and most powerful member firms, including BDO Seidman, and it’s fronted by the loquacious, überconfident CEO, Jeremy Newman of the UK.

    Why do they have poor Paul Van Elten sitting in the hot seat?  He’s only the custodian of the global-size binder clips. What is the ultimate strategy here?  Thomas has already won a judgement with punitive damages for his client against BDO Seidman.  A huge judgement. One that they said two years ago they could not pay.  Is the strategy to hold BDO International responsible for the judgement by showing that it’s all for one, one for all? The member firms then must pony up and pay for the sins of BDO Seidman?  If BDO Seidman or any other member firm of a global accounting network screws up, you can now hold a larger group accountable for the good of the public trust?

    Or is Thomas limbering his fingers and toes for the big prize, US$1 billion dollars or more from KPMG International for New Century?  Is Thomas going to be the one to bring the monster suit against PwC International for Satyam? I think the PwC case will claim damages of more than US$1 billion dollars.  If he gets it right with BDO International, he or any of the others such as Stuart Grant who brought the case against Deloitte International for Parmalat, will have a good template. And he will have poked a hole the size of a Mack truck into the previously impermeable accounting firm “global network” sham structure.

    Update: Just reviewed the clips of Mr. Thomas, the plaintiff’s attorney, with a friend here at the Ferrara Bakery.  He’s a criminal defense attorney.  Usually works with guys whose names end with vowels, but well, I have likened the audit firms to the Mafia…  Anyway, he says Mr. Thomas is using some very tried and true techniques here, especially if the jury is a group of ordinary people who are not well versed in the issues at hand.  

    • “Rule of three” means repeating your points three times, to help the memory of the jury and get it in transcripts repetitively.  
    • “Looping” means repeating what the witness says and prefacing your next question with his last statement. This also reinforces answers and gets them cited repeatedly in transcripts that will be reviewed later by the jury during deliberations.
    • Using techniques usually reserved for cross examination during direct testimony such as the attorney providing “testimony” and content himself so that the witnesses answers are short and sweet, yes and no, I agree, you’re right, etc. This is especially helpful here with Mr. Van Elten as he seems to be a soft spoken, European gentleman. They had several problems with audio quality and his microphone at the beginning of his more than an hour long testimony.  Mr. Thomas’ use of this technique may have been because he was given permission to treat this witness as “hostile” or the judge may be permitting it because of the complex nature of the case.  We shall see.

    In any event, it’s hard for me to feel comfortable with a case so complicated, hinging on international law, principal agency as it relates to a global member network, and accountancy being decided in this way by a “jury of our peers.”  No disrespect to the citizens of Florida, but will it provide the most definitive, irrefutable soluton to an important issue, no mater what the outcome?

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    31 Responses »

    1. @francine – entertaining as always but there is a point here that’s not been considered. Enforcement. Given that BDO International is registered in Brussels, what chance do you think the plaintiffs have of getting financial satisfaction from that entity (assuming they win?) And assuming BDO I or whatever it calls itself these days has any material assets – which is very much doubt given what Newman said when we met.

      Regardless of the veracity of the plaintiff’s claim, it ain’t much good if they can’t enforce and international settlements are, by their very nature, notoriously difficult to collect upon. So even if the plaintiffs win, it could end up a Pyhrric victory don’t you think?

    2. @ Dennis Howlett

      You raise a good question. As I mentioned in the post, the judgement is already in. BDO Seidman has to pay itself (or declare insolvency) or this trial can force BDO International, which is essentially an organization made of member firms, to share the burden. That’s why they are bringing suit. It may force the member firms to cough up for BDO Seidmans shortfall by force of law versus voluntarily to save the network as we discussed. If the lawsuit was brought in Miami and if they have forced its international officials to testify, then US jurisdiction has been established and the entity will have to honor a judgement. It’s not unprecedented. KPMG International is based in Amsterdam and is being sued in New York over New Century. Deloitte International, which is based in Switzerland, is being sued in New York over Parmalat and PricewaterhouseCoopers International Limited which is based in UK officially will be sued in US for Satyam. I think the objective is to punch a hole in the sham structure which is the international firms using BDO as first step and make way for Deloitte, KPMG, and PwC later. They seek to make the member firms take responsibility for their members in any country they do business, sort of like a multinational corporation has to. I will follow up with legal friends to get a better handle, but I would not count anything out. It’s bad for BDO Seidman and BDO no matter if they win or lose this “post mortem” because the US firm is already dead.

    3. As far as I am concerned this is nonsense. The SEC and PCAOB should have ended this “we’re one firm except when we get sued” story years ago.

    4. Ok, so obviously the “global firm” thing is a sham. So how would justice be served by a judgement making the foreign firms pay for BDO Seidman’s negligence when they are, in practice, unrelated?

    5. I don’t think this is the “most definitive, irrefutable solution”. This is not an appeals court, where precedent is set which will impact future cases. This is trial court, where the lawyers get to practice their techniques for future cases. What will be learned is whether these plaintiff and defense techniques are effective. Future lawyers will consider this trial in designing their trial strategy.

      Regarding the enforcement issue, it seems to me that the question isn’t just about payment. If the international firm chooses not to pay, I presume that they will have to break apart the global network, which will turn BDO into a small time accounting firm, with no ability to audit international firms, and signficantly reduced brand value (maybe not quite to Friehling and Horowitz level). This is how Anderson ended, all of the international firms level the global network.

    6. There is zero chance of BDO Stoy Haywood UK (or pick a country) paying any of the fine for negligence here in the US. Why should they? It is a different partnership in a different country. BDO international maybe found guilty but they have no assets. Who is going to enforce the fine, how are they going to collect and what will they get – there is nothing? What am I missing?

    7. Anon 1970 @ 6 —

      Assume you are correct and that the member firms do not (or cannot) pay any damages assessed by the court against BDO International. What happens next? What happens to the global partnership?

      What do the clients think about that situation? Are they okay with a global partnership that is comprised solely of independent firms with no legally enforceable ties to each other?

      In your scenario, where does BDO go from there? I don’t see how it can just be “business as usual”.

      Just as importantly, if you are correct, what are the implications for the Big 4 firms and their “global partnerships”? Just as an example of one issue that comes to mind, how does one country firm rely on the work of the other country firm(s)?

      Food for thought, perhaps?

      — Tenacious T.

    8. When BDO U.S. desolves, who will gain from loss of this work? Is this big 4 work or next tier/local work?

    9. I think Dennis Howlett opened up a very interesting set of possibilities: If BDO International loses, but then effectively stands up in Belgium and says “we’re over here, where you have no jurisdiction, so yar boo sucks to you”, what next? Does BDO Int. become a fugitive from US justice, a sort of accounting Roman Polanski? And then suppose the precedent does get applied to PwC re Satyam, KPMG re New Century, Deloitte re Parmalat? Surely this may occur, with equal likelihood of success? Do these firms then all effectively stand outside US jurisdiction in a perpetual stalemate? This seems ludicrously unlikely.

      Or — in those putative circumstances — would the US, having established that these firms are component parts of a whole organisation, then come after the US partnerships, which have to reside in their jurisdiction to do their job, for what their international organisations owe them? This seems plausible to me. Should that happen, would the US partners wear the consequences of their global partners’ sins without seeking their help? So ultimately, will this matter of jurisdiction do anything more than stall the inevitable, should the case be lost by BDO? It seems that way to me. But the whole “fugitive from justice” scenario feels like it would be a very entertaining way of getting there…

    10. This case doesn’t really mean anything. The utility of destroying the holding firm is to go after the US partnership in a non-US scandal (i.e. Satyam & my old friends Parmalat). DT actually has the best protection of the internationals, with the Swiss Verein. The Parmalat case is made more interesting since the real problems came from a BDO audited subsidiary. Just reinforces all of our prejudice against Tier 2.

      As to who takes biz from BDO’s death – Tier 3 (is there a Tier 3?) and locals. Tier 2 hardly ever wins business that Big 4 want, and Tier 2 clients don’t want Big 4 for price and other reasons. The only competition from Big 4 for Tier 2 comes from offices that the Big 4 wished they didn’t have and functioned as Tier 2 offices anyways, and in emerging markets where 2nd tier is accepted for listings in local stock markets.

    11. Excellent coverage Francine. I look forward to hearing more as the trial progresses. My two cents—the fact that there is no true “international law” doesn’t necessarily mean they won’t be able to collect on the verdict if “BDO Global Coordination” (cute) is successfully added as a party to the litigation. There are international reciprocity agreements and treaties that have the affect of compelling local courts to force companies within their jurisdiction to honor decisions of US courts, or even waive enforcement of their own decisions in conflict-of-law situations (LICRA v. Yahoo! in France). It’s my understanding that, under Florida law, damages that would have the affect of bankrupting a company can be set aside. This trial is all about making sure that won’t happen. I’d be willing to place a bet that the full amount of the verdict will never be collected, but that a negotiated settlement will be reached fairly quickly once this is decided. The settlement amount will likely look something like the net present value of the verdict, plus interest, less the amounts that would be allocated to non-US entities with weak enforcement of international law (Nigeria comes to mind, but the UK doesn’t!) – less the interest for those unlikely to have been collected. And I too would be shocked if BDO managed to convince jurors that it can have its cake and eat it too, and falls for the international “coordination” bunk.

    12. @10 Ex DT

      #1 Utility of going after BDO International in this case is to get more folks on the hook for money already owed by BDO Seidman that they already said they don’t have. It was in the original case, thrown out, and re activated on appeal, unfortunately with a new jury two years later. Lost some mo’ but the more folks on the hook for a judgement already won, the better, no matter how hard it may be to enforce. If the case is being tried here, it can be enforced from here. #2 And then there’s the template opportunity for lawyer Thomas in his KPMG New Century case… The Deloitte International Parmalat case will be tried in New York. Swiss verein has already turned into Swiss cheese since a judge has said the case will be tried.
      Francine

    13. @11 Mark O’Connor
      Thanks so much for that explanantion of the international law aspects. I know you know your stuff.
      I believe the issue of whether or not the original judgement with penalties would bankrupt BDO Seidman came up in the original trial. That’s why they were forced to reveal their capital balances and ability to pay. They said they couldn’t. Since the issue of BDO International share in liability was there originally and then won right to separate trial on appeal, the issue of whether the judgement can be set aside because it is too much is still open, pending this decision.

      We shall see!

      Francine

    14. Bear in mind that the damages were $179 million, but under Florida law, the jury tripled it to $550 million. The first thing that occurs to me is why would any international firm want to conduct business in an anti-business state like that. Second Banco Espirito santo will have netted over $300 million if they prevail while the audit fees were probably no more than $100k. .Is that fair since their own due diligence was faulty? Plus , an uninformed jury is deciding what is essentially a complicated case. But I don’t believe that a loss will cause BDO to dissolve as I’m sure it will be settled for what the US firm plus their insurance company can afford to pay.

    15. @14 Martin

      Insurance is minimal. Maybe $50 million. Would you lend a firm money to pay a judgement?

      Why would you say their own due diligence was faulty?

      Firms have no choice but to do business in Florida. Would be hard to avoid..

      Francine

    16. @6:

      Surely the point about going after BDO International is basic agency law? It’s quite obvious that the international body is an agent for the principles (each national firm) and therefore they are liable for anything done by the agent in the ordinary course of affairs.

    17. Warren Buffett famously noted that it is not until the tide goes out that you can see who has been swimming naked. Buffett’s comment was directed primarily at the performance of management, but it can be equally applied to external auditors. Their role is to independently verify the accuracy of the financial statements prepared by companies – a duty enshrined in the Corporations Act. We all need to see what the tide brings forth before convicting prior to trial.

    18. @17 EX BDO

      BDO Seidman has already been found guilty of gross negligence regarding Banco Espirito Santo. Now it’s just a matter of how many more take blame and pay price.
      Francine

    19. Francine – I believe DT to have more protection against the Verein being pierced so that DT Germany, etc get judgments. Being sued in a US court isn’t really that much of a shock. The US firm is at substantial risk but other firms I’m not sure. Of course DT will want to keep the US firm afloat and so the global network will pitch in. I’m just more skeptical of the ease of “making” them pitch in if they didn’t have a viable US firm.

      Enforcing these judgments internationally will be rather hard. No US nexus that makes them want to pay, and the veil piercing will need to be relitigated in every jurisdiction. Just because a US court ignores the international structure doesn’t mean that a UK judge will accept that. Much larger burden than a normal international suit where the organizations involved have a traditional corporate structure.

      The BDO case highlights why you want to do business with the Big 4. In nearly every possible case the US firm of a Big 4 member won’t be destroyed by a lawsuit, so the global firms will band together to cover any damages you may have. Losing the BES case means the end of BDO US so no reason for other parts of BDO to try to help with judgment to maintain the US presence. Orders of magnitude easier to enforce judgments against firms that have an inarguable US nexus and an ongoing business.

    20. This suit will go on for years. Even if BDO International is deemed to be party to the suit, the award will be appealed.

    21. @19 I don’t know if this case will confirm that “Big 4 is best”. If a precedent is set whereby the notional protection these structures offer, under some circumstances, doesn’t exist, then the big 4 are potentialy facing global liabilities that, if they don’t bring them down, would at the least make partnership in them far less attractive. Things Would Change.

      @10, DT’s Swiss Verein may be better than KPMGs structure or PwC’s, who knows? But the test here appears to be not what the legal entities actually are, but what function they perform, and how they are represented to clients. If the verein does anything on the “wedding planning” list, then it’ll be up for grabs faster than you can say Parmalat. The test for Deloitte also seems to be that if you tell your clients all about your seamless global organisation full of expertise you can draw on at the snap of your fingers (and I have pasted that hokum into enough proposals to make me blush with shame), you can hardly run to the umpire with a diagram of all the double stitched seams you swore blind weren’t there. Worth testing as a notion, anyway.

      And (@20) even if this BDO thing is appealed to the end of time, it may well be grist to the mill for the Deloitte case. Then PwC and KPMG and then maybe EYs model all go to the test as well. Maybe they all go into 20 years of appeals too. But this alone may be enough to slow the charge to partnership among people in those firms (who wants partnership when the liability is global?). Without that incessant avaricious internal momentum, can these firms survive as they are?

    22. […] – Banco Espirito Santo vs. BDO International.  My first dispatch, with exclusive clips, was posted over the weekend, with more to come as I review complete trial footage after each day of court.  All this takes is […]

    23. @EX BDO
      if u were an auditor u would know that an auditor role is not to verify the accuracy of a companies financial statements
      their role is to verify if the FS are true and fair reflection..but they never say a FS is accurate..
      thats auditing 101..

    24. Koodi@23 —

      If you read this blog more comprehensively, you would find discussions of a Supreme Court decision where SCOTUS found that that auditors “certify” the financial statements of the companies they audit. Certify as to the accuracy of the numbers is a fair way to look at that decision.

      I think that knowing the judicial interpretations of the highest court in the land, as it pertains to auditing in the USA, is a significant part of Auditing 101. Don’t you? Maybe u r not such an auditor expert after all? LOL

      — Tenacious T.

    25. Slam dunk huh?

      http://www.miamiherald.com/news/breaking-news/story/1100013.html

    26. @25

      Just twittered what I’ve seen on the wires, including this story. Looks lie judge made a decision on the punitive damages case, which has a “gross negligence” requirement. I’m very surprised given the testimony. We’ll see what happens on the general loss portion. Looks like this lawyer has some homework to do before he takes on KPMG International. I am hoping for an interview to fill in the blanks later on what happened.
      Francine

    27. Unfortunately this is all part of the distruction of a good firm led astray by management that was too focused on service $ and not on quality control. Recently the former chairman of the firm has been indicted on charges stemming from the sale of tax shelters to wealthy individuals, which the government is alleging were bogus. The international firms of the large accounting organizations , are established to try to coordinate the joint activities of member firms throughout the world and to give clients who operate in more than one country a place to go for accounting and auditing services. To hold the international members liable ( since the international umbrella organizations don’t have much in the way of assets themselves) would open up a pandors box which would result in the potential split up of these organizations in a way which would not be in the interest of the business community and the public in general.

    28. FM – Looks like you couldn’t have been more wrong. Thomas wasn’t on a roll….and he lost. Nice prediction.

    29. @fm – As a general rule of thumb, when preparing for a jury trial, it should be assumed that the jurors have an education level of about a 12 year old. The wedding planner metaphor may work well as it is something that people can relate to. Things that are obvious to you and worth academic and intellectual discussion/debate must be reduced to this level in court because the average person isn’t that bright or familiar with the industry.

    30. […] clear that BDO International did not do what they told the public they said they do. They were not managing and controlling one of their largest and most important member firms and have tried to wiggle out of that liability […]

    31. […] the jury had to find that BDO International exerted control. They did not. They believed the testimony of the BDO International Secretary. “Why do they have poor Paul Van Elten sitting in the hot seat? […]

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