• EY Settles SEC Charges Re: Bally’s Fraud-Lives To Audit Another Day

    By • Dec 17th, 2009 • Category: Latest, The Case Against The Auditors

    Reuter’s:

    “These opinions were false and misleading,” the SEC said in a statement.

    “Ernst & Young has agreed to pay $8.5 million to settle civil charges that it violated accounting rules in connection with a fraud at Bally Total Fitness Holding Corp, the U.S. Securities and Exchange Commission said Thursday.

    The SEC accused the accounting firm of issuing unqualified audit opinions that said that Bally’s 2001 and 2003 financial statements conformed with U.S. accounting rules.

    Six of the accounting firm’s current and former partners also agreed to settle SEC accounting violation charges as part of this investigation, the SEC said.

    In settling the allegations, Ernst & Young and the former and current partners did not admit to any wrongdoing, the SEC said.

    “These settlements allow us and several of our partners to put this matter behind us and resolve issues that arose more than five years ago,” Ernst & Young said.”

    What none of the stories that just hit tell you, though, is that at least two of the EY partners charged, Fletchall and Sever, held leadership positions with the AICPA in the past.

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    Three of the partners were members of EY’s leadership team/national office, giving advice, guidance, and making decisions about accounting standards on behalf of engagement teams nationwide.

    Did Mr. Fletchall get off with a slap on the wrist given his AICPA leadership position, AICPA PAC contributions and significant campaign contributions to Senator Christopher Dodd? Mr. Fletchall is used to telling the SEC what it should do. Quite used to it.

    EY can put an old case behind them… Yes, of course, since it’s December of 2009 and it’s taken the SEC six years to resolve a case from 2001-2003.  No wonder the firms’ answer to any settlement or disciplinary proceeding is always, “that’s in the past.”

    EY had independence issues recently and was supended from taking on new audit clients for six months.  And even more recently they were fined millions by the SEC for allowing a significant vendor relationship with an executive who also served on the Boards of three of their audit clients, including their Audit Committees. How many strikes does a firm get?  Why no strong statement, sanction or other disciplinary action from the PCAOB for the partners or the firm in relation to this case? Maybe because  Mr. Fletchall was also a member of the PCAOB’s Standing Advisory Group.

    Is Bally’s hidden in one of the EY inspection reports from this era?  Not likely, since the issue occurred right at the dawn of the first inspections, post-Sarbanes-Oxley’s creation of the regulator.

    More as this story develops.

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    15 Responses »

    1. Ugh, what a mess. I read the SEC complaint against Carpenter. E&Y should never have allowed certain revenue recognition to take place.

    2. Francine –

      You should be ALL OVER this.

      If there a reason for your blog to exist, it should be to shed the light of day on travesties like this. Here is not a story of auditors being deceived by a client, of auditors negligently missing issues, or of young auditors being overworked and underappreciated by their employers. Those stories are of passing interest, but this is the real deal: partners in a major auditing firm conducting fraudulent act upon fraudulent act to the detriment of the investing public, and then walking away with a wrist-slap. And all in your own backyard.

      It is hard to imagine that – in the immediate wake of Enron – that EY believed that its Chicago audit practice could independently perform an audit of a client where both the CEO and the CFO were former partners/current drinking and golfing buddies of the current audit partners of that office. Add to that the fact Bally’s was continually in a state of financial distress, the financial team there was highly rewarded to deliver strong financial results, and the EY auditors were under immense pressure to meet revenue targets….. and the result was inevitable: Bally’s management perpetrated a fraud, and EY assisted them along the way.

      EY Fraudulent Act #1 (The Greed): Bally’s was routinely accruing revenue from future (!) customers and EY signed off on this for years so as to continue to collect large fees for the audit and other services. EY knew that this was an unsupportable revenue recognition policy, but knew also that they had signed off on years on bad financial statements and therefore were in deep trouble with the advent of Sarbox, et al. Rather than come clean (and display some integrity) they instead chose to commit:

      EY Fraudulent Act #2 (The Cover-up, Part 1): EY attempted to co-conspire with their fraudulent client by trying to persuade Bally to covertly fix their revenue recognition problem gradually over several quarters – a clear admission that the current practices were wrong, and a clearly inappropriate and fraudulent means of addressing the problem. Either Bally’s execs couldn’t see an upside for them to any change, or thought EY would back down, or both. This forced EY’s hand and, EY again – rather than taking the professional, ethical, and law-abiding route – instead chose to commit:

      EY Fraudulent Act #3: (The Cover-up, Part2): After EY resigned (and let’s give them no credit for doing this… it was clearly the economic risk they were running from; this was not an act of valor on the firm’s part), Bally’s reported to the SEC and the investing public that there were no disputes with EY, and EY does not correct this outright lie. If fact, EY affirmatively reported the same to the SEC, knowing that it was a complete falsehood.

      Was EY crazy? Did they really think that the revenue recognition issue, the need for restatement, and the fraudulent acts of Bally’s management would not come to light under the succeeding auditor? Did they not realize that their own fraudulent behavior would not become known?

      No! But they also apparently knew that no more than a few slaps on the wrist would follow:

      Slap on the wrist #1: $8.5 million…. That’s all? Spread across the U.S. firm, this translates into less than 1% of the average EY partner’s annual pay (and that asumes that it is not coverd by the frim’s insurer. Take the fees earned by EY from Bally’s during the period of the fraud, put them in a money market account for the 10 or more years from the start of the fraud to the settlement date, and the interest alone will be more than this settlement. This fine will have no impact on changing the behavior of EY or its partners.

      Slap on the wrist #2: Barring the two former engagement partners and the former office managing partner from practicing before the SEC after all three had retired (at normal retirement age) from the firm? Did it really to take more than four years to investigate what had happened here? Was it not appropriate for the SEC to exact any direct or indirect financial penalty from these partners?

      This is a sad, sad situation, Francine, and representative of the daily behavior that continues at EY’s Chicago office and most assuredly elsewhere.

      Please don’t let them sweep this under the rug.

    3. PCAOB? Hahahahahahaha. It exists to put small CPA firms out of business.

    4. Is this case being viewed through the platonic cave? At one level, elements within E&Y (yes they do have some wonderful people there, the other 3 too) achieving their rank due to their pathological obsession with maximizing numbers (exceeding that of their peers?). I can’t bring myself to say crooked.

      At another level, the relationships between accounting firms, regulators, honorable senators, and assorted peripheral players have become incestuous beyond recognition? Or is this case seeing daylight due to the SEC seeing an easy mark and squeezing a quick settlement, then sifting out the next one. The SEC (elements within) continuing and making a revenue stream out of this? Say it ain’t so.

    5. The Vice Chair of Audit and head of Risk Manangement(!) was cited for an instance of “highly unreasonable conduct”. The spin on this ghastly matter is dreadful. All of the accused are fine felllows, loved by all, paragons of virtue, leaders of the profession, it was a “diferent time”. Oh, that is my favourite. 10,000 BC? 1776? last week? Good grief.

    6. […] How long will it be until the SEC finishes its investigation of the case, with regard to Flanagan and/or Deloitte?  Six years like Bally’s? […]

    7. […] own Vice Chairman Thomas Flanagan for breach of contract related to inside trader charges and the SEC’s recent actions against six Ernst & Young partners regarding the Bally’s fraud. In the Deloitte case, although the lawsuit against their partner was initiated as a result of SEC […]

    8. […] own Vice Chairman Thomas Flanagan for breach of contract related to inside trader charges and the SEC’s recent actions against six Ernst & Young partners regarding the Bally’s fraud. In the Deloitte case, although the lawsuit against their partner was initiated as a result of SEC […]

    9. […] own Vice Chairman Thomas Flanagan for breach of contract related to inside trader charges and the SEC’s recent actions against six Ernst & Young partners regarding the Bally’s fraud. In the Deloitte case, although the lawsuit against their partner was initiated as a result of SEC […]

    10. […] feeder fund exposure, Ernst and Young recently went through a terrible phase focused on their Bally’s sanctions, the Akai scandal and another fraud in Hong […]

    11. […] relationship with Lehman continued until the bitter end.  So it comes as no surprise to me that EY had a hard time acting independently with their “sticky” client.  Lehman Bankruptcy Examiner Anton Valukas, of local […]

    12. […] EY's relationship with Lehman continued until the bitter end. So it comes as no surprise to me that EY had a hard time acting independently with their "sticky" client. Lehman Bankruptcy Examiner Anton Valukas, of local Chicago Jenner & […]

    13. […] sometimes fail to hold the same perpetrators accountable.  When it comes to the auditors, the SEC can hold them accountable, and does occasionally, but often very late and the courts dismiss. By issuing these false and […]

    14. […] receiving lucrative contracts with the government and the vehicles created to manage the bailouts. E&Y recently won a government tender to provide loan valuation services to NAMA, a government agency […]

    15. […] resolution of the enforcement action. The most egregious example of that delay in my memory? The Ernst & Young case related to Bally’s – six years from last violation to enforcement. Page 1 2 « Previous Page […]

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