Deloitte, Delphi, and GM: Duped or Duplicitous?By Francine • Nov 21st, 2010 • Category: Latest, Pure Content, The Case Against The Auditors
It’s as wicked as it seems…
What the SEC is doing at Delphi is quite expedient. Merriam-Webster defines expedient as:
1: suitable for achieving a particular end in a given circumstance
2: characterized by concern with what is opportune; especially : governed by self-interest
Expedient usually implies what is immediately advantageous without regard for ethics or consistent principles
Deloitte partner Nick Defazio testified on November 17th in the Securities and Exchange Commission’s civil securities-fraud case against former Delphi CEO J.T. Battenberg III. Mr. Difazio testified, on behalf of the SEC, that in 2000, Delphi management withheld documents from Deloitte, their auditor, that might have raised red flags about how the company booked a large payment to General Motors, also audited by Deloitte.
The SEC says a $237 million payment by Delphi to GM was to compensate GM for faulty parts. Delphi improperly booked most of it as pension and employee-benefit expenses and avoided an earnings hit, according to Automotive News.
“Based on these documents I’ve shown you this morning, … do you believe the accounting for the settlement was correct?” SEC attorney Jan Folena asked.
“I have serious questions about whether it was correct,” Difazio answered. “It appears it was not.”
GM booked the entire $237 million as a warranty payment, which went straight to its bottom line as profit that quarter says the SEC.
Mr. Difazio was sanctioned by the SEC for not doing enough to identify the real purpose of this transaction and others at Delphi.
On February 26, 2008 the Commission instituted two settled administrative proceedings finding that Nicholas Difazio and Duane Higgins, Deloitte & Touche LLP (D&T) engagement partners on the 2000 and 2001 audits of the financial statements of Delphi Corporation, engaged in improper professional conduct on those audits.
In its first Order, the Commission found that Difazio, the lead engagement partner, engaged in improper professional conduct in auditing: (1) Delphi’s improper accrual of an estimated warranty expense by its former parent as a direct charge to equity in the second quarter of 2000, rather than as an expense of the period in accordance with GAAP; (2) Delphi’s improper classification of most of a $237 million payment settling the former parent’s warranty claims to pension and other post-employment benefit “true-up,” causing the amount to be accounted for as prepaid pension cost in the third quarter of 2000 in contravention of GAAP; and (3) Delphi’s failure to account for the fourth quarter 2000 sale of certain batteries and generator cores, coincident with a side agreement to repurchase that inventory, as a financing transaction, as required by GAAP…
In each Order, the Commission found that Difazio and Higgins, among other things, failed to obtain sufficient competent evidential matter to afford a reasonable basis for the opinion rendered by D&T, to exercise due professional care in the planning and performance of the Delphi audit, and in performing the audit to identify material departures from GAAP in the financial statements.
The Commission’s Orders denied Difazio the privilege of appearing or practicing before the Commission, pursuant to Rule 102(e)(1)(ii) of the Commission’s Rules of Practice, with a right to reapply after three years…
Mr. Difazio, although not admitting or denying the charges, consented to the sanction. He is not eligible for reinstatement to practice before the SEC until at least 2011.
In the meantime, he leads Deloitte’s IFRS initiative.
Yes. That makes a lot of sense. You want a guy who can’t get the GAAP right to advise your company on the impact of converting from GAAP to IFRS and lead new auditors down the path.
How can the SEC allow this? Perhaps Mr. Difazio agreed to testify on behalf of the SEC against Delphi executives to avoid a monetary penalty.
But which is it? The auditors didn’t do enough? Or the company hid documents from them?
It seems that the SEC can claim auditors should have known, could have known, and would have known Delphi, with GM’s help, was pulling a fast one if Difazio and his colleagues had, “obtained sufficient competent evidential matter to afford a reasonable basis for the opinion rendered by D&T, exercised due professional care in the planning and performance of the Delphi audit, and performed the audit to identify material departures from GAAP in the financial statements.”
But when the SEC wants to bring civil charges for fraud against the company’s executives, the story is that the auditor was duped. That’s because the judges say it’s usually not possible for anyone else to be guilty when company executives do bad things. It’s especially hard when there’s been a bankruptcy.
In December of 2007, Deloitte, as a firm, settled with Delphi investors.
As settlements go, this is relatively minor. However it is another in a long line of settlements rather than trials for Deloitte, whose spokesperson, the hardworking Deb Harrington, always says:
…the company had a strong legal case but “concluded that it was in the best interests of the firm and its clients to settle this matter now rather than face the burden, expense and uncertainty of continued litigation.”
Delphi, you may remember, is one of the Tier 1 automotive suppliers to GM and a close relation of GM, another company with ongoing issues related to poor internal controls. It seems the apples don’t fall far from the trees and poor business practices, bad management and outright fraud were a part of how these companies “made money,” if you can ever believe their numbers.
The accounting company Deloitte & Touche has agreed to pay $38.25 million (€26.3 million) as part of a $325 million (€223.9 million) settlement of investor claims of misconduct by Delphi Corp. — the largest auto parts supplier in the U.S. — and those that oversaw its finances.
Delphi filed for bankruptcy protection in 2005, acknowledging that hundreds of millions of dollars in earnings that it had claimed since General Motors Corp. spun it off in 1999 were invalid. A U.S. Securities and Exchange Commission investigation found that Delphi manipulated its earnings from 2000 to 2004, using several illegal schemes to boost its earnings, including the concealment of a $237 million transaction in 2000 with GM involving warranty costs.
Deloitte & Touche, now part of the privately held Deloitte Touche Tohmatsu, served as Delphi’s outside accountant.
“It’s about holding the gatekeepers accountable,” said attorney Stuart Grant of Grant & Eisenhofer, one of four law firms representing public employee pension funds and other Delphi investors in the class action suit.
There’s another interesting aspect to Mr. Difazio’s testimony. Deloitte, as you know, was auditor for both Delphi and GM until the end of 2005. (Delphi switched to Ernst & Young in 2006. Deloitte remains GM auditor.) The warranty/pension expense transaction is another example of a transaction treated differently in two public companies audited by the same auditor. I’ve written about that issue with regard to PwC presiding over the long running dispute between their two clients, AIG and Goldman Sachs, over the valuation of credit default swaps. I wrote about it again last week in reference to two public companies in litigation with each other and their corresponding litigation disclosures.
The former Delphi General Counsel testified, under oath, that Deloitte, the firm, knew that the two companies were treating the transaction differently and blessed this subterfuge.
“Deloitte & Touche knew intimately what was going on, on both sides of this transaction,” former Delphi general counsel Logan Robinson testified yesterday. “They fully supported it.”
Mr. Difazio rationalizes that.
Difazio said it’s not unusual for two companies to account for the same transaction differently.
Does that sound right to you when we’re talking about GM and its spawn, Delphi?
Delphi and GM have an up close and personal relationship. GM’s audit team probably provides the training ground for Delphi’s audit team. Both engagement teams belong to the Automotive practice group at Deloitte and operate out of the same geographic area. Just like in the PwC relationship with AIG and Goldman Sachs, it defies credulity that the team leadership wouldn’t talk to each other and to their industry experts about approach, methodology, and proper GAAP. In fact, it’s required by their audit methodology and audit risk management policies.
I’ll be writing more about this issue in future posts.
Main photo from this site.