If you’ve been reading me for a while, you know that I pretty much stick to discussing the largest 4 audit/accounting firms.  This is for practical reasons – keeping my sanity in dealing with so much information –  and to be realistic. Put the three next tier firms in the US together and they don’t equal either the critical mass in terms of experience and infrastructure nor the client/revenue base of any one of the Big 4.  They will never, either individually or collectively, be able to step up and absorb the detritus from another Big 4 firm failure, either in the US or out.  

That doesn’t mean the next tier don’t serve the clients they have well.  Mostly.  Just means that the next tier are not ready to play in the same pitch as Cristiano Ronaldo. (Front page photo/Portuguese.)

Or even Ronaldinho. (Brazilian)  (Pictured here with Ronaldo the Brazilian)

And this conclusion is drawn before you consider the considerable litigation threats each one faces.  RSM and Grant Thornton both have Madoff exposure and Grant Thornton also has Refco.   And BDO, well, in addition to Madoff exposure, there’s the BDO International litigation and the judgement against BDO Seidman US for Banco Espirito Santo.  You’ve heard of zombie banks?  Well, BDO in the US, at least, and potentially overall if the case against BDO International is also won, is a zombie audit firm.

So I’m constantly amazed to find Grant Thornton’s CEO Ed Nusbaum acting as the designated spokesboy for the accounting industry. He probably drew the short straw at the last Center For Audit Quality back room with cigars and cognac pow-wow.  And I’m incredulous to see Jeremy Newman of BDO International still huffing and puffing a seemingly progressive and transparent patter with whomever will interview him.

Now, that’s no slight to my friend Dennis Howlett.  I was genuinely chuffed to see Newman post a comment to Dennis’ blog. Dennis blogged about Newman’s “candid” admissions in his Huffington Post blog post regarding the auditors and mark-to-market accounting. 

“It is easy to look at the details of the accounts with hindsight and see how banks results were boosted by certain transactions. The transparency required by current accounting standards ensures we can see how banks were affected by increases in the market values of financial assets. However, it seems no-one realized the fragility of the markets in such securities. When problems first emerged in the sub-prime debt market, no-one was prepared to recognize the scale of the impact. In reality, we all looked for reasons why the problem would not be contagious.

Should accountants and auditors have identified these issues? Should regulators have realized the vulnerability of banks’ capital and reserves? Should governments have recognized that a problem in one bank would affect others? The answer to all these questions is “probably.” We believed that real value was being created by these new financial instruments and wanted to believe that the “good times” were here to stay…”

My comment in Dennis’ original post responds to this Pollyanna-ish pronouncement.

“Unfortunately, I don’t agree that any of the Big 6 firms are “recovering” from the intoxication with good times at all. All you have to do is observe closely, which I am, all the reductions in force and other cost cutting moves they’re making because of the way they say they indulged themselves with too many resources and overhead during the good times.

Although I value the candour exhibited by that emphatic “probably,” I’m less ecstatic about the firms’ complicity in the creative accounting we are seeing at Citigroup, for example…

Inspired by Mr. Newman’s seeming desire for a conversation, Dennis grabbed the bull by the horns, or the CA by the short-hairs, and asked for a meeting.  And he got it.

I helped him draw up some questions and was excited for him.

On May 15th Dennis interviewed Mr. Newman in London and tells us he spent two hours shooting the bull with Newman, a man he already admired for his candor. His post, Jeremy Newman, The Cautious Maverick, begins with some flattery. 

“I also had the sense I’d be meeting a person willing to speak with passion for a profession that I and others believe needs to change. It is perhaps a reflection of the liveliness of our discussion that what was meant to be a one hour meeting turned into nearly two hours of debate that only ended because we each had other things to conclude that day…”

To Dennis’ credit, his first question is the toughest one:  What of the BDO franchise?

In light of the crippling Banco Espirito Santo judgement against their US firm and the impending trial for BDO International to determine their culpability in this case, I’ve said BDO US is already dead.

“He was unequivocal: “It will be dealt with and we’ll move on. And no, we’re not at any risk.” I have no reason to disbelieve him…”

Well,  I have 521 million reasons to disbelieve him.  That’s the number of millions BDO has to pay. It’s already been adjudicated in the BDO Seidman vs. Banco Espirito Santo case.  They lost.  They’re hanging on by the thread of a desperate appeal. At the time of the judgement in August of 2007, a mere two years ago, mandatory discovery revealed that they could not pay it.  It would break them.

Jury Awards Rise Against BDO Seidman 
“A jury on Tuesday ordered the accounting firm BDO Seidman to pay more than $351 million in punitive damages in a negligence case, bringing BDO’s potential liability in the case to roughly $521 million, an amount the chief executive said threatens its operations.
The Florida jury had found BDO negligent for failing to find extensive fraud in its audits of a financial services company backed by a Portuguese bank. The amount will be added to the same jury’s award of $170 million in compensation to the bank, Banco Espírito Santo.”

`Big Problem’

““The big problem is a single case can bring down a big firm,” University of Georgia Professor Dennis Beresford said. Firms such as BDO Seidman typically distribute most of their profit to partners each year, leaving little in reserve for large legal judgments, said Beresford, a former chairman of the Financial Accounting Standards Board. ”

So what’s changed in two years?  Has BDO, in this period of pre-recession and recession, sold enough profitable services, asked partners for more capital, and begged, borrowed, or worse enough to cover the judgement if they lose on appeal?  Given the lack of transparency of all the audit firms with regard to actual profits and reserves for such contingencies, it’s hard to know for sure.  

In the year ending June 30, 2008, BDO’s US firm had revenues of $659 million and claims 81 percent cumulative growth over the past three years (2005-2008). But how much profit?  The profit margin for the year ended 2007 was 30%. If the numbers are accurate, how much could they have set aside since?  Would you lend money to an accounting firm to pay a judgement? 

“Jurors were given financial statements indicating Chicago-based BDO made a $176 million profit last year after collecting $526 million in revenue, up 25 percent over the previous year.

BDO chief executive officer Jack Weisbaum testified the firm has about 2,800 employees and its 250 partners made $131 million in total compensation last year.

“The company couldn’t pay punitive damages. We certainly wouldn’t look the way we do now,” he said. 

Back in February, after being granted the umpteenth BDO International requested delay in the case which is due to start May 26th in Miami, Mr. Newman was much less effusive:

BDO International’s defence has always centred on the fact that the umbrella body only has 10 employees and the audits conducted by member firms are done independently. BDO International has said it has no control over its audits and should therefore not be held responsible.

Jeremy Newman the CEO of BDO International would not comment on the issue.

Mr. Newman: I dare say, you’re bluffing.

Photo credits here and here.

Jeremy Newman the CEO of BDO International would not comment on the issue.

Not so long ago, Dennis Howlett and I went public with a bet:  

Which Big 4 audit firm is the next to fail?

This may seem like a dead pool – a quite depressing and morbid fascination with something that will add pain and misfortune to so many.  I have been accused of being so totally negative that I strain credibility.  After all, isn’t there anything good to say about any of the firms?  

Isn’t some audit failure natural? Isn’t some error and omission in the audit process the result of a rational cost/benefit formula at work – one that determines how much more testing, sampling, investigation, questioning, and verification work should be done to reduce risk of material misstatement to an “acceptable” level?

Isn’t everyone cutting staff in this recession? Why can’t the audit firms run a business like any other capitalist and make a profit? Why are auditors any more responsible for the public interest than lawyers?

Aren’t plaintiffs’ lawyers too aggressive and going after audit firms only because they have “deep pockets” ? Aren’t auditors responsible only for certifying based on what management tells them? Can anyone hold them responsible if they were “duped” by bad guys? 

The litany of crybaby defenses goes on and on.

Frankly, it’s getting a little tedious.

Let’s face facts. Dennis may be right.  It may be EY that’s next.  

Even before the conviction this week of four current and former partners of Ernst & Young for criminal tax fraud involving tax shelters, EY had a bundle of other trouble.  They were the auditors of Lehman Brothers and are being sued for their role in that failure. They have Madoff exposure.  They are also co-auditors for Societe Generale and auditor for UBS – two problem children, for sure. There is speculation about EY in other quarters, and although I don’t agree with their reasoning, the conclusion is the same.

Dennis believes that I’m betting on PwC as next to fail.  I don’t honestly remember committing to that, but I’m willing to go with it for the sake of argument.  This is in spite of the fact that the other Big 4 have plenty to worry about and the next tier firms are in no way ready for prime time.  Wishful thinking that BDO can somehow win their appeal in the Banco Espiritu Santo case, that Grant Thornton won’t get hurt by Refco, or that McGladrey is innocent in the Sentinel case is trumped by the fact all have additional exposure to Madoff.

KPMG, of course, has New Century, Anglo Irish Bank, Citi, Siemens, and others.

Deloitte, well, too many to count. And the Parmalat case is a potential model changer. And a very embarrassing insider trading scandal. Then there’s the loser consulting gigs and a declining demand for consulting, all of which makes for never ending cuts and a not so rosy outlook.

And yet, for my money, PwC is still the closest to the precipice, if only now because of Satyam.

Think about it.  It’s their third strike (at least that we know of) internationally after Japan and Moscow.  Two of their Indian partners, for God’s sake, are still in jail – thrown to the prosecutorial sharks by the Indian Central Bureau of Investigations. The Chairman (soon to be retired ) of Pricewaterhouse International Limited, Sam DiPiazza, has pulled out all stops in investigating what occurred in India, sending US and other professionals to “assist” colleagues in India with comprehensive audit quality reviews, and personally meeting with Indian government officials and others worldwide to try to repair the “lost trust.”

And then there’s PwC’s Madoff exposure.  

And the lawsuit for wage and hour violations in California that they’ve already lost on the facts but are vigorously appealing. They completely flubbed the administrative responsibility test in this case and will lose the licensing argument.  Why?  Because the fear mongering they’re trying to stir up through proxies (there have been friend of the court briefs filed by business organizations sympathetic to PwC) are just that. Empty threats. The law firms have nothing to be afraid of if audit firms are required to pay overtime to not-yet-licensed associates. The law firms exposure is minimal.  After all, you pass the bar and are a licensed attorney in most states by late fall of the year you graduate.  Most law firms don’t tolerate a delay or a failure to pass the bar the first try, especially for top graduates. Contrast this to the audit firms. You can work for five to seven years, eighty hours a week during busy season, before making Manager level, the typical cutoff for future promotions without a CPA.  

And there are still questions lingering over their role in Northern Rock. And their forays into gambling audit have not been so successful all the while they’re advising the US to open up online gambling in order to reap the tax revenues.

The rumbling has also started in the comments on this blog over PwC’s stealth “reductions in force” and their broken promises over start dates and starting salaries to graduates. It’s fully expected that additional staff cuts will come soon and be of such a volume that it will be hard to hide behind the “didn’t fit with our performance culture” excuse.  

Finally, there’s the strategically disastrous purchase of BearingPoint’s Commercial Services practice.  Sources tell me due diligence has been non-existent, it’s solely an ego-trip for current leadership, and there’s a shell game going on in public statements regarding their interest in full blown systems integration services. The probability that  integration of the operations, financials, staff and infrastructure will be smooth and trouble-free is in the low single digits.

Yep.  Of the Big 4, my bet is with PwC US to fail in the next twenty-four months.

Photo Source

“A friend recalled this scene from decades ago: The president of a small Orthodox synagogue in New York had apparently absconded with about $2 million from the congregation, a huge sum in those days. But since he had not yet been formally charged or arrested, he was free to attend Shabbat services. Which he did.

Seeing the alleged scoundrel, another man — a Holocaust survivor — rose and faced his fellow congregants, banged on the bimah table and demanded a judgment from the rabbi before the Torah portion was chanted. “In America, if you are willing to work hard, you can earn a living,” the man said angrily. “You don’t have to steal!”

…there is a gnawing temptation to subject Bernard Madoff to such a ceremony, to publicly point the finger on behalf of the family members, friends, rabbis, business partners, communal leaders and untold numbers of ordinary folk whose lives and good causes have been permanently disrupted by his audacious, unfathomable deceit and say: You didn’t have to steal! You didn’t have to steal from us, your people!…”

What’s worse is that those who should be the guardians of the public trust and watchdogs for those who can not watch for themselves were, in the words of one source today, “…either complicit, incompetent or duped.” None of these conclusions is very appetizing.

From the Jewish Daily Forward again:

“…Any doubt that the proper regulatory function of the federal government was stripped bare and impotent during the Bush administration should now be laid to rest. Even the chairman of the Securities Exchange Commission had to acknowledge that his agency was shamefully asleep at the wheel. Congress, too, must work swiftly to undo the mess it helped create on its sprint to deregulate too many sectors of the economy that clearly cannot be left to guard their own hen houses.”

Within the last forty eight hours or so, at least four lawsuits have been brought against audit firms by clients of so called “feeder funds” that invested in Madoff funds.

From The Financial Times:

Top accounting firms were hoodwinked by Bernard Madoff’s alleged $50bn fraud as well as several leading banks and some of the world’s biggest hedge fund investors, according to lists of service providers to Madoff-linked funds.

PwC, KPMG and Ernst & Young, three of the “big four” accountants, and an arm of BDO International, the fifth largest, were all auditors of the feeder funds which channelled money into accounts at Mr Madoff’s New York brokerage.

The New York Law School became the first Madoff victim to target an accountant this week when it named BDO Seidman in a lawsuit alongside Ezra Merkin and his Ascot Partners fund, which invested almost all its money with Madoff and was audited by BDO.

PwC was auditor of Fairfield Sentry, the $7.3bn feeder fund run by New York-based Fairfield Greenwich; of Kingate Global, a $2.75bn feeder fund run by London’s FIM Advisors; and of Gibraltar-based Reliance Management’s $488m Defender fund.

KPMG audited two of Tremont Group’s Rye Select funds, which had $2.37bn invested with Mr Madoff. Other Tremont funds also invested with Mr Madoff, giving clients of the the New York-based manager a total exposure of $3.3bn, according to people familiar with the situation.

Ernst & Young audited at least four feeder funds. Two of them with $2.5bn are from Herald Asset Management, linked to Vienna’s Bank Medici, which is part-owned by Unicredit of Italy. The other two funds with $870m are managed by Pioneer Alternative Investments, a Unicredit subsidiary.

Fairfield itself is now considering suing PwC…”

I laughed out loud when a Google Alert pointed me to the FT article excerpted below. 

BDO Consulting Forms Corporate Advisory Practice

BDO Consulting, a division of BDO Seidman, LLP, announced the formation of BDO Consulting Corporate Advisors. The practice will provide strategic and financial consulting services to companies in distress…

BDO International could be a “credible challenger” to the Big 4 accounting firms, according to its new head. Jeremy Newman, newly appointed chief executive of the company, told the Financial Times that he sees a large opportunity in the market but that becoming a fifth tier to the dominating Big 4 “would be a sign of failure”.

“Being a credible alternative doesn’t mean being the same. There’s no doubt the Big 4 are essentially global corporations driven out of head offices. We’re more adapted to the local market,” he said.

…BDO …has over 600 offices in 100 countries.

You’ve got to wonder what this guy is smoking…The FT article goes on to quote Mr. Newman, “…there are invisible barriers to entry to the market for top-level company audits (for the non-Big 4).” The article also states, “In the UK, for example, all the FTSE 100 are audited by the Big Four and only eight of the FTSE 250 are non-Big Four, shared between BDO Stoy Hayward and Grant Thornton, its biggest rival.”

Recent UK research by BDO Stoy Hayward showed nearly half of investors would be concerned if a company switched to a non-Big Four auditor and a third would review their investment decisions. But of those with concerns, a quarter were unable to say why and a third could only cite lack of reputation.

“A lot of these perceptions are based on assumptions that have been there a long time,” said Mr Newman. “We’ve managed to displace those in the UK and the US…”

Why would the FT print such incredible crap? It’s PR, not news. Where’s the critique? That sounds like some good reasons for lack of credibility. I’m not sure the US firm will be much help to BDO International or that anyone has displaced those concerns here. On the contrary, the statistics and their reputation are not much better with US based companies.

Per Ames Research Group International:

BDO Seidman US Marketshare
With BDO Seidman’s future in the US audit market now the subject much speculation and discussion, it might be useful to look just how big their US marketshare is.

BDO Seidman audits approximately 305 US-based “public” companies—meaning they file a 10K with the SEC. Not all of that number are currently trading. Furthermore, this excludes mutual funds and benefit plan audits. By that measure, BDO Seidman is the the 2nd largest 2nd tier firm, behind Grant Thornton with about 50 more clients.

KPMG is the closest Big Four firm, with almost 3 times more clients.

For another view on why the next-tier firms are “not ready for prime time“, go to Jim Peterson at the IHT.

In June of 2006, the last time this report was published in this form by Compliance Week, the statistics were startling.

This Internal Control Report Scorecard, developed by Compliance Week, tracks the “Pass/Fail” grades of public companies on Section 404 of The Sarbanes-Oxley Act of 2002. The data are from the 10-Ks of the Russell 3000, and are derived from the section titled: Report of Independent Registered Public Accounting Firm.
The Big Four

Deloitte & Touche, LLP
10-Ks Audited 488
10-Ks Passed 442 Percent Passed 90.57%
10-Ks Failed 46 Percent Failed 9.43%

Ernst & Young, LLP
10-Ks Audited 756
10-Ks Passed 708 Percent Passed 93.65%
10-Ks Failed 48 Percent Failed 6.35%

KPMG, LLP
10-Ks Audited 530
10-Ks Passed 484 Percent Passed 91.32%
10-Ks Failed 46 Percent Failed 8.68%

PricewaterhouseCoopers, LLP
10-Ks Audited 618
10-Ks Passed 571 Percent Passed 92.39%
10-Ks Failed 47 Percent Failed 7.61%

All Big Four
10-Ks Audited 2392
10-Ks Passed 2205 Percent Passed 92.18%
10-Ks Failed 187 Percent Failed 7.82%

The “Second Six”
BDO Seidman, LLP
10-Ks Audited 57
10-Ks Passed 44 Percent Passed 77.19%
10-Ks Failed 13 Percent Failed 22.81%

BKD, LLP
10-Ks Audited 4
10-Ks Passed 3 Percent Passed 75.00%
10-Ks Failed 1 Percent Failed 25.00%

Crowe, Chizek & Company, LLC
10-Ks Audited 9
10-Ks Passed 8 Percent Passed 88.89%
10-Ks Failed 1 Percent Failed 11.11%

Grant Thornton, LLP
10-Ks Audited 57
10-Ks Passed 44 Percent Passed 77.19%
10-Ks Failed 13 Percent Failed 22.81%

McGladrey & Pullen, LLP
10-Ks Audited 8
10-Ks Passed 8 Percent Passed 100.00%
10-Ks Failed 0 Percent Failed 0.00%

Moss Adams, LLP
10-Ks Audited 4
10-Ks Passed 4 Percent Passed 100.00%
10-Ks Failed 0 Percent Failed 0.00%

All “Second Six”
10-Ks Audited 139
10-Ks Passed 111 Percent Passed 79.90%
10-Ks Failed 28 Percent Failed 20.10%

A little while ago, after writing about the BDO litigation, I received an email from someone who had quite a bit of information and very strong opinions about the issues in that case.

That person also told me about the suicide of one of the BDO partners involved in the case at an earlier stage. After writing about the litigation, I started to see Google Searches looking for more info on the “BDO executive suicide,” including daily ones for a while by someone at the US State Department. Makes you wonder…

Then yesterday, as a result of my writing about the Siemens bribery scandal and perhaps as a result of the link from The Daily Caveat, I received this email:

“I found your blog last week while investigating/researching a related matter. Your discussions regarding Siemens accounting issues are compelling reading. Were you aware that Siemens is extensively involved with Nokia and that they have various joint ventures such as Nokia Siemens Networks?

Nokia’s head of legal was killed last week. Apparently he accidentally fell off a balcony at a Swiss hotel and this news seems to be getting suppressed and or very little attention in the press. The man’s name is Carl Belding. I find the Belding story to be VERY odd. How many grown men of significant business stature “accidentally” fall off a balcony to their death in the country known for it’s financial anonymity??”

We have continued to correspond, as the writer, who is a “significant investor in Qualcomm” seems to think I can help to identify and bring additional exposure to what he believes is “Nokia management that is boastful, bordering on arrogant, abusive and less than forthright in their public pronunciations regarding their current legal status and negotiations with Qualcomm. I believe their “negotiating position” in these matters is perhaps not as favorable as they have lead their investors to believe, and that an unfavorable (for Nokia that is settlement with Qualcomm will take place within the next 12 months.”

Well, this is heady stuff for me. Far be it for me to get involved in such a nasty dispute and the potential it has for negative impact all the way around. And my interest is the Big 4.

So what’s the hook?

Well, with a hunch and a little digging, it was easy to put one obvious connection on the list of co-winky-dinks:

PwC is the auditor for both Nokia and Qualcomm.

So what you say? Well, interestingly enough, Siemens’ new Chief Auditor, the one they just announced in their latest shakeup and attempt to prove they are doing something about their mess, is Hans Winters, a current partner at PwC who will take the job as soon as he severs that relationship…

Ok, so there are only so many poor schmucks who would take the job of Chief Auditor at Siemens right now. It had to be a guy who thinks it might be fun to go from the frying pan that is PwC Netherlands into the fire at Siemens.

But still, who cares?

Well, Nokia and Siemens have just entered into a joint venture which is more like an Enron SPV in its insularity. There are only Siemens or Nokia executives on its Board, even though it racked up Euro 3.4 billion in sales for the 2nd quarter of 2007, its first in business.

It had a rather inauspicious start-up.

“The second quarter 2007 was the first quarter of operations for Nokia Siemens Networks. Net sales were negatively impacted primarily by competition related issues as the price competition in the infrastructure market was unusually aggressive. Net sales were also impacted by challenges related to the start of operations, including delayed purchases by customers to a greater extent than expected, increased management focus on integration, and implementation of the previously announced compliance program, which also required certain management attention.

Nokia Siemens Networks second quarter operating profit was negative EUR 1.3 billion, with an operating margin of -36.8%. The reported second quarter 2007 operating profit included a charge of EUR 905 million related to Nokia Siemens Networks restructuring costs and other one time charges. The operating profit for the second quarter 2007, excluding these charges, was negative EUR 361 million,with an operating margin of -10.5%…”

Back to the poor guy, Mr. Belding, Nokia’s General Counsel, who “fell off the balcony”. Mr. Belding joined Nokia at the beginning of 2006 after 20 years as IBM’s VP and General Counsel for Europe, Middle East and Asia.

Any guess who is IBM’s auditor? Righto! PwC!

Nokia is currently in some heated litigation with Qualcomm over licensing of patents for WCDMA technology, very high stakes, very serious stuff. Mr Belding was the point person on this litigation.

On the other side, Qualcomm has had some turnover in their General Counsel’s seat.

Qualcomm, the second-biggest maker of chips that run mobile phones after Texas Instruments, named Donald Rosenberg, the outgoing general counsel of Apple, as its new top lawyer.

Rosenberg, who will join Qualcomm on Oct. 8, was previously general counsel at International Business Machines.

So, Mr. Rosenberg, the new GC at Qualcomm, arch rival in litigation with Nokia, was Mr. Belding’s boss at IBM!

So why did Mr. Belding “fall off a balcony” in Switzerland?

Is it because he had confided in Mr Rosenberg about either the Qualcomm litigation or some other issue at Nokia and/or Nokia Siemens Networks before Rosenberg took the job and now could not face him as an opponent?

Was it because Belding was mixed up in something with Nokia Siemens Networks that has something to do with Siemens usual business practices? Too much to bear…

Maybe it has something to do with the Enron style conflict of Mr Belding signing SEC disclosures for the business dealings between Nokia and the Nokia Siemens Network entity as both GC of Nokia and GC of the joint venture?

Or does it have something to do with a woman? This woman, a former communications consultant to Mr. Belding at IBM, was so fortunate to have him write a glowing endorsement of her book and includes Mr. Belding as a personal reference on her CV?

As far as PwC, their fingerprints are all over this story. It’s interesting to read the disclosures or lack thereof in both Nokia’s and Qualcomm’s Annual Reports about their pending litigation. Both reports have almost the word for word, exact same text that basically, in following FAS 5 says that there is no reserve and no disclosure necessary. How does it work when an audit firm is on all sides of such heated litigation?

$19M deal struck to settle Suprema suit
The former auditor of failed cheese company Suprema Specialties and several others will pay $19 million to settle a class action lawsuit that alleged they should have known about a massive fraud that doomed the business.

Accounting firm BDO Seidman, as well as several former Suprema board members and underwriters, signed a memorandum of understanding following more than a year of mediation, according to a letter submitted to a federal judge last week by a plaintiff’s attorney.

Attorney Eric Kanefsky wrote he expects the parties to sign a stipulation of settlement within the next few weeks. Along with BDO, the settling parties are former board members Rudolph Acosta Jr., Paul Desocio and Barry Rutcofsky, and underwriters Janney Montgomery Scott, Pacific Growth Equities and Roth Capital Partners.

The securities class action case has been pending since early 2002, when Paterson-based Suprema evolved from a high-flying public company to one raided by the FBI and bankrupt. Since then, federal prosecutors have secured six guilty pleas and two convictions against former employees or customers who participated in the scheme…

This is an interesting case, profiled in the WSJ Law Blog a while back. Unfortunately, the “I was duped” defense didn’t cut it for BDO in this case.

The company, whose former stock symbol was CHEZ, was liquidated after its two top executives were charged in an indictment alleging they orchestrated a massive fraud involving millions of dollars in fictitious cheese sales…The Third Circuit opinion was particularly critical of Suprema’s auditor, BDO Seidman: “The accounting violations set forth here surpass an inference of ordinary negligence; they reasonably suggest that BDO either knew of, or willfully turned a blind eye to, the fraud at Suprema.” But the court also hastened to add that there could be validity to the auditor’s claim that it too was a victim of fraud. BDO attorney Ira Greenberg told the Star-Ledger that while he was disappointed with the ruling, “we will defend the case vigorously.”

I’ve heard that BDO has already asked their partners to dip into their own pockets for the $50m bond that was posted in the BES case. They can’t possibly have had any significant insurance coverage say my sources, and the event may not have been covered. Did they report the claim on a timely basis? I’ve also heard that they have the audacity to be considering some kind of public offering or other type of solicitation for outside capital to fund the judgement and punitive damages award.

It isn’t unprecedented for partnerships to raise outside capital to fund ongoing operations or acquisitions. A law firm in Australia did it, traditional partnership-model investments banks like Goldman Sachs did it, and even “private” equity firms are doing it. Finally, all the Big 4 plus Andersen did it by selling off their consulting arms. However, the efficacy of this strategy for a public accounting firm of any significance has already been exposed as a myth, by a preeminent expert. And who in their right mind would give them money for any piece of the business if those funds are intended to go directly to pay a legal settlement. Not in this credit environment…

Where is the PCAOB in all this? When are they going to tell the firms it’s time to open their books and let us all know their overall financial exposure to ongoing litigation, where they’re going to get the money to fund the settlements, (hopefully not someone from some guys whose last name ends in a vowel,) and the approach they use to estimate the necessary reserves? That kind of transparency, the type they enforce on their clients, doesn’t seem to hurt their clients’ chances when going to court. There’s really no excuse.