E&Y: Repeat Offender?

FDIC sues E&Y for $2 billion; claims auditor has 11-year pattern of failing to adhere to audit standards. Plus: Pitt on thin ice, Cigna under the microscope, and what's going on at Marriott?


Generally speaking, it doesn’t make a whole lot of sense to sue somebody who doesn’t have any money.

Hence, it was not overly surprising when the Federal Deposit Insurance Corp. (FDIC) announced last week it will not be suing Superior Bank FSB, which went bust last year. Instead, the FDIC filed a $2 billion suit against Superior’s independent accountant, Ernst & Young, for the firm’s role in the bank’s insolvency—the fourth-largest bank failure since 1992.

According to published reports, the suit claims the fourth-largest accounting firm committed fraud, accounting malpractice, and gross negligence in its reports of Superior’s finances.

E&Y “was required to make full disclosure to the FDIC about Superior’s deteriorating financial condition,” the FDIC reportedly said in its complaint.

The complaint alleges that E&Y did not fully disclose Superior’s problems because, at the time, the consultancy was in negotiations to sell its consulting business for $11 billion, according to Bloomberg. Any bad press stemming from Superior may have affected—or even scuttled—those negotiations, the suit alleges.

Specifically, the FDIC claims Superior and E&Y did not properly account for the value of bank bonds secured by high-risk, high-interest loans, the wire service reported. The suit reportedly claims that during the past 11 years E&Y “has engaged in a pattern of repeatedly failing to adhere to established accounting and auditing standards.”

This was not E&Y’s only setback last week.

The auditor also failed to get a postponement in the inquiry by the Accountants Joint Disciplinary Board, which regulates accountants in the United Kingdom, of the firm’s handling of Equitable Life Assurance Society. The British insurer, which almost collapsed, has sued E&Y for negligence and is seeking $4 billion in damages.

In yet another matter, securities regulators are considering civil charges against three auditors at E&Y in connection with accounting irregularities that cost Cendant Corp. $3.2 billion. This according to Bloomberg, citing lawyers close to the case.

The wire service said the Securities and Exchange Commission sent Wells notices to the three auditors—Marc Rabinowitz, Ken Wilchfort, and Simon Wood.

The three individuals audited the financials at CUC International Corp., which merged with HFS Inc. in 1997 to form Cendant.

Bloomberg added that E&Y and Cendant are not targets of the investigation.

E&Y has already paid $335 million to resolve Cendant-related shareholder lawsuits, while Cendant has agreed to pay shareholders $3.2 billion in cash and stock.

Pitt Stop?

Will Harvey Pitt last out the week as SEC chairman?

Hard to say, considering the firestorm touched off last week by press reports that Pitt apparently hid critical information about William Webster, the newly elected head of the Public Company Accounting Oversight Board (PCAOB). Pitt reportedly favored Webster over shareholder-rights activist John Biggs to head up the PCAOB. Webster was selected by the commission in a vote last month.

According to Reuters, the Bush Administration is seriously mulling whether to oust Pitt this week. Other press accounts indicate the White House will hold off dumping Pitt until after Tuesday’s election.

“I don’t think asking [Pitt] to go is as easy a choice for the White House as everybody is making it out to be,” a Republican congressional source told the wire service. “It does look extremely difficult for him, but the White House has to look at realistic alternatives and it will be a tough decision for them after the elections.”

Webster on Sunday told ft.com that if the controversy surrounding his appointment hindered the board’s work, he would consider resigning.

“I’d like to wait and see what’s going to happen over the next few days,” Webster told the Web site for the Financial Times. “My main concern is that the new board is able to begin its work. I have to make a judgment whether my presence will help or hinder that objective.”

Dow Jones reported Friday that House Financial Services Committee chairman Michael Oxley (R-Ohio) said he has seen no evidence so far to contradict the original conclusion of the SEC that Webster is the right man to chair the new accounting oversight board.

In a statement, Oxley said the issues surrounding Webster’s service as a director—and chairman of the audit committee—at US Technologies “are being addressed in a forthright and reasoned way.” US Technologies, a Washington, D.C.-based investment fund, has been accused of fraud.

Meanwhile, Bloomberg reported that the SEC has expanded its review of Webster’s selection to include his work on the audit committee of US Technologies.

This investigation, led by the SEC’s top lawyer, is in addition to the SEC inspector-general inquiry announced Friday. That probe is reportedly examining how the choice of Webster was made by Pitt and other SEC officials.

More Scandals

Maybe it’s the new requirement that top corporate executives certify their financials. Or maybe Wall Street analysts are now being encouraged—and perhaps rewarded—for issuing sell recommendations. Or maybe short-sellers, buoyed by huge gains for nearly three years, are devoting more resources to uncovering accounting shenanigans.

Whatever the reason, the number of accounting scandals continues to mount. Last week there were more suspected accounting irregularities than there were people calling for Harvey Pitt’s resignation.

On Thursday and Friday alone, new accounting controversies cropped up at Cigna, Lucent Technologies, and Marriott International.

Cigna, the insurance giant, reported an $877 million loss for the third quarter, citing shortfalls in its health-care business. The insurer also announced that the SEC has opened an informal inquiry into that loss. The company’s management said it will “cooperate fully” with the inquiry.

As CFO.com reported during the past two weeks, on October 23, Cigna CFO James G. Stewart announced he is retiring after spending 36 years with the company, 19 as chief financial officer.

Shortly afterward, Cigna warned that earnings for the third quarter and all of 2002 will come in lower than previous company guidance.

The day after that warning, Cigna indicated that operating income for 2003 will be below forecasts. That announcement resulted in a 38 percent decline in the company’s share price.

As a result, law firm Milberg Weiss Bershad Hynes & Lerach LLP filed a class-action suit against Cigna, chairman H. Edward Hanway, chief accounting officer James A. Sears, and Stewart, alleging they issued “a series of materially false and misleading statements” May 2, 2001, and October 24, 2002.

Lucent’s Latest Woes

Meanwhile, things are looking bleak at Lucent Technologies.

On Friday, the Wall Street Journal reported that federal regulators are investigating possible earnings manipulations at the telecom-equipment maker going back as far as the mid-1990s.

In addition the SEC is trying to determine whether any current or former Lucent board members were aware of accounting violations at the company while they took place, according to the paper. That list of past and present directors includes current Treasury Secretary Paul O’Neill.

The Journal said Lucent officials denied any knowledge that an investigation has widened and called the report old news.

Spokeswoman Mary Lou Ambrus told Reuters that Lucent reported its revenue-recognition problems in November 2000, and revised fiscal 2000 fourth-quarter sales by $679 million a month later.

“We have no reason to believe the SEC has expanded its investigation,” she told the wire service. “In our conversations with the SEC [on Thursday], they have told us they are close to completing their two-year investigation. We look forward to the SEC conclusions and putting this matter behind us.”

Last Friday, USA Today reported the SEC is looking into whether Lucent used aggressive accounting in 1999 and 2000 to inflate sales numbers. The commission apparently plans to send the company a Wells notice within a few days. Such a notice indicates the SEC is likely to bring charges against a company.

According to Friday’s Journal story, the SEC is looking into whether Lucent overstated earnings going as far back as 1996, when it was spun off by AT&T Corp.

Questions Raised about Marriott

Major companies are not just feeling the heat from regulators and politicians; these days investors are also closely scrutinizing the income statements and balance sheets of publicly traded companies—particularly those with complex financials.

For example, a number of Wall Streeters are questioning CBM Joint Venture LLC, one of Marriott International’s off-balance-sheet entities. That venture contributes a substantial slice of the hotel management company’s earnings, according to Friday’s New York Times.

The reason investors are delving deeper: CBM’s largest unit, Courtyard by Marriott II LP, said in a recent regulatory filing that it would not make cash payments for various fees to the owners of CBM (which include Marriott) for at least the fourth quarter, said the paper. Management at Courtyard by Marriott II also said it might defer interest payments to Marriott on a $200 million loan made to CBM, theTimes added.

The paper explained the moves are intended to help Courtyard by Marriott II save money so it can pay its nearly $436 million in debts.

Marriott and Host Marriott, a separate, publicly traded hotel company, are partners in CBM. Host owns the 120 hotels, and Marriott manages the properties.

The paper pointed out that Goldman Sachs analyst Steven Kent recently wrote in a research note that with CBM, Marriott may be setting itself up “to take a charge down the road.”

The paper said Marriott chief financial officer Arne M. Sorenson responded that these concerns were exaggerated. When asked by the reporter whether Marriott might take a charge against CBM, he reportedly said: “No, the chances are nearly nil.”

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