Judge Keeps E&Y Papers Private

A bankruptcy court judge rules that potentially damaging documents against the Big Four firm won't be made public. Separately, E&Y prevails in a shareholder class-action case that questioned its audit of Clarent Corp.

A bankruptcy court judge ruled last week to keep documents that could be damaging to Ernst & Young from becoming part of the public record in a securities class-action lawsuit, the Associated Press reported.

The decision, handed down by U.S. Bankruptcy Court Judge Patricia Williams stems from a case charging that E&Y was negligent in its audit of the now bankrupt Metropolitan Mortgage & Securities.

Met Mortgage, which filed for bankruptcy in March 2004, was at one time a $2 billion financial conglomerate. Currently it owes 16,000 creditors $580 million.

P.J. Grabicki, an attorney representing Met Mortgage creditors, told the newswire that the decision means that the bankruptcy trustee must spend more time and money to obtain the documents, which could increase the creditors’ claims against E&Y.

Jim Clanton, who heads the creditors’ committee in the case, stressed that the documents would bolster charges that E&Y knew about questionable business dealings at Met Mortgage and “had an obligation to stop them,” AP reported.

Before the judge made a decision to keep the E&Y papers private, the documents were reviewed by court-appointed examiners. The examiners noted that E&Y and other companies may have played a role in Met Mortgage’s “dubious accounting methods,” according the newswire.

Because the E&Y documents were initially turned over to the Securities and Exchange Commission as part of a broader investigation, they were deemed private by E&Y. Lori Lynn Phillips, an attorney representing the audit firm, urged creditors to use traditional discovery instead of relying on documents given to the examiner by the SEC to support their charge, AP reported.

In her decision, Judge Williams noted that turning over the documents would have had a “chilling effect” on future bankruptcy examinations and SEC investigations, according to AP.

Separately, E&Y prevailed in a shareholder class-action suit that questioned its audit of Clarent Corp., a computer networking company based in Redwood, Calif. A unanimous, nine-person jury found that the audit firm wasn’t liable for any fraud that occurred at Clarent.

The case, held in a Northern District of California court, was filed by shareholders after accounting irregularities were discovered at Clarent in 2001, according to The Reporter, a legal journal.

Clarent allegedly overstated revenue by $130 million, and shareholders sued the company and its corporate officers. But the proceedings were stayed after the company filed for bankruptcy in December 2002.

E&Y and Cooley Godward, a law firm, were pulled into the case in 2003. Former Cooley partner Deborah Ludewig had served as Clarent’s corporate counsel. The shareholders claimed that E&Y was liable for about $125 million.

“My takeaway is that it’s possible in 2005 to put on a merit-oriented defense and ask jurors to grapple with auditing issues, even though fraud has occurred,” The Reporter quoted Peter Wald, a partner with Latham & Watkins who represented E&Y in the case, as saying.

While the shareholders did not receive a monetary award, their attorneys declared victory, according to the legal journal. The E&Y case sends “a stern message to corporate America that public companies and their auditors will be held accountable for misinforming the public,” declared Blair Nichols, a litigator with Bernstein Litowitz Berger & Grossmann who represented Clarent shareholders.

Officials at the law firm point out that trials are extremely rare in securities fraud class actions, noting that the E&Y case was only the third national trial in the last decade,The Reporter noted.

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