Deloitte & Touche LLP could be on the hook for as much as $2 billion if it loses a legal claim related to the use of insurance products that are under investigation by government regulators, The Wall Street Journal reported. The brewing legal battle is based on so-called earnings-management insurance products that a Deloitte client used.
The case, which is headed into court-ordered mediation, involves the Big Four accounting firm’s audits of Fortress Re Inc., a reinsurance company that specialized in reinsurance for aviation risk. Fortress Re collapsed following the Sept. 11 terrorist attacks, according to the newspaper. Deloitte reportedly denied any liability in the case.
Two Japanese insurers that bought reinsurance from Fortress allege that the company’s use of unconventional coverage and its fraudulent accounting resulted in roughly $3.5 billion in losses for them and a third Japanese insurer that was forced into bankruptcy, according to the report.
Fortress managed a great deal of reinsurance business for the three Japanese companies, and by the late 1990s, the Fortress pool was reportedly among the world’s largest in the aviation reinsurance field. As a result, according to the paper, Fortress would have to “pay up if a plane crashed almost anywhere on the globe.”
Two of the Japanese insurers — Sompo Japan Insurance Inc. and Aioi Insurance Co. — claim that Deloitte failed to tell them of huge hidden liabilities that Fortress had incurred on their behalf, noted the Journal. The companies assert that Fortress told them it had obtained insurance to cover losses on their policies. However, the insurers eventually learned that the claim was inaccurate, and that Fortress was instead relying on “financial reinsurance.”
Such coverage resembles a loan, is cheaper than traditional insurance, and exposes the buyer to more risk. Thus, the reinsurer’s purchase of the coverage had the effect of forcing the Japanese insurers to absorb added losses on every claim, according to the newspaper.
Deloitte officials said in a statement that “the entire premise of this lawsuit — that two of Japan’s largest and most sophisticated insurance companies did not understand their own high-risk business strategy — is demonstrably false and incredible on its face,” noted the paper. The accounting firm also reportedly said it communicated the extent of the liabilities to Fortress.
Therefore, if the reinsurer failed to provide the Japanese companies with accurate information, “any claim would be against their own agent, Fortress, not Deloitte,” the accounting firm added.
The paper also recounted a court hearing held earlier this year in which Robert S. Bennett — a former defense attorney for President Bill Clinton hired to defend Deloitte — called the case “a life-and-death situation” for the accounting firm. Deloitte, however, said this week that Bennett’s comments were an overstatement and officials believe “it will win this case,” the Journal reported.
Fortress lost a $1 billion fraud case earlier this year to Sompo, when an arbitration panel ruled that two executives of the reinsurance company used misleading accounting to fool the Japanese insurer.