Ernst & Young Sued for Allegedly Covering Up Bad Audits
A Dania Beach, Fla., businessman who merged his company with a bank that later collapsed claims auditing failures and a subsequent cover-up by accounting giant Ernst & Young cost him hundreds of millions of dollars in damages.
Alan Schein contends in a suit filed in Broward Circuit Court that he relied on the E&Y audits that gave Illinois-based Superior Bank a clean bill of health for more than a decade in deciding to merge his mortgage marketing company with the bank in 1998. Schein also claims he could have undone the merger and taken his company back at any time before the bank was seized, but didn't because he thought the bank was safe based on the assurances of the auditing giant.
Regulators shuttered the bank in 2001 after learning that its assets were $420 million lower than reported. Schein claims his company was worth $400 million to $600 million when it was taken over as part of the bank. The plaintiff is also seeking an unspecified amount in punitive damages.
During opening statements Monday, Schein's attorney Jack Scarola told a Broward jury that Ernst & Young, one of the world's largest accounting firms, had a $10 billion motive to keep its mistake under wraps.
"What began as a mistake, a dumb mistake, one that never should have been made … turns into an active cover-up supported by lies, fueled by a $10 billion motive for a company and a multimillion-dollar motive for individuals who participated in that cover-up," Scarola told the jury.
FEAR DERAILED DEAL
Scarola alleges that Ernst & Young didn't disclose its accounting error because it feared a deal would be derailed to sell its consultancy arm to French conglomeration Capgemini for almost $10 billion. E&Y's partners also had a personal profit motive to ensure the 2000 deal went through, because they were due to get stock in the merged company.
But Ernst & Young attorney Barry Richard said Monday that the Capgemini deal had no bearing on how the auditing side of Ernst & Young performed. He argued regulators were aware all along about how Superior Bank and Ernst & Young were valuing the financial institution assets. He contended there was no foul play.
"You'll see nothing in this case that suggests there's anything sinister here, except for speculation and innuendo and lawyer talk," the Greenberg Traurig shareholder told the jury. "There was never any secrets from anyone and nothing was ever concealed."
Richard also maintained that Schein did not chose to separate his company from the bank even after Ernst & Young realized the accounting problem. He called the plaintiff's claims a "phantom case" that is not supported by the evidence.
The four-week trial before Judge Jeffrey Streitfeld was almost sidelined during its first day. Before the trial began Monday morning, a juror spoke to one member of the shadow jury hired by the plaintiff to observe the trial. Litigants in high-stakes cases often use shadow juries to determine how their case might be playing to the real jury and make tactical decisions.
During a break, the juror used his cell phone to Google what a "shadow jury" was. He had also told a fellow juror about the shadow jury and by the afternoon the rest of the jury was aware of the presence of the shadow jury.
When brought in for questioning, the juror said he was friends with a member of the shadow jury. He asked his friend what he was doing in the courthouse.
"He said, 'Oh, I'm on a shadow jury,'" the juror told the court. "I said, 'Oh cool, I'm a regular jury.'"
Streitfeld dismissed the juror, replaced him with an alternate and issued a stern warning to the remaining jurors to not talk about the case with anyone or research anything on the Internet.
"I want the rest of the jury to appreciate how bad this is," Streitfeld said to the attorneys. "If this is how we start, what will happen during Week 2."
Scarola contends that although federal regulators raised questions about the bank's assets, Ernst & Young continued to assure the bank that its accounting was accurate until after its deal with Capgemini was completed.
He said that when the bank and regulators asked for independent reviews of its findings, instead of hiring independent auditors, Ernst & Young had its own auditors review their own work and charged the bank $200,000.
Scarola also contends that the audits reflected several E&Y partners had approved them, when in fact they did not.
"Those financial statements with seals of approval by Ernst & Young were ticking time bombs," Scarola told the jury. "The defects in those financial statements were a poison that threatened the safety and welfare of everyone who believed them to be true."
RELIED ON REPORTS
Scarola said his client relied on those reports when he decided to merge his business with the bank. As part of the deal, Schein continued to run his company as a division of Superior.
Schein was the president, CEO, chairman and sole shareholder of Results Technologies, a high-end marketing company that developed a computer-assisted program to identify potential clients and market mortgage loans.
As part of the merger, Schein had the right to take his company back and walk away. However, because Schein relied on reports provided by Ernst & Young that said the bank was in great financial condition, he never took advantage of this unwind provision, Scarola said.
Scarola contended that at the time the bank closed in July 2001, the Universal Lending Division, based in Dania Beach, was worth $400 million to $600 million.
After the bank collapsed in 2001, the FDIC acting as receiver for Superior sued Ernst & Young in Illinois federal court. The company settled for $125 million and agreed to make substantial changes in how it conducted future bank audits.
Ernst & Young helped Superior, which was owned by a holding company held by two of America's wealthiest families, the Pritzkers and the Dwormans, develop and implement a business model for securitizing mortgages.
During the six-and-a-half year lead-up to the trial, Ernst & Young refused to produce thousands of requested records, claiming Illinois' accounting-client privilege exempted them from disclosure. It also directed witnesses not to answer questions. The accounting firm later tried to use many of the documents as part of its defense, but Streitfeld blocked that move saying if the defense claimed privilege for the plaintiff, it should also be barred from using the documents.
Richard contended in his opening statement that Schein is not the extraordinary businessman that Scarola made him out to be. Rather, Schein tried to apply telemarketing techiques to a variety of fields in hopes of making a quick buck. The mortgage loans the Universal Lending Division put together cost investors a lot of money.
He said that the bank was in the risky subprime mortgage business and Schein knew it. Richard also contended that the E&Y auditor reviewing his own work was not a problem.
Richard said Schein had plenty of opportunity to take his company back, but didn't. He said Schein knew there were problems at the bank as indicated by numerous letters he sent to the head of Superior expressing concern about how the bank was performing and the fact he wasn't being paid.
Richard said it took two months after Ernst & Young told the bank that auditors no longer supported the Superior's accounting methodology before Schein tried to unwind his merger with the bank. Schein also estimated the value of his company in letters to bank management at $3.2 million to $12 million -- not the hundreds of millions he is claiming in court, Richard said.
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