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A class-action lawsuit, settled earlier this week, says the audit firm should have considered the homebuilder's "make the numbers" culture to be a red flag as the housing market tanked.
Sarah Johnson, CFO.com | US
May 7, 2009
Deloitte & Touche has agreed to pay investors of Beazer Homes USA nearly $1 million to settle claims the firm should have noticed the homebuilder was issuing inaccurate financial statements as the housing market began to decline earlier this decade.
The audit firm, Beazer, and former Beazer executives have settled the class-action lawsuit for a total of $30.5 million, pending approval by the U.S. District Court for the Northern District of Georgia. Deloitte is scheduled to pay $950,000.
The investors had accused Beazer of managing earnings, recognizing revenue earlier than allowed under generally accepted accounting principles, improperly accounting for sales/leaseback transactions, creating "cookie jar" reserves, and not recording land and goodwill impairment charges at the proper time.
For example, according to the allegations, Beazer conducted house closings on homes that weren't move-in ready to push up the date the company could record the revenue from the sales and backdated documents of home sales so that they could be recorded in earlier financial reporting periods. Under FAS 66, Accounting for Sales of Real Estate, the seller recognizes its profit only after a sale is completed.
In a complaint filed nearly two years ago, the plaintiffs said that because of Beazer's culture to "make the numbers" during a time when housing sales had significantly slowed, the company's employees were dealing with unrealistic budgets and pressure to hit financial goals or risk losing their jobs — and that Deloitte should have noticed these issues existed and planned its audit accordingly.
The investors accused Deloitte of turning "a blind eye" to the myriad of "red flags" that should have alerted the firm to potential GAAP violations. These warning signs included the "excessive pressure" employees were under to meet their higher-ups' sales goals, tight competition in Beazer's market, and weak internal controls. Accusing the auditor of "severe recklessness," the shareholders alleged, for example, that Deloitte should have noticed that Beazer was likely overdue in recording impairments on their land assets, as the real estate market began to decline, among other the other alleged accounting violations.
"Deloitte either knowingly ignored or recklessly disregarded Beazer's wide-ranging material control deficiencies and material weaknesses during the class period," according to the shareholders' complaint. "For example, Deloitte was specifically aware that financial periods were regularly held open or re-opened because it had access to Beazer's detailed financial and accounting information via, among other means, access to Beazer's JD Edwards software."
In an educational brochure on public-company accounting released yesterday, the Center for Audit Quality, the trade group for audit firms, said auditors consider potential areas of misconduct for a particular company when deciding what areas of a business to review. However, the CAQ cautioned, "because auditors do not examine every transaction and event, there is no guarantee that all material misstatements, whether caused by error or fraud, will be detected."
In the Beazer settlement, none of the defendants has admitted wrongdoing. "Deloitte denies all liability and settled to avoid the expense and uncertainty of continued litigation," a spokeswoman told CFO.com.
For its part, Beazer says its insurance provider will pay for the settlement, meaning "there will be no financial contribution by the company." By settling, the firm added, "the uncertainties, distractions, burden and further expense associated with this litigation" have been eliminated.
The suit's plaintiffs include institutional investor Glickenhaus & Co., Northern California Carpenters Pension Fund, and other pension funds. Shareholders holding Beazer stock between January 2005 and May 2008 would benefit from the settlement.
Last year, Beazer restated several years' worth of financial statements to fix many of the same issues mentioned in the class-action suit. An internal investigation into its mortgage-origination business also resulted in the firing of its chief accounting officer who was accused of violating the company's ethics policy by trying to destroy company documents.
Beazer settled a related case with the U.S. Securities and Exchange Commission without paying any penalty. It is still under investigation by the U.S. Attorney's Office in North Carolina, according to its most recent 10-K.