Auditing

BDO Found Guilty, But How Guilty?

In the first phase of a negligence lawsuit a jury found the top-tier auditor guilty; but the second phase of the trial will determine the degree of...
Marie Leone and Stephen TaubJune 18, 2007

BDO Seidman could be on the hook for hundreds of millions of dollars after a jury ruled on Friday that the accounting firm was negligent in failing to detect a massive fraud that cost a Portuguese bank $170 million, according to the Associated Press. Banco Espirito Santo sued the fifth largest accounting firm in 2004 after the collapse of factoring firm, E.S. Bankest, according to the report. The bank helped launch the firm and had invested in it. BDO Seidman was E.S. Bankest’s auditor for seven years.

Following a two-month trial, a Florida jury found that the accounting firm had committed gross negligence. Under current Florida law, Banco Espirito Santo can pursue punitive damages of as much as $510 million, according to the AP. “A judgment of that size certainly would have a severe impact on any firm,” a BDO spokesman told CFO.com. Court documents filed by BDO Seidman last year, but which have since been sealed, said that if the maximum damage award was levied, the audit firm would be forced to layoff thousands of employees, noted recent press reports.

Officials at BDO Seidman say the firm does not agree with the jury that the auditors failed to adhere to generally accepted auditing standards (GAAS), further stating that, “we are confident that this portion of the verdict will be reversed on appeal.”

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The Public Company Accounting Oversight Board has cited BDO Seidman for audit deficiencies in 2004, 2005, and 2006; although the 2006 report showed improvement. Indeed, many firms, including the Big Four — PricewaterhouseCoopers, KPMG, Ernst & Young, and Deloitte — also received notices of audit deficiencies from the PCAOB during its first three audit cycles.

According to the suit, E.S. Bankest was a factoring firm jointly created in 1998 by the bank and Bankest Capital. The complaint alleges that Bankest “did almost no legitimate factoring,” and was instead used to funnel money from Banco Espirito Santo investors to Bankest principals. The plaintiff charges that BDO audited financials were used by Bankest to issue debenture notes — that ultimately proved to be worthless because of the scheme.

The lawyers representing Banco Espirito Santo could not be reached for comment at press time.

During the first phase of the trial, the jury heard arguments related to whether GAAS were followed during BDO Seidman audits of Bankest that were conducted between 1998 through 2002. The second phase of the trial, which gets underway this week, will determine the damage award.

During the second phase, the jury will be hearing new, and more detailed evidence, and be expected to determine how much responsibility should be assigned to BDO Seidman, and how much should rest with others. This is the second time the case has been tried. The first attempt ended in a mistrial.

The firm added that the second phase of the trial will give the jury a chance to assess which parties are responsible for the fraud. BDO Seidman claims that the “plaintiffs, the officers and managers of Bankest, and others,” are the responsible parties, further noting that, “any amount assessed to BDO would be a fraction of the damages sought.”