Auditing

Jury Finds Accounting Firm Guilty

A questionably clean audit to a defense contractor leads to the verdict, but no damages are awarded to the hedge fund that sued.
Marie LeoneDecember 13, 2007

In a case that tested the bounds of auditor liability, a jury in Virginia found accounting firm Goodman & Company guilty of aiding and abetting a client company that allegedly breached its fiduciary responsibilities. Yet despite the guilty verdict, the jury did not award damages to the plaintiff, hedge fund Costa Brava Partners.

Furthermore, Goodman was cleared of three other charges — two counts of conspiracy and one of interference with contractual relations. “We are pleased that the jury agreed with us on the majority of the findings,” said the Goodman Managing Partner Tom Wilson. “While disagreeing with the single verdict, we think it is significant that no damages were awarded.”

Goodman was cited in the lawsuit for issuing a clean audit report in 2004 to Telos Corporation, a defense contractor that Costa Bravo is suing for breach of fiduciary responsibility, among other charges. Costa Brava claims Telos management orchestrated a campaign that deprived preferred shareholders of mandatory payments due under a provision in the share registration agreement, and enriching themselves in the process. Costa Brava owns 16 percent of Telos’s preferred shares.

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According to the Telos lawsuit, problems began when the contractor ceased declaring and paying mandatory preferred dividends in 1991, claiming it did not have “sufficient legally available funds to fulfill the financial obligation.” The cumulative accrued unpaid dividend currently exceeds $30 million, Costa Bravo said in its complaint.

The hedge fund claims Telos was able to avoid paying the mandatory dividend by manipulating and misrepresenting the company’s financial condition, which is a breach of fiduciary duty. For Goodman’s part, the audit firm issued an unqualified audit opinion in Telos’s 2004 annual report, which according to Costa Bravo, allowed Telos to file materially false and misleading statements with the Securities and Exchange Commission. In July, Goodman resigned as Telos’s independent auditor.

Costa Brava managing partner Seth Hamot told CFO.com he was “quite ecstatic that the jury agreed with what we’ve been saying for three years.” He added that the hedge fund was not disappointed with the jury’s decision not to award damages, noting that “it was a hard case to prove, and the jury took its time to understand [the issues].”

Goodman, an auditing firm with 80 partners and about 350 CPAs and other professionals on staff, is preparing to file a motion to have the one guilty verdict overturned on the basis that no damages were awarded, said Wilson.

In April, the Public Company Accounting Oversight Board issued a clean inspection report on Goodman & Co., finding no deficiencies in the firm’s audit processes. The PCAOB is charged with inspecting the work of smaller audit firms every three years. Inspections of larger audit firms are conducted annually.

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