Risk Management

Comverse Backdating Suit Raises Auditor Liability Questions

Reportedly on the lam in the Republic of Congo, former Comverse CEO Kobi Alexander sues Deloitte in connection with his former company's stock-opti...
Marie LeoneMarch 4, 2009

In the latest example of an auditor’s work being tied to fraud allegations, former Comverse Technologies CEO Jacob “Kobi” Alexander and the company’s one-time legal counsel, William Sorin, are suing Deloitte & Touche in connection with the purported $57-million stock-option backdating scandal that came to light more than two years ago.

Alexander, who became a fugitive from the FBI when he allegedly fled the U.S. for Namibia, where he is living today, filed a law suit separate from Sorin’s suit against Deloitte in federal District Court in Brooklyn, N.Y. In the complaints, Alexander and Sorin said that if they are held liable in the backdating case, Deloitte & Touche should bear some responsibility for damages, according to Knight Ridder/Tribune. Deloitte has been Comverse’s independent auditor since 1994.

In an e-mail response to CFO.com, Deloitte officials commented: “These are meritless claims filed by one individual who has already plead[ed] guilty to federal criminal charges and by another who has fled to Namibia to try to escape the American criminal justice system. We are confident that these claims will be disposed of in short order by the Court.”

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In the original suit against Comverse executives, lead plaintiff and Comverse investor the Menorah Group charged that Alexander, Sorin, and other officials, including former chief financial officer David Kreinberg, had falsified financial statements to inflate the company’s stock price and to mislead investors about the true condition of the company. “Central to the alleged fraud was a stock option backdating scheme, in which Comverse granted undisclosed ‘in-the-money’ stock options to its employees by backdating its stock option grants,” noted court documents.

In addition, the investor suit accused Alexander and Kreinberg of funneling some of the backdated options into a hidden “slush fund” from which they then granted options to several Comverse employees. Menorah Group is charging that the slush fund dates back to 1996, and was used up until November of 2006 when the scheme was uncovered.

It is unclear whether Deloitte, as Comverse’s auditor, will be held liable for any damages related to the suit. However, the idea of suing or calling into question the work of a third party — such as an independent auditor — that is not directly connected to the alleged fraud may be gaining steam.

In December 2008, the tiny accounting firm of Friehling & Horowitz became the focus of an investigation by the Rockland County, N.Y., district attorney for its involvement in the $50 billion Madoff Ponzie scheme scandal. Friehling & Horowitz was the private accounting firm that signed off on the financial statements of Bernard L. Madoff Investment Securities LLC. Also in December, audit firm BDO Seidman was sued by The New York Law School, an investment client of Ascot Partners, which was heavily invested in Madoff’s firm. BDO Seidman is the auditor for Ascot Partners.

Then in January, the work of Price Waterhouse India was called into question related to the $1 billion Satyam Computer Services scandal. While no lawsuit has been launched, many experts, including H. David Sherman, a former SEC academic fellow and currently a professor of accounting at Northeastern University, says the audit firm was partially to blame for the not catching the fraud scheme, which lasted more than five years.

January was also the month when investors received approval from the U.S. District Court in Manhattan to proceed with a suit against Deloitte & Touche concerning the role that the firm’s Italian affiliate played in the $18-billion scandal and eventual collapse of Parmalat Finanziaria in 2003. Deloitte & Touche belongs to the larger worldwide membership organization Deloitte & Touche Tomatsu. Judge Lewis Kaplan, when he ruled to allow that suit to continue, said that Deloitte & Touche Tomatsu “exercised substantial control over the manner in which the member firms conduct their professional activities.”

The U.S.-based Deloitte noted that it issued no audit reports on Parmalat SpA, other than an audit of its U.S. operations, and had nothing to do with the dairy company’s alleged misconduct. Charges against Deloitte in connection with Parmalat’s U.S. operations already have been dismissed by the courts.