State May Revoke License of Former Lincoln Auditors : Thrifts: The Board of Accountancy’s staff says Ernst & Young showed ‘gross negligence’ in the 1987 audits of the S&L; and its parent company.
The state Board of Accountancy is seeking to revoke or suspend the California license of Ernst & Young, one of the nation’s largest accounting firms, for alleged “gross negligence” in audits of Lincoln Savings & Loan in Irvine and its parent company.
The administrative action, brought by the board’s staff, charges that Ernst & Young failed to follow proper accounting procedures in audits of the 1987 financial statements of Lincoln and its parent firm, American Continental Corp. in Phoenix.
The state’s action also seeks to revoke or suspend the California license of Arthur Young & Co., which merged last year with Ernst & Whinney to form Ernst & Young, and Francis J. O’Brien, a co-director of Ernst & Young’s Western regional office in Los Angeles.
Eugene R. Erbstoesser, the firm’s associate general counsel, said Ernst & Young “absolutely” denies the charges.
The state’s accusation--brought by the board’s interim executive officer, Karen J. Scott--is the most serious ever brought against a major accounting firm to the agency, which licenses and regulates the state’s accounting profession.
And it comes at a time when Ernst & Young and other major accounting firms are facing mounting liability claims from allegedly bad audits. Potential claims from such litigation have forced at least one major accounting firm into bankruptcy and others could follow.
The filing, which also could result in a reprimand or probation of Ernst & Young, sets in motion a hearing process. No date for that proceeding has been set, said John O. Horsley, a San Francisco lawyer for the state attorney general’s office representing the board’s staff.
The charges were filed Nov. 16, but were not publicly announced. The firms were served with the accusation on Nov. 21.
An Ernst & Young spokesman questioned the propriety of the action in California, pointing out that the work in question was largely done out of the firm’s Phoenix office.
Erbstoesser also questioned timing of the action, speculating that the state attorney general could be trying to gain some leverage to force a settlement of a $250 million lawsuit brought by the state against Arthur Young for alleged negligence in the Lincoln audit.
“I believe this whole thing is totally unnecessary,” he said. “All of this is just making the firm’s resolve more determined to clear its name.” Ernst & Young has 25,000 employees and partners in 118 offices nationwide and had annual revenue last year of $2.2 billion. It is the second largest accounting firm in Orange County, with 333 partners and associates.
It was Arthur Young’s unqualified opinion that American Continental’s and Lincoln’s upbeat financial statements for 1987 “fairly represented” their financial condition that is the heart of the accusation against them.
The state board’s staff charges that the financial statements were misleading and were used by American Continental to sell the company’s bonds to the public.
The accusation filed with the board asserts that the accountants recognized $62 million in profits on eight real estate deals when accounting principles required that they not recognize any profits. As a result, American Continental reported a pretax earning of $26 million in 1987.
But the filing said the proper accounting of those eight transactions alone--mostly in the huge desert master-planned projects known as Estrella and Hidden Valley Ranch southeast of Phoenix--would have given American Continental a $36-million loss in 1987.
The administrative action charges that the firms’ “gross negligence” resulted in small investors relying on faulty financial statements when they purchased about $200 million in American Continental bonds at Lincoln branches in Southern California.
The bonds have become worthless since American Continental filed for bankruptcy protection in April, 1989. Regulators seized Lincoln the next day. They predict the S&L; will cost U.S. taxpayers more than $2 billion, making the failure one of the costliest in history.
American Continental investors have sued Arthur Young over its audits of the company and Lincoln. California Atty. Gen. John Van de Kamp also filed a suit against Arthur Young for allegedly failing to disclose sham real estate transactions at Lincoln.
The savings and loan debacle alone has resulted in more than $1 billion in claims against Ernst & Young relating to its work at Lincoln, Western Savings in Dallas and a series of thrifts in Tennessee.
