Account Firm Accused of Fraud in O.C. Suit : Courts: Action is latest development involving Prudential Securities’ embattled petroleum partnerships.

Investors in Prudential Securities’ embattled petroleum partnerships have filed a $1.1-billion lawsuit in Orange County against Arthur Andersen & Co., the nation’s largest accounting firm, in which they allege to have uncovered a massive accounting fraud in connection with the investments.

The suit, filed in Orange County Superior Court, also names the accounting firm of Deloitte & Touche, which played a lesser role in auditing financial statements of Prudential’s Energy Income Funds, a series of oil-and-gas investment partnerships.

The suit is the first time that the scandal has spread to the accounting industry. A spokesman for Arthur Andersen said the accounting firm had done nothing improper, while Deloitte & Touche could not be reached for comment.

Most of the investors were retirees or people near retirement. The Energy Income partnerships took in $1.44 billion from 1983 to 1990 from about 137,000 investors, including an estimated 10,000 to 15,000 from California.

“We have a number of investors from Orange County,” Jeff Dennis Ferentz, a Newport Beach attorney and co-counsel for the plaintiffs, said Sunday. “The target group Prudential went after were the elderly--the retiring and the retired--and these partnerships were sold as proven winners when, in fact, they were losers. Many of the investors are furious.”

The suit marks the latest development in a long-running financial drama that has engulfed one of the nation’s premier securities firms. Prudential’s problems with these investments have already cost the securities firm dearly in settlements and judgments. The company is also the subject of a federal criminal investigation.

In October, Prudential agreed to settle a lawsuit filed by the Securities and Exchange Commission by saying it would pay at least $371 million in penalties. But it neither admitted nor denied findings that it defrauded limited partnership investors.

If the claims in the latest legal action are substantiated, it could compound the legal woes of Chicago-based Arthur Andersen. Like other major accounting firms, Andersen in the last two years has been forced to make large settlements for allegedly negligent audits.

In August, the accounting giant agreed to pay $82 million to settle a suit brought by the Resolution Trust Corp. contending that Andersen had negligently audited the books of Charles Keating’s Lincoln Savings & Loan and another failed thrift.

Jack Ruane, a spokesman for Andersen, said the firm had not yet received a copy of the lawsuit. But, he said, “we are confident that we conducted our audits in compliance with generally accepted auditing standards and are unaware of any factual basis for a lawsuit.”

Prudential spokesman William J. Ahearn said the firm had not seen a copy of the suit and therefore didn’t have any comment. The suit was filed late Friday.

The timing of the Orange County suit is noteworthy because it comes shortly before a federal judge in New Orleans is due to rule Jan. 19 on a proposed settlement in a separate class-action suit against Prudential involving the same partnerships.

Once approved, that settlement would ban most Energy Income investors from taking action against Prudential’s accountants or other advisers.

The suit in Orange County charges that Andersen, which audited the partnerships’ books, allowed Prudential to issue false financial statements and prospectuses, hiding the fact that “profits” investors were receiving actually was their own money being paid back to them.

The suit charges that, in effect, small investors paid substantially more than the true purchase price of oil and gas properties the partnerships acquired. The overpayments allegedly were later used to make the partnerships appear profitable when most were actually losing money.

The charges include allegations that contracts for the purchase of oil and gas properties were backdated, often by months, court papers show. As much as 59% of the monthly profit distributions paid to investors in various partnerships was actually their own capital being returned to them, documents filed with the suit indicate.

The suit contends that Andersen, which audited the partnerships’ financial statements, knew of the misrepresentations, but never disclosed them to investors. The audits were carried out by the accounting firm’s office in New Orleans, located near the headquarters of now-defunct Graham Resources, the firm that managed the Energy Income partnerships.

Three senior Graham officials, including its treasurer and executive vice president, had previously been accountants in Andersen’s New Orleans office. Andersen has denied that there was any improper relationship between that office and Graham.

Attorney Ferentz, who joined Austin, Tex., lawyer Stuart C. Goldberg in filing the suit in Orange County against Andersen, said the $1.1 billion sought in damages represents the investors current out-of-pocket losses, plus 10% interest per year. (The suit was filed in California because so many of the investors live in the state.)

The suit also asks that in addition to that treble damages be awarded based on a provision of California law that allows damages to be multiplied in cases involving senior citizens or disabled people.

The charges in the suit center on what were called “pre-closing revenues.”

Graham would sign a contract to buy oil and gas properties for the partnerships. As with buying a house, there would be a closing later, when the properties actually changed hands. But because the oil and gas from the properties was being sold continuously, the properties continued to generate revenue between the time the contract was signed and the closing.

On the date of closing, the seller would pay Graham these “pre-closing revenues.” Under accounting rules, this payment is supposed to be treated as a reduction in purchase price, not profit, but nevertheless was booked as profit in the partnerships financial statements, the suit says.

Graham and sellers routinely agreed to back-date the effective dates of the contract--not only to before the contract was actually signed but before Graham even had made a bid for the properties, the suit alleges.

This arrangement allegedly enabled Graham to collect more from investors than the properties were worth, and use the overpayments to make investors believe that they were receiving profits.

“It would be like having a prenuptial agreement effective before you even met the woman,” Goldberg said. “It’s phony.”