Audit Firms' Global Ambitions Come Home to Roost

In the Parmalat fraud case, a judge serves notice that audit firms can't boast of global reach while claiming no connection to local units

By Nanette Byrnes

In a lawsuit over the demise of an Italian milk company, global audit firms this week were sent a serious warning that they may be on the hook for a host of local blowups they had long sought to avoid.

Though they heavily market their global reach to clients, the Big 4 and other large accounting firms have long argued in legal proceedings that their global entities are simply loose affiliations. But in a Jan. 27 ruling in a case centered on Italian shelf-stable milk maker Parmalat, Judge Lewis Kaplan of U.S. District Court for the Southern District of New York ruled in effect that they can't have it both ways.

Auditing has never been more global than it is today. That point was driven home with news coverage of the Jan. 24 arrest of two partners of Price Waterhouse India over the audit of tech outsourcer Satyam. And the prospect of rising liability is something none of the Big 4 welcomes. "All of them have structures designed to build fire walls" between local companies and the global firm, says Stanford law professor and former SEC commissioner Joseph A. Grundfest. "The question is, will the dikes hold when you have this kind of a flood?"

Links or No Links

In the case involving Parmalat, Judge Kaplan held that Deloitte Touche Tomatsu, or DTT, the global network, and its former CEO, James Copeland, should remain defendants in a shareholder case seeking damages from an alleged fraud. Kaplan cited DTT's marketing practices and financial and other links between Deloitte firms in Italy and Brazil and the global firm DTT.

"The judge said you can't sell yourself and run your business like that and then say, 'no, we're just a loose affiliate under Swiss law,'" says Stuart Grant, a partner at Grant & Eisenhofer and co-lead counsel for the plaintiffs. "In essence, the parent can't hide from the misdeeds of its children."

The judge's ruling did not find that DTT is responsible, only that there is enough evidence for it to stand trial as a defendant and face a jury verdict. In response to the ruling, Deloitte issued a statement saying the firm is "disappointed in the Judge's decision, but we are confident of victory at any trial of this matter."

The firm further noted that "Deloitte Touche Tomatsu is a Swiss Verein [membership association] and provided no services of any kind to any Parmalat entity."

Cooking the Books

The Parmalat scandal stretches back to the early 1990s, when the Italian dairy conglomerate launched an aggressive growth plan financed by debt. An expansion into South America went bust, and according to executive statements, the company, needing to cover both millions in losses there and the diversion of funds by the CEO and his family, began to cook the books. Management created fictitious bank accounts allegedly with the help of then-auditor Grant Thorton, according to the judge's summary of the case.

Deloitte's involvement came when Grant Thornton had to rotate off the account under an Italian law that mandates periodic changes in auditor. Deloitte failed either to discover or to report the problems. Eventually the scheme unraveled, and by Dec. 24, 2003, Parmalat was bankrupt.

The plaintiffs' lawyers have long built their case around the global affiliation, in part because Parmalat's original auditor, Grant Thornton's Italian firm, is no longer a going concern.

Financial Ties

Kaplan supported their line, noting connections between the local entities and DTT that included: quality control between the global and local Deloitte firms; financial ties and a dispute resolution process used at Parmalat that ended with a decision by the global firm, DTT. As for financial ties, DTT gets funding from local Deloitte firms. In 2001, $80 million of its $218 million budget came from the U.S. firm, for example.