Deloitte & Touche LLP agreed to pay more than $50 million to settle charges brought against it by the Securities and Exchange Commission related to two of its former audit clients.
The payments are part of separate settlements related to the Big Four firm's 2000 audit of cable giant Adelphia Communications Corp. and the 1998 audit of Birmingham, Ala.-based Just For Feet, a defunct shoe and sports apparel retailer. Deloitte did not admit or deny wrongdoing in either case.
Adelphia, the sixth-largest cable television provider in the United States, filed for bankruptcy in 2002. An SEC order found that Deloitte engaged in improper professional conduct because it failed to detect the massive fraud perpetrated by the cable company and members of the Rigas family, which owned it. The SEC also alleged in a federal court complaint that Deloitte failed to implement audit procedures designed to detect the illegal acts at Adelphia.
A day earlier, the SEC and the U.S. Attorney settled the financial fraud case against Adelphia and the Rigas family for $715 million.
As part of the Adelphia settlement, Deloitte & Touche will pay a $25 million penalty to settle the federal court action, and another $25 million to settle the administrative proceeding. The entire $50 million will be paid into a fund to compensate Adelphia shareholders and debt holders. The firm also agreed on steps to enhance audit quality for its clients.
"What is especially troubling here is that Deloitte recognized the risk of fraud posed by this client at the outset. When auditors turn a blind eye toward misconduct on a high-risk client and allow a fraud of this magnitude to go undetected, the consequences will be severe," said Mark K. Schonfeld, director of the SEC's Northeast Regional Office, in a statement.
As part of the Just For Feet settlement, the firm agreed to be censured and to pay $375,000 to the U.S. Treasury. The SEC also charged the Deloitte engagement partner, Steven H. Barry, and the audit manager, Karen T. Baker, each of whom agreed to be barred from practicing before the SEC for two years and one year, respectively.
In the case of Just For Feet, the SEC found that Deloitte, Barry and Baker didn't "respond adequately to indications that the company was recognizing unearned and fraudulent vendor allowances as income." The SEC order also cited Deloitte, Barry and Baker for failing to test adequately the company's reserve for obsolete or excess inventory, and failing to respond adequately to indications that Just for Feet was fraudulently increasing income through the phony purchase of display booths from vendors. The SEC also said that while Deloitte's National Risk Management Program identified Just for Feet as a high-risk client, Deloitte didn't carry out the responsibilities required by such a designation.
"Deloitte & Touche LLP believes that the settlements are in the best interest of its people, clients and the organization," the firm said in a statement, noting that the settlements are its first enforcement cases since it was formed by a merger in 1989.
Deloitte said that it was "deliberately misled" in both cases by its client and some senior executives and others through the financial information that they provided.
"These cases raise a larger issue facing the auditing profession. Among our most significant challenges is the early detection of fraud, particularly when the client, its management and others collude specifically to deceive a company's external auditors," Deloitte chief executive James Quigley said in a statement. "Deloitte & Touche LLP has implemented, and will continue to implement, a number of additional improvements in its policies and procedures for auditing clients in its risk management program and to aid in uncovering fraudulent activity in a more timely manner."
Quigley also noted that the firm will implement changes that it says should help to improve the performance of future audit engagements, including improved audit procedures for clients in the risk management program; more tailored audit procedures in response to identified risks; improved documentation of the conclusions regarding issues raised; the completion of specialized training for all audit professionals in detecting potential fraud; and deploying forensic specialists to assist audit teams in the planning stages of audits for all clients in the risk management program.
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