Ernst & Young won a decision involving a defunct hedge fund after its liquidators sued the firm's Cayman Islands unit, accusing it of performing a deficient audit and failing to detect the investment managers' fraudulent valuation.
In August 2002, Beacon Hill Master, a hedge fund established in the Cayman Islands in 1997, lost $300 million, about half its net asset value. The SEC charged the fund managers with inflating the value of their investment portfolio. They denied wrongdoing, but settled with the SEC for $4.4 million in 2005.
In 2004, a court appointed Theo Bullmore and Phillip Stenger as joint official liquidators of the fund. They sued the fund's former investment managers along with Ernst & Young's Cayman Islands unit and the fund's administrator, ATC Fund Services (Cayman) Ltd., in 2005. The other defendants settled with the liquidators, but Ernst & Young continued to fight the suit. The firm had conducted the fund's only audit, covering the period between Jan. 2 and March 31, 2002, and issued a clean audit opinion.
Judge Charles Ramos of the New York State Supreme Court ruled in favor of Ernst & Young Cayman Islands on June 24 of this year and dismissed the liquidator's claims against the firm. The judge noted that the investment managers effectively controlled every aspect of the fund's operations and they made material misrepresentations to Ernst & Young. He also said the independent directors left it to management to run the fund and probably would not have acted to stop the fraud and remove the investment managers if Ernst & Young had alerted them to valuation discrepancies.
"The undisputed evidentiary record demonstrates that the directors ceded control of the fund to the investment managers, permitted them to operate the fund with impunity until they were removed by the SEC, and appear to have ignored their own responsibilities to the fund by failing to review the financial statements, despite attesting to their accuracy in the representation letter," said the judge.
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