Grant Thornton faces appeal on fraud and negligence lawsuit
Grant Thornton LLP is awaiting a ruling from an appeals court that’s expected to decide in the next few weeks on a case involving a manufacturing company owner who sued the firm for fraud, negligence and other claims after the firm failed to advise him of a tax strategy that potentially could have saved him over a million dollars and then allegedly tried to cover up the error.
The case, which was dismissed on technical grounds by a circuit court last October, involves Arrowhead Systems Inc., a small Wisconsin company that makes items such as pallet and conveyor belt systems, owned by sole shareholder Thomas Young. Grant Thornton had been preparing tax returns and auditing financial statements for Arrowhead for a number of years, and Young asked the firm to provide tax planning and tax strategies. According to a brief filed in the case, Young asked Larry Bovee, a managing director of tax services at Grant Thornton, “Are you going to bring your A game? Are you going to take care of my companies? Are you going to take care of me? . . . Are you going to give me your all, your best, not screw up, take care of me, yes or no?” Bovee and the others at the meeting agreed to look after his best interests.
Bovee and his colleagues at GT regularly offered Young advice on how to structure the ownership of Arrowhead and its subsidiaries and related companies, how to take advantage of tax credits, and how to handle various potential sales, joint ventures and acquisitions over the years. Young regularly asked Grant Thornton to come up with ways to minimize his tax burden, especially at the end of the year. But according to the complaint, they failed to inform him about the existence of a strategy known as IC-DISC (short for Interest Charge Domestic International Sales Corporation), which can be used by manufacturing exporters like his company to lower their taxes.
When an Arrowhead employee by chance heard about IC-DISC at a conference he attended in late 2013, Arrowhead asked Grant Thornton why it hadn’t been used and how much could have been saved. Grant Thornton did an analysis in February 2014 and sent it to Young, estimating it would have saved $124,519, less than what Arrowhead estimated to be the cost of suing the firm.
Later, however, Arrowhead uncovered emails between Bovee and other employees during discovery in the case in which they appeared to try to lower the estimated tax savings. Initially the tax savings were estimated to be $563,083. When a Grant Thornton employee sent that estimate to a colleague, he jokingly wrote, “Hope the client is going to go after us for this lost benefit!” Employees appear to have worked instead on lowering the estimated tax savings to $322,616, then $217,266 and eventually the final estimate of $124,519. At one point, an employee wrote, “We are working on minimizing this number as much as possible.”
Arrowhead began using the IC-DISC tax strategy and within a few years found much greater tax savings. In 2014, the tax savings were relatively low, but for 2015 the benefits from the lower tax rate on the IC-DISC commissions amounted to $509,333, and in 2015 they were $1,224,611. In late 2016, Arrowhead and Young decided to file suit against Grant Thornton and Bovee for negligence, breach of fiduciary duty and breach of contract. After learning about the emails, they amended the complaint to accuse the firm of committing fraud.
Last October, a circuit court dismissed their claims on the grounds of Young’s standing in the case, and the fact that he had signed engagement letters with Grant Thornton every year between 2007 and 2012 for doing his taxes and providing other services. Arrowhead and Young appealed the ruling to the Wisconsin Court of Appeals, which may rule on the case in the next few weeks, although the timing isn’t certain, especially with the coronavirus pandemic delaying court schedules around the country.
Grant Thornton anticipates the appeals court will come to the same conclusion as the lower court. “Grant Thornton LLP is confident that the appellate court will affirm the trial court’s dismissal of this case and looks forward to its ruling,” said a statement from the firm. Bovee referred questions to the firm when asked for comment.
Joseph Newbold, an attorney representing Arrowhead, argues that the firm is at fault. “Grant Thornton, from our perspective, failed to recommend the IC-DISC tax strategy, at a time when it could have saved us quite a bit,” he said. “We went for quite a bit of time without having it recommended to us while Grant Thornton was recommending it to other people and we could have had substantial tax savings from it.”
He believes the emails offer evidence of fraud that go beyond the usual negligence cases filed against accounting firms. “A lot of folks will throw around allegations of things like coverup and fraud, but it’s rare where you see an email chain that actually shows a desire to cover up something or to minimize the damage from a harm that was caused,” said Newbold. “But here you really do see manipulation of numbers and you see an email chain showing it, as laid out in our appellate brief. You’ve got emails that say we want to minimize this number as much as possible and joking about how we hope Arrowhead doesn’t hold us liable for this. It’s rare to see that level of blatant desire to manipulate numbers to cover up a mistake, and you have it here.”
Arrowhead and its owner, Young, are seeking the tax savings that were missed as a result of not using IC-DISC for the years in question. “An expert has gone back and he’s done the IC-DISC tax calculation, and it’s over a million dollars that we would have saved in tax liability if we had the IC-DISC in place,” said Newbold.
“We started using it immediately and we found that the tax savings were vastly in excess of what Grant Thornton said they would be,” said Newbold. “We were able to save quite a bit of money from having the IC-DISC in place.”
Arrowhead won’t be able to file amended tax returns for the years when it wasn’t using the strategy. “You have to have the IC-DISC set up in advance before you can begin to claim any of the tax savings,” said Newbold. “Your tax savings don’t begin until the IC-DISC is set up, so filing an amended return doesn’t really make a difference.”
He believes the lower court erred in dismissing the lawsuit, and Arrowhead is hoping for a more favorable ruling from the appeals court. “The circuit court dismissed the case looking at these engagement letters and looking at the standing argument,” said Newbold. “We disagreed with the standing argument that the circuit court made, and we also disagreed that the engagement letter applied. I think the way that Grant Thornton is attacking the case is they kind of view the engagement letter as a ‘get out of jail free’ card. We don’t think the court should give an accounting firm a get out of jail free card if they harm their clients. That’s why we think that the appellate court is going to reverse the circuit court’s decision.”
He is uncertain whether the COVID-19 pandemic will affect the timing of the appeals court ruling, but he does believe it will ultimately rule in his client’s favor. “From our perspective, we believe that we had an accounting firm that was charging us Grant Thornton rates,” he said. “They were charging us $750 an hour. It came to over a million dollars for 2008 to 2016. We expected a certain quality of service from those services that they provided, and when we’ve gone back in and looked at things, we found that they were recommending a strategy to potential customers, but they didn’t recommend it to us, a paying customer that had been a good customer for many years.”
Grant Thornton is certain to defend itself against the fraud and negligence claims and is counting on the appeals court to uphold the lower court’s ruling. The firm recently published an Anti-Fraud Playbook in conjunction with the Association of Certified Fraud Examiners, which was released during the ACFE’s online conference in June. The playbook offers a set of best practices and tools for implementing, improving or benchmarking a business’ fraud risk management program, along with some of the questions, checklists and insights that a company can use for its fraud risk management program.
Grant Thornton CEO Brad Preber spoke on a panel during the conference about how accounting firms and their clients can handle fraud risks during the coronavirus crisis when so many employees are working from home.
“I represent professional accounting, audit, tax and advisory services, so there are several effects that we’re dealing with just within the industry,” he said. “If I look internally first, the control systems that we typically use to control fraud and other risks have been largely circumvented by work from home and virtual client service environments. That, however, does not mean that these controls have been compromised. Through management objective policy and control modifications, we have rapidly assessed, adjusted and implemented modifications to controls to ensure they continue to meet our objectives regarding ethical behavior and fraud intolerance. So I would say, internally we really are not seeing a big change in the fraud risk profile, although we are seeing a number of phishing campaigns and other devices that are being used through our email and other systems that we’re having to deal with."
"Now, externally, we’ve had to change our service offerings to be responsive to market demands around liquidity preservation, cost controls and unprecedented fraud risks," he continued. "So I would say in the marketplace, fraud risks are probably at the highest levels I’ve ever witnessed in my lifetime.”