CAMICO War Story
|Stay on the Side of the Angels When Suspecting Fraud |
Subject: Uncooperative General Partner
Services: Audit of Financial Statements
Beneficial Capital Partners was a limited partnership, whose general partner was Munificent Funding, owned and managed by Robert Plummer. Plummer created and promoted Beneficial as a vehicle for investing in second mortgage loans issued by Castle Home Loans, which was owned and operated by Eric Valhalla.
Munificent/Plummer hired Timothy Hansoff, CPA, to audit the financial statements of Beneficial Capital. During the audit, Hansoff became aware that the only significant assets of Beneficial were funds that the partnership had loaned to Castle Home Loans. Hansoff then asked Munificent/Plummer for Castle’s audited financial statements in order to determine whether the Beneficial funds would be recoverable from Castle.
Plummer told Hansoff that Castle’s audited financial statements had not been completed. Hansoff knew, however, that regulations required the filing of the statements with the U.S. Department of Housing and Urban Development. When he later mentioned this to Plummer, Hansoff eventually received a copy of Castle’s financial statements from Munificent/Plummer, along with a signed audit report bearing the name of Jordan Bigelow, CPA.
Hansoff then spoke with Bigelow to verify the accuracy of the statements and discovered significant differences between the statements he had received and the statements Bigelow had issued. Hansoff e-mailed Plummer to advise him that the statements he had sent were not issued by Bigelow.
Hansoff then received two financial statements—another from Munificent/Plummer, and one from Castle directly. Hansoff spoke with Bigelow again, and again determined that both statements were not issued by Bigelow. Hansoff again communicated with Plummer and informed him that he could not issue a report on Benefical without resolving the issue of the inconsistent Castle audit reports.
Plummer requested that Hansoff issue a limited report on Beneficial, without referring to what Castle was doing with the funds advanced by Beneficial. Hansoff declined and advised Plummer that he should be concerned about the possibility of fraud and that the amounts advanced to Castle might not be recoverable.
Plummer then asked Hansoff to return all of the Beneficial documents in Hansoff’s possession. Hansoff agreed to this, and Plummer told him that he was terminating the auditor-client relationship. Hansoff never issued an audit report for Beneficial or a disclaimer of opinion.
Did Not Communicate
Although Hansoff had indicated his suspicion of fraud to Munificent/Plummer—the general partner for Beneficial Capital Partners, Hansoff did not communicate the suspected fraud to the limited partners (investors) of Beneficial. Nor did Hanson contact the legal counsel for the partnership.
The Securities and Exchange Commission eventually discovered that Eric Valhalla had misappropriated some $300 million worth of funds invested in Castle Home Loans. The SEC shut down Castle and sued it in federal court. The limited partners then sued Munificent/Plummer, alleging that the general partner was a participant in Valhalla’s fraud scheme.
The investors also sued Hansoff for: aiding and abetting the fraud allegedly committed by Valhalla and Munificent/Plummer; conspiring to defraud investors; breach of contract and fiduciary duty; professional negligence; and fraudulent concealment. Their lawsuit essentially asserted that Hansoff had a duty to report what he knew to the limited partners (investors) as well as the general partner (Munificent) of Beneficial.
When the trial went before a jury, the plaintiff’s counsel was able to make it appear that Hansoff had struck a deal with Plummer: The CPA would return the Munificent/Plummer documents and not report the potential fraud in exchange for being paid in full for his work.
Hansoff’s legal counsel argued that according to GAAS and the engagement letter, Hansoff had no duty to report to the limited partners. Hansoff’s attorney also argued that GAAS and state regulations prohibited the auditor from disclosing confidential client information without permission of the client.
The plaintiff’s counsel rebutted by stating that while the engagement letter and GAAS may have permitted Hansoff to maintain his silence, they did not compel him to maintain silence. Counsel argued that even if Hansoff’s actions were lawful, they still assisted in the perpetration of unlawful acts.
Expert witnesses for the plaintiffs also testified that, when an auditor is engaged by a limited partnership, the client includes the limited partners as well as the general partners, and that the limited partners should have been notified that fraud was suspected.
The jury ultimately agreed with the plaintiffs in that, while Hansoff’s inaction was not in itself illegal, it allowed the defrauding of investors to continue until the fraud was finally exposed.
Loss Prevention Tips
A CPA who provides services to a limited partnership has duties to the partnership and to the limited and general partners. The CPA: 1) should not become biased by the fact that the general partners hire him and pay the fees; and 2) should avoid being on one side or the other.
When something looks amiss, it is better to be on “the side of the angels,” usually the passive limited partners. In this situation, the CPA should have insisted that the general partners notify the limited partners of the discrepancies in the financial statements. If the general partners refuse to disclose to the limited partners, the CPA should disclose.
Sometimes the general partners will fire the CPA in an attempt to avoid disclosure. In such circumstances, the CPA still has a duty to disclose even if fired. Consult CAMICO for guidance in these instances at 1.800.652.1772.
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