ScherzerBlog | Scherzer International

On August 31, 2012, Belford High School, Belford University and several of their co-conspirators were ordered to pay $22.7 million to a class of more than 30,000 U.S. residents who were duped into purchasing fake high school diplomas from Belford. The defendants were also ordered to forfeit the websites used to perpetrate the scam, including www.belfordhighscool.com, www.belfordhighschool.org, www.belforduniversity.org, and www.belforduniversity.com.

The lawsuit, filed on November 5, 2009, charged that Belford High School is an Internet scam that defrauded students of their money by offering them a supposedly “valid” and “accredited” high school diploma. As affirmed by the judgment, the school is a fake and the diplomas are not valid. The lawsuit also alleged that the two accrediting agencies by which Belford claimed to be accredited – International Accreditation Agency for Online Universities and the Universal Council for Online Education Accreditation – are not legitimate accrediting agencies.

Notably, we came across Belford University in 2010 when a bachelor’s degree from the “school” was listed on an employment application by a candidate for a professional level position with one of our clients. Click here to read the 2010 blog.

It all started in 1905 with the lawsuit Smith v. London Assurance Corporation whereby an auditor was held liable for failing to audit its client’s branch office and detecting embezzlement.

Now more than 100 years later, the legal liability of auditors in detecting corporate fraud  will be decided in two cases that were heard on Tuesday, September 14, 2010, in the New York Court of Appeals, potentially increasing the Big Four accountants’ exposure to multibillion-dollar shareholder lawsuits for malpractice. In both cases, the court will rule whether auditors can rely on the legal doctrine of in pari delicto (“in equal fault”) to reject claims for fraud allegedly committed by company insiders. The doctrine prevents someone from recovering damages from a defendant if that someone is also at fault. The argument is whether the shareholders, as owners of the company, can be held at fault for frauds committed within the company and barred from suing its auditors for not discovering the wrongdoing.

The first lawsuit facing scrutiny was filed by the shareholders of AIG against PricewaterhouseCoopers (PwC), the insurer’s auditor. The shareholders claim that PwC failed in its job as auditors in the early 2000s, when various AIG officers and directors, including ex-CEO Maurice Greenberg, allegedly engaged in fraudulent transactions to pad AIG’s bottom line. Authorities subsequently caught the fraud, and AIG had to restate years of financial statements that “eventually reduced stockholder equity by $3.5 billion.” AIG ended up paying more than $1.5 billion in fines, and the shareholders say that since PwC missed the fraud, they should be allowed to sue PwC for malpractice. The Chancery Court in Delaware dismissed their request to sue PwC, and the case was appealed in Delaware’s Supreme Court. That court asked the New York’s Court of Appeals to decide whether the shareholders have a claim under New York law.

The second case relates to protracted litigation by the bankruptcy trustee of Refco Inc., the failed futures broker, seeking damages from a number of the firm’s professional advisers, and auditors including Grant Thornton, KPMG LLP, Ernst & Young LLP, PricewaterhouseCoopers LLP, Mayer Brown, LLP, et al. The trustee alleges that Refco’s outside counsel Mayer Brown, and several other insiders are liable for defrauding Refco’s creditors by helping the defunct company conceal hundreds of millions of dollars in uncollectible debt. The U.S. Court of Appeals for the Second Circuit found that the trustee’s argument to revive claims against the corporate insiders raised unresolved questions concerning his standing under New York law to sue third-parties for Refco’s fraud.

SI was engaged to investigate a national company along with two of its principals as part of our client’s risk management program. The company’s ads have appeared almost daily in major newspapers and on the Internet, and the merits of its consumer services (for confidentiality, we can’t say what they are) have been touted in the professionally scripted testimonials of “real” customers. But SI’s investigation found media reports and court documents showing that the claims were not so credible. There is a pending federal class-action lawsuit against the company and its principals alleging several fraudulent business practices, including the misleading advertising of a service guarantee that “is riddled with restrictions, waivers and limitations” and service enrollments without authorization. Six additional lawsuits for similar causes of action are pending in various county-level courts.

Further, SI’s investigation uncovered the checkered backgrounds of the two principals behind the company. Searches of bankruptcy records revealed that both subjects had filed for protection from creditors – and in the co-founder’s case, had filed multiple times. Also missing from the company’s pitch was that the co-founder’s previous career in a similar business culminated in a federal judge’s order barring him from “promoting, offering for sale, performing or distributing any product or service related to [consumer] services.”  Had our client’s decision-makers relied on the company’s presentation of itself and its principals, they would not have been able to realistically assess the risk of engaging in business with the subjects. While a search of media stories might reveal complaints against a potential client, it’s a full in-depth investigation that brings all the pieces together.

A pharmaceutical company already engaged in a long-term business relationship with an accounting firm, as part of its rebranding, brought on several new executives, including a chief financial officer. After learning that this client had not performed background investigations on these individuals, the accounting firm ordered due diligence investigations from SI.

Everything looked great with the chief financial officer: an MBA degree from a prestigious university was confirmed, as well as employment history in financial positions with large companies.

However, in digging deeper, SI’s investigation discovered that the subject, in his capacity of chief financial officer at a previous employer, had been named as a defendant in several federal lawsuits, including a civil complaint filed by the Securities and Exchange Commission which alleged that the subject falsified financial documents. The subject paid $50,000 in fines to the SEC without admitting or denying the charges and agreed to a permanent injunction. His CPA license was revoked, and he was expelled from the AICPA. The former employer was forced to restate its earnings which, in turn, resulted in a shareholders’ class-action lawsuit against the subject and the company. Unrelated to the securities matters, an open federal tax lien filed in 2008 for $469,500 against the subject was located in searches of his previous jurisdiction of residence.