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Heller Creditors Target AccountantsHeller's creditors may sue accounting firm Ernst & Young for failing to raise red flags on its audit of the firm's 2007 financials, according to a bankruptcy liquidation plan and disclosure filed on Thursday. Financial irregularities derailed at least one merger for Heller, according to sources, and are being used by creditors to build a fraudulent-transfer case against former shareholders. The plan also shows that the defunct firm has settled with its hundreds of former employees for about $19 million.
The Recorder2009-10-12 12:00:00 AM
Heller's creditors may sue accounting firm Ernst & Young for failing to raise red flags on its audit of the firm's 2007 financials, according to a bankruptcy liquidation plan and disclosure filed on Thursday just before a midnight deadline.
Financial irregularities derailed at least one merger for Heller, according to sources. They are also being used by creditors to build a fraudulent-transfer case against former shareholders.
The plan, a road map to resolving the bankruptcy, also shows that the defunct firm has settled with its hundreds of former employees for about $19 million -- $7 million of which, however, they'd only see if the estate manages to pay every other creditor off first. Employees may get some of that money by year's end if the plan is confirmed by a majority of creditors.
The plan lays out classes of creditors and in what priority they will receive money. An accompanying disclosure lays out litigation the creditors plan to pursue, most of which has been previously reported, including suits against Bank of America, Greenberg Traurig and Covington & Burling.
One thing missing from the liquidation plan is any settlement with shareholders. Mediation talks are ongoing, as shareholders deny that the firm was insolvent as early as 2007. In their defense, they point to financial audits that raised no red flags.
The Ernst & Young allegation is the latest to come out of the bankruptcy. Creditors allege the accounting firm was persuaded by Heller's management to OK a line that described $11 million in profit distributions as "a loan to shareholders." The line was new in the 2007 statements.
Creditors call it a "thinly disguised improper device used to overpay the former shareholders" to boost the firm's PPP rank. They say the line should have prompted Ernst & Young to qualify its opinion statement on the audit.
"Ernst & Young did not totally ignore this devious device in the conduct of its audit. It waffled on the treatment and on confirmation of the transactions in the audit process and the audit report," the disclosure filing says. "The debtor was damaged by this conduct through both the payments to former shareholders in excess of its distributable net profits, and through permitting it to incur greater losses before its ultimate demise."
An Ernst & Young spokesman declined to comment.
Creditors had previously said in an interim operating report that the partners were overpaid $9 million.
Attempts to cover the overpayments were a main factor in merger talks failing with Baker & McKenzie last year, according to two people familiar with the negotiations who did not want to be named.
"If it had come out earlier, they probably would have done the deal," one source said. "It was missing from the financial information that was part of the due diligence. It took a while to figure out why it was $9 million short. A team of people flew out and spent four days at Heller Ehrman going through the books. Their interfaces at Heller told them repeatedly that they couldn't answer questions about the $9 million without permission from Matt [Larrabee]."
Larrabee, chairman for the firm's final three years, has said he'll fight the creditors' allegations that Heller pumped profits and tried to cover it up.
The second source said rank-and-file partners did not appear to know about the inflated profits.
"That didn't inspire confidence, nor did delays in getting other financial data that reflected the present position of the business," the source said. "The point here was that whatever way you cut it, the profits were inflated and the piper had to be paid, and any acquiring firm had to make that up."
The liquidation plan was due by Thursday if the creditors committee and the Heller estate were going to remain in control of the bankruptcy. The plan is a contract that the parties to the bankruptcy would follow, while the disclosure is meant to lay out in plain English why the plan should be confirmed.
As for the employee settlement, Blum Collins will earn around $1 million after convincing creditors to more than double the settlement amount. Creditors had offered last month to settle with employees for $7.5 million, which the firm urged its clients to turn down.
Thomas Willoughby, the partner at Felderstein Fitzgerald Willoughby & Pascuzzi who represents the creditors committee, said their goal is to get the plan confirmed by mid-December so employees can be paid soon after.
"That's why we wanted a plan earlier, that's why we pushed on the shareholder front early, that's why we filed the Bank of America preference action early," Willoughby said. "It's much better to get money to people in this economy this year than next year."