CohnReznick, Apax and some litigation in the way
What has not been previously reported is that while this deal is being considered and negotiated, CohnReznick is getting ready to go to trial on a "break the firm" auditor liability claim.
Today I want to talk to you about the impact of private equity's incursions in the public accounting industry, using one particular investment in a firm that's a member of the $1 billion revenue club: CohnReznick. What has not been previously reported is that while a deal with Apax is being considered and negotiated, CohnReznick is getting ready to go to trial on a "break the firm" auditor liability claim.
After the paywall, you can read more about the lawsuit against CohnReznick, going to trial on June 2, and what that might mean for private equity firm Apax’s investment in the firm. That deal is expected to close soon, March/April 2025, according to the Apax press release.
I’ve written before about auditors facing “break the firm” trials, notably PwC during an 18-month period while I was working for MarketWatch/Dow Jones.
Those settlements pale in comparison to the total of $6.5 billion that Taylor Bean and Colonial Bank trustees are looking for from PwC. On Aug. 5 U.S. District Judge Victor Marrero in Manhattan rejected PwC’s request to dismiss MF Global’s lawsuit alleging professional malpractice that contributed to the October 2011 bankruptcy of the brokerage firm once run by former New Jersey Gov. Jon Corzine. That suit is seeking $1 billion in damages, bringing the total potential claims PwC is facing over a very short period to $7.5 billion.
Two of the cases were settled confidentially, but the last one, FDIC v Colonial Bank went all the way to trial, with a federal judge who awarded the largest ever damages for auditor liability. The award was later cut in half, after Trump’s new FDIC Chair decided to settle to avoid an appeal and the effort of trying two more stub cases.
But it’s still a pretty big chunk of change PwC had to pay out over a very short amount of time.
The FDIC v. Colonial case is cited in the case against CohnReznick:
Failure to apply procedures directed specifically to the detection of a material, fraudulent misstatement of the financial statements is negligence. See Colonial BancGroup, Inc. v. PricewaterhouseCoopers LLP, 2017 WL 8890271, at *13 (M.D. Ala. Dec. 28, 2017).
But, first, I want to tell you where I'll be in the coming month.
On April 3, I plan to attend in person the PCAOB's "Forum on Auditing in the Small Business Environment and on Auditing Broker-Dealers" in Chicago. Speakers include Chair Erica Y. Williams, PCAOB Staff, FINRA Staff, and SEC Staff.
The last time I attended a forum like this in Chicago was April 2012, after the revelation of the fraud at PFGBest, still the largest individual embezzlement ever. I wrote about PFGBest and my forum attendance for Forbes:
The PCAOB held its first free public forum for auditors of broker-dealers in October of 2011. I attended the full-day broker-dealer auditor forum in Chicago in April of 2012. New PCAOB Board member Jeannette Franzel, a representative from the SEC’s Office of Chief Accountant, a representative from FINRA, and PCAOB staff including the small business liaison, an economist, and professionals from the office of registrations and inspections explained the requirements and answered questions. It was an excellent program and I learned a lot.
One issue that provoked heated discussion at the Chicago forum was auditor independence. It seems many of these Certified Public Accountants and broker-dealer auditors were under the mistaken impression that it's the AICPA’s rules for auditor independence that apply to them, not the SEC’s. SEC rules, post-Sarbanes-Oxley Act of 2002, prohibit an auditor of an SEC-registered firm from performing a list of nine prohibited services including bookkeeping and systems design and implementation for its audit clients.
Several audit firm professionals tried to convince the SEC and PCAOB staff that they were mistaken...
A total of 107 people showed up at the broker-dealer forum in Chicago, representing 56 different audit firms. No Big Four audit firms came but next-tier firms like Grant Thornton, McGladrey and Crowe Horwath sent professionals. PFGBest’s auditor, Jeannie Veraja-Snelling, did not show up. That’s maybe because Veraja-Snelling had no interest in what the SEC and PCAOB were saying.
I look forward to seeing next week whether the auditors of broker-dealers are now on the program. The 13th report on the PCAOB’s interim program of inspection of auditors of broker-dealers, for 2023, still finds high percentages of deficiencies, in particular for audit firms that have never been inspected. Yes, even after thirteen years, there are firms that audit broker-dealers that are being inspected only now for the first time.
We identified deficiencies involving the sufficiency or appropriateness of evidence that firms obtained to support their audit opinions in 56% of audits reviewed, an increase from 50% in 2022. The areas where we identified the highest numbers of deficiencies were, in order: revenue; evaluating audit results (which primarily concerns the presentation and disclosure of broker-dealer financial statements); net capital; and related party relationships and transactions. In our assessment of audit engagements for noncompliance with other PCAOB standards and rules, the areas where we identified the highest numbers of deficiencies were, in order: audit documentation; auditor communications; auditors’ reports on the financial statements and supplemental information; and auditor independence. We identified deficiencies that solely involved noncompliance with other PCAOB standards and rules in 14% of audits reviewed, an increase from 8% in 2022.
On April 7, in Chicago, I will present to the Stigler Center Journalism in Residence (JIR) Program fellows: "How do investors find out about corporate fraud? Short-sellers, whistleblowers, auditors, and journalists.” I was an inaugural JIR fellow in 2017.
On April 10-11, I will attend the "2025 Antitrust and Competition Conference - Economic Concentration and the Marketplace of Ideas." I was fortunate to attend the first conference in 2017, while a JIR fellow, and then the five-year anniversary conference in 2022. I wrote about what changed in between the two and what happened to antitrust enforcement during those years in two stories for the Chicago Booth Review.
From April 23-25 I will be in the UK covering the Cambridge Disinformation Summit. I can’t wait to see my Cambridge colleagues again. Frequent readers of The Dig may recall that I was a guest lecturer last September, in residence for a week in Cambridge, co-teaching the audit module for its Executive Masters in Accounting Program with Professor Michael Willis.
After the jump we'll get into the details of THE SPRUCE HOUSE PARTNERSHIP (AI) LP, et al., Plaintiffs v. COHNREZNICK LLP, Defendant, in the Circuit Court for Baltimore City Maryland, Case No.: 24-C-22-004264, and how that might impact the pending investment by Apax in CohnReznick.
I comment on what this case, and the absence of news of it, says about the dismal state of regulatory oversight of these private equity transactions in public accounting firms. My primary interest in this topic is the impact of private equity acquisitions and investment in public accounting firms and the impact on investors, the audit industry, and the profession.
For example, will regulators step up on a timely basis if these transactions compromise auditor independence and leave audit practices unable to pay claims for negligence and malpractice, as well as employment-related claims and general civil claims from vendors?