Barron's  May 11, '09

In investor lawsuits filed in recent months, BDO Seidman and McGladrey & Pullen stand accused of shoddy audits and signing off on the books of fraud-ridden businesses and investment funds. The cases, together with a string of earlier ones involving the two firms, raise unsettling questions about the level of confidence investors can put in financial audits.

The two audit firms say they stand by their work, and there is, in fact, some murkiness about auditors' responsibilities for detecting fraud. The firms are supposed to "obtain reasonable assurance about whether the financial statements are free from material misstatement, including misstatements caused by fraud," according to the Public Company Accounting Oversight Board, the federal entity that supervises auditors of public companies. The gray area centers on what is reasonable, an issue that often plays out in the courts because accounting firms can be one of the only solvent players left when a company goes down.

-Skip-

California attorney Steven Thomas, who in 2007 won a $522 million jury award against BDO Seidman stemming from its Bankest audits, says the case reflects the kind of cozy interdependence that helped sink Enron and Arthur Andersen. "Auditors are supposed to have professional skepticism, and that is just inconsistent with the client relationships that they try to preserve to keep the money flowing," Thomas says.

-Skip-

The firm also is contesting a civil lawsuit from the collapse of Le-Nature's Inc., a Pennsylvania iced-tea producer shuttered in 2006 after allegedly faking $240 million in revenue, according to forensic accounting undertaken by a bankruptcy court. BDO Seidman auditors had certified that Le-Nature's financial statements were free from material error.

"There is a difference between being fooled and putting your head in the sand so you don't see things," says Robert Loigman, a New York lawyer representing Le-Nature's investors who sued (BDO Seidman). A tour of the company's Latrobe, Pa., warehouse would have made clear Le-Nature's wasn't selling $300 million worth of bottled drinks a year as claimed, he says.