SEATTLE – Ernst & Young LLP charged Metropolitan Mortgage & Securities Co. a hefty $1 million each year for auditing services, betting its reputation that it could handle a firm that was losing money and known for risky business dealings.
The accounting firm also charged the Spokane financial conglomerate for tax advice and business consulting services.
That remuneration made Metropolitan a financial chance worth taking even though Ernst & Young put the Spokane company in a special category of clients that needed “extra attention,” according to testimony Thursday in the criminal trial of Thomas G. Turner, the former No. 2 executive in the Metropolitan group of companies.
Turner is the first Met executive to face criminal charges for his role in the largest corporate failure in Spokane’s history.
Turner’s lawyer, David Marshall, on Thursday began cross-examining Ernst & Young partner Jack Behrens, who said never in his 30 years of audit work had he been lied to and deceived like he was by Turner.
Those allegations are at the crux of the U.S. District Court jury trial, which comes three years after Metropolitan went bankrupt.
Though Turner is on criminal trial, Ernst & Young may have the most to lose. The auditing firm is accused of professional negligence by regulators and investors in at least three other legal actions that could cost it tens of millions dollars, if not hundreds of millions.
Behrens put the blame squarely on Turner, accusing him of lying about, and withholding important information about, a land sale made in the waning days of Metropolitan’s 2002 fiscal year that helped the company dodge a third straight year of losses.
The $24 million transaction allowed Metropolitan to book a $10 million profit on the deal – essentially converting what would have been a $6 million operating loss into a $3.9 million year-end profit.
The turnaround was supposed to have helped Metropolitan soothe the scrutiny federal regulators were applying to the company’s efforts to sell $150 million in new unsecured debenture bonds and preferred stock.
Behrens testified that in the summer of 2003, nearly a year after Turner allegedly misled auditors, an Ernst & Young team found some documents that began to unravel Metropolitan’s financial records.
Behrens recounted how in the autumn of 2002, Turner claimed to have found a buyer for two pieces of land in Everett and San Antonio, Texas.
Arrangements to sell the properties earlier in the year had fallen apart, making the new deal a surprising relief and good moneymaking opportunity.
The buyer was a Bellingham businessman with plenty of cash and sophisticated development plans, Turner told Behrens in explaining the sale.
The deal was structured in such a way that the buyer, Dan Sandy, acting through a company called Jeff Properties LLC, was given a lower-than-normal interest rate in return for costly penalties if Jeff Properties missed a payment. The terms, Behrens testified, helped deflate any concerns that the deal may not be legitimate.
Many months later, in the summer of 2003, Ernst & Young staff came across some different loan documents that outlined how a company called Trillium Corp. was covering Sandy’s interest payments.
Trillium, a timber and land developer based in Bellingham, was one of Metropolitan’s largest borrowers, owing $30 million for projects ranging from timberlands to a troubled downtown Denver development.
Behrens grew suspicious and wanted to understand why one company would cover the debts of another when each was supposed to have independent lender relationships with Metropolitan.
Accounting rules require that profits from real estate deals can’t be booked for financial reporting purposes unless there’s a buyer willing to put at least a 20 percent down payment on the purchase.
The problem was that Metropolitan had been loaning money to Trillium, which was then making payments on behalf of Jeff Properties and Sandy.
According to earlier testimony, Sandy was a major creditor of Trillium and agreed to buy the properties as a favor to Trillium, which could then repay him a $5.5 million loan.
Without knowing the Sandy/Trillium relationship, Behrens testified that he took his concerns to William Smith, whom Metropolitan had hired a month earlier as its chief financial officer.
Behrens testified that had auditors known about the Trillium connection a year earlier it would have been “click … all the bells and whistles go off.”
Behrens said Smith began looking into the matter and the two men asked Metropolitan’s internal audit committee to launch an in-house investigation.
Lona Barnum, the head of Metropolitan’s internal audit unit, led the investigation and together with Smith and Behrens began unraveling the true nature of the real estate deal and Turner’s lies and omissions, according to Behrens’ testimony.
In one interview, Turner said he couldn’t recall meeting Sandy, to which Behrens testified that he stammered: “My God, you just lent this guy $20 million and you don’t remember?”
Behrens added, “My personal reaction was that he was covering up something, was not credible, and was clearly lying to us.”
Behrens returned to Seattle, consulted with Ernst & Young partners, and decided the auditors would resign from Metropolitan and retract the firm’s prior audit work.
On cross-examination, Turner’s attorney Marshall said Behrens and Ernst & Young knew they were in legal trouble and began preparing their defense.
Indeed, Ernst & Young has been sued by the Washington state insurance commissioner because of its work with Metropolitan’s insurance affiliate. The sides are now in arbitration.
Ernst & Young has also been sued by Metropolitan’s investors and faces arbitration with a special bankruptcy trust that’s trying to recover money for the 16,000 investors who lost a half-billion dollars in investments.
The federal government has not alleged wrongdoing by Ernst & Young as it relates to Metropolitan. It has instead focused on lawsuits against former executives and Trillium.