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O.C. Investment Case Opens New Territory

Courts: Teachers who lost $100 million in TMI failure raise issue of an auditor's need for independence.

January 20, 1998|JAMES S. GRANELLI | TIMES STAFF WRITER

The first trial in what has become one of Orange County's bulkiest court cases is set to start today as teachers statewide try to recoup some of the $100 million they lost in real estate deals.

The class action stems from the 1994 collapse of Teachers Management & Investment Corp., a Newport Beach firm that invested teachers' money mainly in undeveloped land that lost value during the real estate recession of the early 1990s.

The teachers accuse accounting firm KPMG Peat Marwick of propping up the insolvent Newport Beach firm in order to take $2.5 million in auditing fees out of TMI's limited partnerships, in which the teachers invested.

Barring any last-minute settlement, jury selection is scheduled to begin today in a case in which more than 3 million pages of documents and 2,049 motions have filled 222 volumes of court files. The volumes are growing daily, and the mounting paperwork is worrying the judge.

"A lot of people have written articles about the abuse of modern litigation," Judge John C. Woolley told lawyers in the case last month, adding, "Maybe we're heading in that direction."

The case stems from the excesses of an overheated real estate market in the 1980s and the actions of many companies to pour good money after bad as the boom went bust.

TMI and its two operators, John R. Martin and Maurice B. Shuman, paid $4 million last year to settle accusations against them. Now, the teachers are going after the deep pockets of the Big Six accounting firm that audited both TMI and the limited partnerships.

The trial will focus on the key issue of the auditor's alleged lack of independence, a hot topic in the accounting profession.

The industry is trying to rewrite its ethics rules to reflect the growing changes in the accounting business, particularly the growth in consulting services. These services can create conflicts with the auditing function.

"The audit is a pipeline straight into the heart of the client," said Rick Telberg, editor of Accounting Today, a trade publication. "Through that, they sell a host of consulting services. This case can demonstrate what can happen when an auditor's independence is questioned."

Nowadays, he said, major accounting firms make more money peddling various consulting services than they do in audit work. Regulators worry that firms may be compromising the independence of their audits by using them to sell more services to clients.

The teachers allege that Peat Marwick's auditors compromised their independence in numerous ways:

* Martin, who had been a Peat Marwick partner with a major role in the TMI account, retired in 1985 and joined longtime business associate Shuman in 1987 to buy TMI. Martin remained close to the Peat Marwick partners who continued auditing his company.

* Though it issued a qualified audit for 1988, saying it questioned whether TMI could remain a going concern, Peat Marwick never told the teachers that the next year it found that TMI had lost $9.5 million and was insolvent. The 1989 audit was never issued, andTMI was not audited after that time.

* Peat Marwick, unable to collect $400,000 in fees from what it knew was an insolvent TMI, instead agreed with TMI in 1990 to write off the fees over three years. They then continued to audit some three dozen limited partnerships and collected $2.5 million in fees from them.

* Peat Marwick sold TMI real estate, tax and other consulting services while serving as its auditor in the 1980s.

In addition, said Ronald Rus of Irvine, lead lawyer for the teachers, Peat Marwick knew that TMI was commingling partnership funds with its own money and was diverting funds to itself.

The accounting firm has denied that it did anything wrong or that it compromised its independence. It asserts that its auditors performed admirably, reporting what they should have reported and conforming to all applicable auditing standards.

Peat Marwick's trial lawyer, Thomas Greene of Washington, said that his client simply audited the partnerships. It didn't provide financial, legal or management advice.

Formed in 1968 by a group of educators and real estate specialists, TMI promoted itself as a way for teachers to save for their retirement by investing in real estate.

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