Quick Take – Dumb Auditors Edition (FEED)

Poor McGladrey, Pullen aka RSM McGladrey, the middle market accounting firm that just happened to be the auditor of now halted Chinese reverse-merger scam AgFeed‘s (FEED) admittedly fraudulent financials. Having the wool pulled over one’s eyes is embarassing enough for an auditing firm, and it makes one wonder how Deloitte and KPMG are even still in business, but at McGladrey it is so much worse. The firm, stupidly, signed off on FEED‘s 10K on 16 March 2011.

On 14 June 2011, apparently unaware that they had already been fooled by the crooks at AgFeed, the PR team at McGladrey decided to rub the Longtop Financial fraud in the face of audit firm Deloitte Touche Tohmatsu, in their biweekly “Insights” newsletter, available here. It stated:

On May 22, 2011, Deloitte Touche Tohmatsu CPA Ltd. resigned as auditor of Longtop Financial Technologies Limited, a Chinese software company. In its resignation letter, Deloitte Touche Tohmatsu stated it was resigning as the result of, among other matters, the recently identified falsity of the Company’s financial records in relation to cash at bank and loan balances and possibly in sales revenue. As part of the process for auditing the company’s financial statements for the year ended March 31, 2011, Deloitte Touche Tohmatsu determined that, in regard to bank confirmations, it was appropriate to perform follow-up visits to certain banks. These audit steps identified a number of very serious defects including: confirmation replies previously received were said to be false; significant differences in deposit balances reported by the bank staff compared with the amounts identified in previously received confirmations; and significant bank borrowings reported by bank staff not identified in previously received confirmations.

This incident, together with several other recent Chinese accounting scandals, indicates the elevated risks of verifying bank balances in China. Both external and internal auditors may need to bolster procedures for confirming bank balances there, including hand delivering the confirmation to the bank and waiting there while the bank officer completes it. Also, extra diligence should be used in auditing accounts receivable because that is where fraud is often first disguised before being hidden in exaggerated cash balances. For example, unreturned confirmations for accounts receivable may pose more of a concern than is normal in the United States and could require more than the traditional alternative procedures.

It is a pity that McGladrey didn’t take any of that advice and just signed away on FEED‘s financials like so many other incompetent, or is that complicit, accountants. A Barron’s article, available here, discusses allegations that McGladrey actively participated in the collapse of Sentinel Management in 2007:

For McGladrey & Pullen, some tough questions have come from Frederick J. Grede, a Chicago bankruptcy trustee who claims the firm’s auditors actively participated in the “looting” of Sentinel Management Group, a $1.4 billion investment fund that failed in August 2007.

A lawsuit filed by Grede accuses McGladrey & Pullen auditors of “preparing false footnotes to Sentinel’s financial statements,” certifying bogus financial statements to federal regulators, “consciously ignoring” serious problems “clearly shown” in the firm’s work papers.

Time to look closely at McGladrey‘s other clients?

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