State to Investigate Accounting Firms for Lincoln S

A state agency will investigate three major accounting firms that worked on financial statements for insolvent Lincoln Savings & Loan in Irvine to determine if they were negligent, a state Board of Accountancy official said Wednesday.

The board will initiate its investigation of Arthur Andersen & Co., Arthur Young & Co. and Touche, Ross & Co. within the “next few weeks,” said Gregory J. Newington, the agency’s enforcement program director. The Arthur Young firm merged with Ernst & Whinney earlier this year and now is known as Ernst & Young.

Federal regulators, who filed a $1.1-billion racketeering suit last week against Lincoln’s former operators, also are investigating the role of those accounting firms in Lincoln’s collapse.

The racketeering suit levels a harsh blast at Arthur Young and Jack D. Atchison, one of its partners in Phoenix who quit last year to work for Lincoln’s parent company, Phoenix-based American Continental Corp. Though it does not name either as a defendant, the suit nevertheless claims that they misrepresented Lincoln’s condition in a 1987 letter to a public official.

The letter, together with the intervention of U.S. senators called in by American Continental Chairman Charles H. Keating, a heavy contributor to political campaigns, “protracted the examination process and afforded (operators) additional time in which to exacerbate their frauds” on Lincoln and regulators, according to the racketeering suit.

“We stand behind the audits,” said Eugene Erbstoesser, Arthur Young’s associate general counsel in Los Angeles. He denied that the accounting firm did anything wrong either in responding to public officials or in auditing Lincoln’s and American Continental’s books.

He also criticized the accountancy board for revealing its investigation through the media. He said his firm had not been notified yet about the board’s intentions.

Lawyers and spokesmen for the other two accounting firms could not be reached for comment Wednesday.

Federal regulators seized Lincoln on April 14, a day after American Continental filed for bankruptcy. Industry experts claim that the S&L;, which has since been declared insolvent, will cost taxpayers up to $2.5 billion, which would make it the most expensive thrift bailout ever.

Last month, the accounting firms, particularly Arthur Young, were roundly criticized in a review by the accounting firm of Kenneth Leventhal & Co. of 15 major real estate transactions at Lincoln. Regulators hired Leventhal to conduct the review.

Leventhal claimed that more than half of Lincoln’s income since American Continental bought it in 1984 was manufactured through “accounting gimmickry.” Leventhal claimed it had seldom seen “a more egregious example” of misapplied accounting standards.

In addition, lawsuits filed by investors against corporate insiders and their advisers, including the accounting firms, claim that favorable audits helped to stall regulators for more than a year in their effort to seize Lincoln.

In that time American Continental sold nearly $200 million of high-risk subordinated debentures, essentially corporate IOUs, through Lincoln’s 29 Southern California branches to some 22,000 investors. Now, the investors expect their holdings to be wiped out in the bankruptcy proceedings in Phoenix.

They also plan to file a lawsuit this week against the state Department of Corporations for its role in approving the sale of those debentures. Earlier this month, the agency rejected a $250-million claim filed against the state.

Newington said the accountancy board’s investigation will center on Arthur Andersen, which audited the thrift’s books through 1985, and Arthur Young, which audited the books for the next two years.

The board also will look at Touche Ross, which was hired to help American Continental prepare the report on its third-quarter results last year, he said.

It was the 1988 third-quarter report that provided the first dramatic public evidence of trouble at the thrift and American Continental. The company wanted to record a $56-million profit as part of what it claimed was an $81-million profit from the increased value of stock a Lincoln subsidiary held after a swap of stock interests with British financier Sir James Goldsmith.

Arthur Young disagreed and quit over the issue. Its replacement, Touche Ross, suggested getting approval from various regulators before booking the profit.

But the U.S. Securities and Exchange Commission rejected the attempt to book the profit. Lincoln then posted a $20-million quarterly loss, and the company reported a consolidated quarterly loss of $36 million.

Newington said Touche Ross’ involvement in Lincoln may be “on the periphery” but will still be investigated.

He said the accountancy board decided to look into the role of the accounting firms after reading press reports about lawsuits filed by investors against the operators of Lincoln and their advisers, including the three accounting firms.

Though the Phoenix offices of the accounting firms ultimately passed on the audits and other accounting work, he said, licensed certified public accountants in their California offices also handled parts of the audit. The fact that some of the work was done in California gives the board jurisdiction.

Any wrongdoing the agency finds could result in sanctions ranging from public admonishments and fines to suspension or revocation of individuals’ licenses, he said. Previous probes against licensed accountants at major firms have resulted in “substantial restrictions,” short of revocations, against individuals and the firms, he said.

The investigation into Lincoln’s outside accountants likely will take “many, many months, perhaps a year or so,” he said.