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The trustee for the bankrupt estate of Foss Manufacturing has charged that the company’s outside accountants enabled officials to loot the company while it was insolvent by turning a blind eye toward fraud.
According to the complaint, Bernard Johnson and Company, located in Topsfield, Mass., violated accounting principals in numerous ways, including not disclosing that it was the sole equity member of Foss Manufacturing Company LLC, a subsidiary of Foss Manufacturing Co. Inc. The trustee wants the firm to give back some of the $900,000 Foss paid it over a three-year period.
The complaint also names David Bernard, a partner in BJC, and Julie Couto, who managed the Foss audit. Bernard referred New Hampshire Business Review questions to his attorney, Kenneth Rubinstein, whose only comment was, “Bernard Johnson has done nothing wrong, and the courts will show that.”
Foss Manufacturing, a Hampton-based privately held manufacturing firm that specializes in non-woven fabrics and specialty synthetic fibers, filed for bankruptcy in September 2005 . A private equity firm has since picked up Foss Manufacturing’s name and assets at a bankruptcy sale, continuing the company and maintaining its workforce. Left behind was the bankrupt shell Felt Manufacturing. While bondholders were paid in full, other creditors were left holding the bag.
Creditors accuse the company’s former chief executive, Stephen Foss, and chief financial officer, Kevin Sexton, with hiding the company’s financial woes while using company funds for personal expenses, including traveling expenses, club members and improvements and payments on homes for Foss and his family.
The creditors also accuse board members, including Foss’s wife and other relatives, of not performing their fiduciary duties to oversee the company.
The trustee’s charges against the accounting firm -- filed last November -- are similar.
BJC engaged in “professional malpractice, negligence and aiding and abetting the Debtor’s officers and directors breaches of their fiduciary duties … by deliberately shutting their eyes to countless red flags,” according to the complaint.
In particular, the accounting firm should have been aware of the fraud because it had been with Foss for more than a decade, according to the complaint. And the firm, especially Couto, was performing tasks that should have been performed by Sexton, the CFO.
Couto “participated in closing the company’s monthly financial statements and on many occasions gave the company’s bookkeeper journal entries to make. … When the bookkeeper did not understand those entries, she questioned Couto, who gave her further direction,” the complaint alleges.
Also, the firm knew that the company’s continuation as a “going concern” was an issue because in a 2004 audit captioned, “Foss Manufacturing Company, Inc. Going Concern Consideration,” contained details of “significant losses from operations the Company had incurred in the past two years,” but the company never revealed that in its audits, according to the complaint.
The complaint also alleges that while generally accepted accounting principles, or GAAP, require that BJC conduct a “fraud risk assessment,” it “failed miserably in this regard,” leaving large sections of the fraud assessment blank. The company didn’t interview Foss, because “in a classic example of leaving the fox to guard the henhouse, BJC, Bernard, and Couto determined that the fact that Stephen Foss was heavily involved in the Companys business” showed he had no “incentive to override the company’s control.”
The complaint asks for compensation damages, subordination of claims of the firm against the bankrupt estate and avoidance of transfers from the Foss to the accounting firm.
On Jan. 18, BJC moved to dismiss the complaint, echoing the defendants’ position that there was no fraud in the first place. Even if there were, the accounting firm says, it was not in the same class as the insiders.
“They were only third party vendors to the Debtor and as such have little or nothing in common with the Insider Defendant,” responded the accounting firm’s attorney. And “there is no allegation that they benefited from any alleged wrongdoing.”
BJC didn’t specifically respond to the allegation that it was a partner in a Foss subsidiary, or that it was paid $900,000 by Foss Manufacturing while allegedly “deliberately shutting their eyes” for signs of fraud.
On Jan. 29, Foss and the other defendants seized on the trustee’s complaint against BJC, arguing that the case should be consolidated because it was based on the same allegations of fraud. In addition to saving all parties and the court time, it also might be helpful to their own case because the Foss officials relied on the advice of professionals like BJC, and loss by creditors could be partly or wholly attributed to accountants.
A hearing on the matter has been scheduled for February 27 in federal bankruptcy court in Manchester. – BOB SANDERS/NEW HAMPSHIRE BUSINESS REVIEW
