In the latest twist in the battle over responsibility for the savings and loan crisis, California authorities have begun proceedings that could revoke the state license of the nation's largest accounting firm for alleged "gross negligence" in the auditing of a failed thrift.
The state Board of Accountancy charged that small investors lost $250 million because they relied on financial statements prepared by Arthur Young & Co., which audited Charles H. Keating's American Continental Corp. and its subsidiary, Lincoln Savings and Loan Association, based in Irvine, Calif.
Both companies subsequently failed and the thrift was taken over by federal regulators in a deal that may cost taxpayers $2 billion.
Arthur Young since has merged with Ernst & Whinney to form Ernst & Young.
An Ernst & Young spokesman said the firm denied any impropriety and would resist the board's action.
"Generally accepted auditing principles were followed in all cases," he said, claiming that the auditors had been victimized by fraudulent practices by some of the thrift's borrowers.
The California move is the latest in a series of actions by both state and federal regulators to hold accountants, lawyers and other professionals -- along with thrift executives -- responsible for the national S&L cleanup, which may end up costing taxpayers $500 billion over 10 years.
Federal regulators have filed large numbers of suits against auditors and others, contending that they should have detected problems at the institutions much sooner than they did.
L. William Seidman, chairman of the Federal Deposit Insurance Corp. and the Resolution Trust Corp. (RTC), the agency in charge of the S&L cleanup, noted yesterday that his agencies are suing Ernst & Young "for ... hundreds of millions of dollars."
So many suits have been filed by different agencies that Seidman said the FDIC and RTC are having trouble finding accounting firms to work on agency business.
"We have a problem in spades right now ... " he said in an interview with reporters and editors at The Washington Post yesterday.
He indicated that the agencies will probably have to do business with firms that were involved with failed thrifts, including firms the agencies are suing.
He said the FDIC and RTC will probably create a hierarchy, ranging from firms the agency will not use at all to firms that have some taint but are not regarded as so deeply involved as to be unacceptable business partners.
"We probably will have a class that says, 'This firm has done so badly and we're suing them for so much money that we won't use them,' " he said.
The transactions at issue in the California proceeding against Ernst & Young involved sales of desert land near Phoenix, according to Michael R. Granen, California deputy attorney general.
In the deals, American Continental or Lincoln sold large tracts of land and recorded large profits, when in fact the purchase money and even the down payment were borrowed from Lincoln and the buyer had little hope of ever being able to make payments on the debt.
According to one study, Lincoln sold 1,000 acres and booked an $11.1 million profit, even though the buyer had a net worth of only $31,000.
Had these transaction been properly accounted for, Granen said, American Continental would have shown a $36 million loss for 1987 instead of a $37 million profit.
"Those financials were used to support offerings of over $200 million in debentures which were sold to California residents," Granen said.
Granen said the case will be argued before an administrative law judge, who will make findings of fact and recommend a penalty, if one is warranted, to the Board of Accountancy.
The possible penalties range from probation to suspension to revocation of the firm's license, he said.