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Fake Occupants Caused Some Some Problems in Grant Thornton’s Audit of Assisted Living Concepts

The SEC announced a settlement with Grant Thornton and two partners today over some bad audits that went down in America's Dairyland. The firm will pay $3 million in fines, plus forfeit $1.5 million in audit fees with interest. The partners, Melissa Koeppel and Jeffrey Robinson agreed to a $10k fine and a 5-year ban and $2.5k and 2-year ban, respectively.

The Commission's press release has everything most people would want to know, but you're not most people; you're accountants and the details are delicious, so let's dispense with the preamble and get to the fun stuff, shall we? 

The clients in question are Assisted Living Concepts ("ALC"), a senior housing provider and an alternative energy company called Broadwind Energy. Koeppel was engagement partner for both companies and Robinson came in later on ALC. Koeppel was GT's Wisconsin managing partner from 2008 to April 2011 and Robinson was MP from April 2011 to July 2015 when he retired.

I'm going to focus on the audit of ALC since a) the fraud is so bad and b) lots of elderly people actually got evicted from the ALC facilities as a result. The SEC settled with ALC's former CEO Laurie Bebo and ex-CFO John Buono last year and back in October, Bebo was ordered to pay $4.2 million. It's all pretty ugly.

The ALC fraud itself arose out of the company trying to avoid covenant defaults under its lease agreements with Ventas, Inc. the REIT who owned the facilities. Here's the SEC order discussing those covenants:

The Ventas lease contained financial covenants (the “financial covenants”), which required that ALC maintain certain quarterly and trailing twelve-month occupancy percentages and coverage ratios, both at each facility and at the portfolio level.  The lease defined “coverage ratio” as cash flow divided by rent payments. The Ventas lease required ALC to demonstrate its compliance with the financial covenants on a quarterly basis by providing Ventas, within 45 days of the end of each quarter: (1) facility financial statements prepared in accordance with general accepted accounting principles (“GAAP”); (2) schedules documenting compliance with the financial covenants; and (3) an officer’s certificate, signed by an ALC executive, attesting to the completeness and accuracy of such information.   

If ALC fell out of compliance, Ventas could terminate the lease, throw out ALC and accelerate the future rent payments. In other words, there was a lot at stake for ALC. 

Almost immediately after ALC entered the lease agreement in 2008, occupancy in the facilities "declined sharply." This caused Bebo and Buono to take action, specifically, " direct[ing] ALC accounting personnel to include in the covenant calculations between 49 and 103 fabricated occupants for every day from July 2009 through December 2011." Those fabricated occupants included:

(1) [Bebo's] family members and friends; (2) family members (including the seven-year old nephew) of another ALC executive; (3) employees who did not travel to, let alone stay at, the facilities; (4) employees of the Ventas facilities, who lived nearby and did not stay overnight at those facilities; (5) employees who had been terminated by ALC or employees who ALC anticipated hiring but who had not yet started; (6) various ALC employees as occupants of multiple Ventas facilities for the same time period; and (7) other individuals who were neither ALC employees nor residents of the Ventas facilities. ALC did not disclose any of this to Ventas.

But they did disclose it to Grant Thornton and told them that Ventas was in the loop:

Bebo and Buono told Grant Thornton that Ventas had agreed that ALC could include in the covenant calculations ALC employees who travelled to and stayed at the Ventas facilities for business purposes.6

However, in actuality, no such agreement existed and Ventas was never told that any ALC employees were being included in the covenant calculations.  Even if Ventas had agreed that ALC could include in the covenant calculations employees who actually stayed at the Ventas facilities, given that only a small number of ALC employees actually did so, ALC would still have missed the covenants by significant margins. 

The whole thing unraveled in May 2012 when Ventas sued ALC for "unrelated failure to meet state regulatory requirements" and learned — because ALC admitted it — that this "employee adjustment" was even happening. Grant Thornton's audits for 2009, 2010 and 2011 were subject to all these employee adjustments and therefore, you know, fraudulent.

Okay, so what did GT miss? Well, the order goes into excruciating detail so I won't cover it all but here are a few things from the 2009 audit:

  • GT knew that ALC's occupancy was falling and they were close to breaking the covenants.
  • A GT staff person "noticed discrepancies" in the covenant calculations and asked ALC about it. ALC then provided an "occupancy recon" that showed the "employee adjustment." ALC provided an email mentioning that the company "may rent rooms" to certain employees. Koeppel was made aware of all this, a manager even called it "unusual" but told her that they had evidence and she didn't look into it further.
  • GT didn't confirm any of this with Ventas.
  • A summer intern was working on the second quarter review wrote a note on the adjustment:

The employee adjustment relates to extra rooms at each facility not currently occupied by ALC residents.  The rooms are subleased through ALC to improve the overall performance of each facility…Since the units are subleased, an adjustment is needed to show ALC occupancy and for Ventas testing.

  • Koeppel signed off on this, with the knowledge that there was no such agreement.
  • GT noted "unusual" journal entries related to the employee adjustment for all the audits in question, including those that hit "negative revenue" that "offset $1.2 million in non-GAAP revenue on the financial statements of the Ventas facilities associated with the employees included in the covenant calculations." 
  • Didn't even mention the "employee adjustment" in the testing of the fourth quarter, when ALC included 103 employees in the covenant calculation.

Like I said, this was just 2009! What happened next is even more concerning. In 2010, GT's national professional standards and risk management personnel learned that Koeppel had several "negative quality indicators" because she had four clients issue restatements in the prior two years. One of these restatements was for Koss Corporation. The same Koss Corporation that we covered exhaustively back in 2009-2010 when a fraud perpetrated by its VP of Finance (who had a bit of a shopping problem) was exposed. Koeppel was the audit partner on 3 of the 4 years of that fraud.

Things continue to spiral as one of the managers on the ALC engagement quit, leaving only a manger who was not "SEC designated" as required by Grant Thornton policy. This new manager was made aware of the employee adjustment by a staff member but, while skeptical, Koeppel stated that she knew about it and was comfortable with it. That's where the investigation into the matter more or less stopped. The new manager did have it as item to bring up to ALC's audit committee, but Koeppel removed it from the agenda.

In 2011, Robinson took over the ALC job. Right away, it should have been obvious that things were fishy when Buono told him that there had been an "exchange of letters" about the employee adjustment. The SEC order states that Robinson never followed-up on those letters.

Then, in the first quarter of '11, this happened:

Grant Thornton learned that ALC had provided information showing that it failed one of the Ventas lease occupancy covenants.  In reality, ALC had mistakenly included an insufficient number of employees to meet the covenant at issue. After Grant Thornton raised the failed covenant with ALC, ALC provided Grant Thornton with revised covenant calculations in which ALC added employees in order to pass all of the covenants.

In the following days, a Grant Thornton engagement team member emailed the Engagement Manager to apprise the Engagement Manager of her concerns that ALC had added employees after initially failing a covenant.  The engagement team member also proposed that the Engagement Manager request from Buono a letter confirming Ventas’s agreement to allow 16 employees to be included in the covenant calculations. When the engagement team member spoke with the Engagement Manager, the Engagement Manager shared her assessment that ALC’s use of new employees to remedy a covenant failure was “odd.”  However, Grant Thornton did not request additional support from ALC.  When a second junior engagement team member learned that Grant Thornton had not followed up with Buono on obtaining a letter concerning the employee adjustment, he wrote an email to the first engagement team member observing that:  “I don’t think we’re ever going to get this mystery letter."

Oh, man. At this point, you might think that it couldn't get much worse, but it does! Robinson put the employee inclusion issue in a representation letter, Buono asked him to remove it. Robinson complied.

I'll wrap up soon, I swear. But you're gonna love this next part. When GT staff requested the covenant calculation that ALC sent to Ventas, they were given the "occupancy recon" that excluded the employees added to keep them in compliance:

A Grant Thornton engagement team member emailed the materials to the Engagement Manager and wrote:  “The excel document [sent to Ventas] is exactly what we receive [in the occupancy recons], except they exclude the tab where they add employees (as we had kind of expected)” (emphasis added).  The Engagement Manager responded to the email by writing that “I just don’t know how comfortable I am with this.” the Engagement Manager wrote that she called Buono to seek an explanation, but left a voicemail when Buono did not answer.  The engagement team member then forwarded the Engagement Manager’s email to a junior team member, but not the Engagement Manager, writing:  “I wish I could be on this call . . .”  The junior engagement team member responded: “Holly s—.” 

Holly shit indeed! Don't you love how the SEC preserves the typos?

In early 2012, Ventas started revoking ALC's licenses and in May a whistleblower finally came forward stating that "employees included in the covenant calculations were not performing any services at the Ventas facilities or even leaving ALC headquarters." There was an investigation by a law firm and GT stayed on until ALC was purchased by TPG in 2013 and the relationship was terminated.

So! That's all pretty atrocious auditing. What did we learn? Well, I think it could be argued that Koeppel's poor track record was relevant to investors in both ALC and Broadwind. However, as it stands, no one outside of Grant Thornton's national professional standards group probably knew that her audits were so bad. I mean, four restatements in two years seems like a lot and GT may have acted in a timely fashion, but that's all internal policy and I assume they have no duty to notify their clients or anyone else about those partners' performance.  A new PCAOB rule on audit partner disclosure is forthcoming, but depending what those disclosures include, the past performance of an audit partner may not be fully known.

According to the SEC Order, Koeppel is still with Grant Thornton as a managing director outside of the audit practice. In a statement to Reuters, GT said, "We are pleased to have these several years-old matters resolved and we maintain a strong commitment to continually improving the quality of our work."

[SEC Order]
[SEC Press Release]