In last Tuesday’s Preliminary Analytics we mentioned the case of Tom Petters, the Minnesota businessman accused of running a multi-billion dollar Ponzi scheme.

The trial is in its first week and already there has been testimony from the star witness — Petters’ former office manager — that included a recording of Petters saying ‘This is one bi his own defense counsel comparing him to a cocker spaniel:

[Defense counsel, John] Hopeman countered that while Petters was an accomplished salesman, he didn’t have the corporate skills necessary to run companies.
“He has the attention span of a cocker spaniel — about 15 seconds,” the defense lawyer told the 10-woman, six-man jury. “He couldn’t read a whole book if his life depended on it.”

Okay, a couple things before we get to the crux.

• Most cocker spaniels we know have attention spans exponentially longer than fifteen seconds. It would be much more believable if defense counsel had said, “He has the attention span of a pomeranian and you can’t leave him home alone or he’s eats the furniture.”

• Petters couldn’t read a whole book if his life depended on it? Are we talking classic literature? Because if we are, then he’s got company. What about children’s books? Do magazines count? He strikes as a guy that could at least make it through the pro football season preview.

Moving on…

Now that the trial is underway we’ll be following the more interesting developments in the case but we’ll be especially interested in the litigation involving the auditors of the hedge funds that cycled funds to Petters’ businesses.
There is pending litigation in Texas that involves both Ernst & Young and McGladrey & Pullen related to the audits the two firms performed for feeder funds for Petters’ businesses.

These feeder funds received purchase orders for high-end electronics from Petters’ businesses that were seemingly made by big-box retailers such as CostCo. The feeder funds then solicited money from investors, including the plaintiffs in the case, in return for promissory notes for Petters’ businesses. The merchandise on the purchase orders secured the notes. Allegedly, there was no merchandise and Petters used the money received to pay off other investors who were looking to get out and so on and so forth.

The feeder funds that are the defendants in this case are Arrowhead Capital Partners II, L.P. of Minnetonka, Minnesota, Palm Beach Finance Partners, L.P. and Palm Beach Finance Partners II, L.P. of Palm Beach Gardens, Florida, and Stewardship Credit Arbitrage Fund, LLC of Greenwich, Connecticut. The general partners and investment managers of these funds are also listed as defendants.

E&Y served as auditors for Stewardship while M&P served as the auditors of Arrowhead. A small Florida firm, Kaufman, Rossin, & Co., P.A. served as the auditors for the two Palm Beach funds. The firms are being sued, naturally, for not detecting the alleged fraud. In this case, however, the firms may have it coming since the fraud was run by someone with the alleged attention span of a canine.

We spoke with Guy Hohmann, who is representing the plaintiffs in this case, and according to Mr. Hohmann, M&P has the most significant exposure in the Petters case as they also served as the auditor for Lancelot Investors Fund and Colossus Capital Fund, L.P. both Oak Brook, Illinois based hedge funds. M&P also faces litigation from the investors of those funds in Illinois.

Lancelot’s Vice President of Finance was Harold Katz, who just pleaded guilty last month to one count of conspiracy to commit wire fraud. Mr. Hohmann was recently informed that before taking the job at Lancelot, Katz was a senior manager at M&P that worked on the Lancelot audit. M&P would not comment. It has been speculated now that Katz — who pleaded guilty September 2nd — is cooperating with authorities in the cases against Petters and Lancelot founder, Gregory Bell.

In another strange twist, Mr. Hohmann told GC that Lewis Freeman — the forensic accountant that is under federal investigation that we told you about last week — was appointed as the Chief Restructuring Officer of the Palm Beach funds. The Palm Beach funds are not currently listed as an active case on the forensic firm’s website.

We reached out to all the firms named in the lawsuit, McGladrey & Pullen declined to comment while calls to E&Y, Kaufman Rossin & Co., and Kenneth A. Welt, the current receiver listed on the Lewis Freeman website, were not returned.

According to the complaint, the amount lost by the plaintiffs was $24 million dollars, however, according to a October 6, 2008 Bloomberg article, the two Palm Beach Funds were responsible for approximately $1.1 billion of the alleged $3 billion the scheme while the Lancelot funds held approximately $1.0 billion with Petters. Mr. Hohmann’s understanding was that the Palm Beach funds had provided approximately $1.0 and that Lancelot held approximately $1.6 billion. Because of the complex web of companies in this case, the final dollar amounts may not ever be known.

So regardless of the fact that the case in Texas is in its early stages, future lawsuits from other investors could arise, and all three firms could continue to face significant litigation.

We’ll continue to keep you updated on any developments in the cases involving these accounting firms and will be following any noteworthy developments involving the Petters trial.

The case is SSR v. Arrowhead et al., District Court of Dallas County.
SSRvArrowhead.pdf