Brown-Torrington and Emmett, Orr & Peterson One Giant Down…the other to fall?

Introduction

“I don’t think you understand. This could be the end of us,” said Noel Jameson, senior partner of
Emmett, Orr & Peterson LLP, to the president, Randy Mays. Mays responded, “Not necessarily Noel.
We can recover.”

In early March 2004, Emmett, Orr & Peterson LLP (EOP), a leading U.S. auditing firm was under
question for not stepping in to prevent the accounting malpractice that had led to the bankruptcy of
Brown-Torrington, a Fortune 500 pharmaceutical company. The events leading up to the collapse of
Brown-Torrington shocked the investment community as well as regulators who had heralded Brown-
Torrington as a well-respected and ethical leader in the pharmaceutical industry. The downfall was
ignited when Brown-Torrington management was found to have accounted for special purpose
enterprises (SPEs) off the balance sheet. These SPEs had a high level of debt, which was not fully
transparent to Brown-Torrington’s shareholders. After a series of top management fled from Brown-
Torrington, it became obvious that something had ran amok. Within weeks, Brown-Torrington’s share
price plummeted leaving shareholders and pensioners with worthless stock and the company with a
mountain of debt.

When the accounting issues at Brown-Torrington arose, the spot light was immediately turned on the
accounting firm EOP. On January 25th, 2004, EOP management admitted to shredding important
documents that contained details about Brown-Torrington’s suspicious off-the-balance sheet
transactions. EOP was now on the precipice of disaster. Was it their responsibility for what had
happened at Brown- Torrington? Could they have prevented the malpractice? What should be done to
maintain their client base?

Pharmaceutical Industry

The pharmaceutical industry was one of the largest industries in the world with estimated global sales of
$300 billion USD per year. While the industry had experienced strong growth throughout the 1990s, the
rate of increase had slowed to about five per cent per year in 2003. Even though there was tremendous
opportunity with an aging population in North America, Western Europe and Japan (the world’s three
largest markets), many pharmaceutical companies were struggling to allocate research and development
dollars and develop the next “blockbuster” drug. Governments, health insurance companies and
consumers had all put downward price pressure on new drugs being released into the marketplace.

The process of introducing new drugs was an exhaustive process sometimes exceeding ten years and
costing up to $300 million USD per drug. In order to develop new drugs, pharmaceuticals allocated up
to 15 per cent of their sales in research and development. Although this allocation was considerable,
pharmaceutical companies were not necessarily guaranteed that their developed drugs would hit the
marketplace. This process was frequently referred to as the “pipeline” which had three major phases:
pre-clinical, clinical testing and the drug approval and registration. The pre- clinical phase took
approximately four years and before moving into the clinical testing phase, pharmaceuticals took out a
20-year, non-renewable patent. This meant that pharmaceutical companies had to be mindful of the time
in the preceding two stages. The second stage of clinical testing involved a series of tests on humans.
The phase typically lasted five to six years. Finally, if the drug had made it through the other two stages,
it was ready for approval and registration. The governing body for pharmaceuticals in the U.S. was the
Food and Drug Administration (FDA), who required that companies demonstrate the superiority of their
product over existing drugs. The approval process took approximately 18 months. Delays were costly to
pharmaceutical companies with some industry observers estimating that each day cost $1 million USD
in lost sales.

Once a drug’s patent expired, other pharmaceutical companies were permitted to produce a “generic”
version of the same drug, often at a 30 per cent price discount. This was considered to be the last part of
the drug’s life cycle from a profit perspective. Thus, it was vital that the large pharmaceuticals continued
developing their “pipeline” for future blockbusters.

Ethical considerations in the Pharmaceutical Industry

The pharmaceutical industry was heavily regulated by the government. Governments levied regulations
on the testing, content, pricing and relationships that pharmaceuticals had with the rest of the health care
industry. A number of major ethical debates existed within the bioscience industry. The first involved
scientific and testing issues such as genetically modifying foodstuffs, testing on animals, prematurely
releasing a drug by skipping testing phases and the treatment of human embryos and the human genome.

The second central issue involved the actual business practices of companies participating in the
bioscience or pharmaceutical industry. Several scandals had come to light in recent years such as insider
trading at ImClone, misleading business statements by Biopure, charges of fraudulent activity at
AstraZeneca and Merck- Medco and the questionable marketing practices of ‘fen-phen’, a diet drug
produced by Wyeth-Ayerst.

An on-going debate in the industry was the extent to which physician incentives should be provided by
pharmaceutical companies. A study conducted in 2002 by the Kaiser Family Foundation discovered that
61 per cent of doctors received free meals, travel and entrance to events in exchange for prescribing new
drugs to their patients.
The industry had also been prone to pharmaceutical companies offering kickbacks to doctors for using
their drugs. In response to rising pressure, the Pharmaceutical Research and Manufacturers of America
(PhRMA) put forth a voluntary Code on Interactions with Healthcare Professionals that stipulated
appropriate expenses for the purpose of marketing to physicians.

History of Brown-Torrington

Brown Pharma was founded in 1926 by Joseph Raymond Brown. Brown was a leading academic and
scientific researcher from Northwestern University. He was one of the first pharmaceutical academics to
form his own company and build a stand- alone research staff. By the Second World War, the U.S.
government became more involved in drug research. Brown was credited as forging positive
relationships with the U.S. government, developing an anti-malarial drug in the 1940s and being on the
forefront of commercially viable penicillin in the 1950s. Brown’s undying dedication towards
pharmaceutical development was the cornerstone of his organization. He had instilled strong academic
principles, while pushing his company’s scientists towards drugs that would be profitable. When he
died in 1974, Brown had left behind a highly successful scientific-driven enterprise.

Under new management the company flourished throughout the late 1970s and 1980s, until it was
investigated in 1986 by the U.S. government for its pricing practices. The company had priced a number
of new drugs by claiming incorrect categories that allowed for higher prices. Industry observers felt that
Brown Pharma had made a grave error, which would cost them their company. However, the company
paid out compensation, decreased its prices and reduced its overhead by cutting back on its oversized
sales department. By the late 1980s, the company had returned to profitability through the release of a
“blockbuster” drug. By 1994, its problem was quite different – it had plenty of cash but it had no other
blockbuster drugs in the pipeline. It targeted Torrington Stills for a takeover.
Torrington Stills had been founded by a group of pharmaceutical and agricultural scientists in 1967. The
company was quite different to Brown Pharma in that it had fostered group activities in its development,
marketing and sales approaches. The company had become known as an alternative to the larger
corporate pharmaceuticals. By the early 1990s however, some industry observers felt that the company
was part of the mainstream. Although it was credited in recognizing new trends in drug development
and having a strong research arm, the company had had several problems with late releases. Analysts
questioned Torrington Stills’ ability to compete in the industry, since industry players were constantly
cutting out time in the development process to bring new drugs to the market. By 1994, Torrington
Stills was highly leveraged and could not meet its loan payment requirements, making it ripe for a
takeover.

In November 1994, Brown Pharma purchased Torrington Stills and Brown- Torrington was the new
name given to the merged entity. The challenge of the merger was to integrate Brown Pharma’s
expertise in marketing, sales and production, while utilizing the group development process at
Torrington Stills. The integration process was long and taxing. One senior manager from Brown Pharma
who participated on the integration team commented, “Just because they’re a bunch of long-lost hippy
scientists, does not mean that everything can be effectively done in a group. There’s no accountability.
They don’t seem to understand the dynamics in getting a product’s cost down and getting it out into the
market.” A member from the Torrington Stills team recalled the integration process, “the Brown Pharma
side was very demanding and a little too quick. Contrary to popular belief, we’re very aware of the
importance of getting products out quickly. However, that should not come at the cost of developing a
quality drug. It may cost $1 million per day for every day, but that’s a lot better than several million if
the drug proves to be harmful!”

Brown-Torrington had overcome its integration challenges and by 1997, it was considered to be one of
the fastest growing companies in the pharmaceutical industry. The company posted superb financial
results from 1998 through to 2002, growing at a compound annual growth rate of 21 per cent at a time
when industry growth had slowed to five per cent. In early 2001, an analyst report stated: “We feel that
Brown-Torrington is well positioned. They have some great blockbusters and have sorted out their
pipeline problem that plagued them a few years ago. The company has managed to innovate and build
production capabilities to take advantage of making generic drugs. We believe that they will continue to
outperform their earnings per share (EPS) estimates.”

In 2002, the company had posted record revenues of $18.7 billion USD and profits of
$4.6 billion. The company’s stock price had soared to $32.80 from the previous year’s level at $23.56.
Credit agencies rated the company’s debt instruments as triple A. Financial success was not its only
strong point – the company had been selected by the popular press as one of the Top 100 best companies
to work for in the U.S. Scientific organizations, management consultants and business schools all
studied the company’s unique development process and how it had managed to leverage the expertise of
its merged companies and innovate successfully. The company’s CEO and Chairman Aaron
Wheelwright was credited with much of the firm’s vision and was handed several awards for one of the
best CEOs in the U.S.

The Auditing Industry

Auditing rose to prominence in the 1930s as companies looked to independent firms to evaluate their
public financial statements on an objective basis. The role of auditing firms was to provide technical
expertise and objectivity in interpreting generally accepted accounting principles (GAAP). Accounting
was not deemed to be an exact science. GAAP provided a framework for companies to prepare their
financial statements and for auditing firms to ensure that the financial statements were reliable. Exhibit 1
shows a list of GAAP definitions. The reach of auditors work was wide as banks, creditors and investors
all made decisions based on a particular company’s financial statements. This objectivity and coherence
to a set of principles was particularly important to instill confidence in the general investing public who
chose to buy and sell shares on security markets. In fact, the growth of the worldwide stock markets was
often credited to auditing, which had worked to allay the fears of the investing public by providing an
objective view of financial performance.

The Securities Exchange Commission (SEC) was the governing body in the United States responsible
for the public trading of securities. SEC required that any company engaged in public trading of stocks,
bonds or any type of security, submit a set of audited financial statements on an annual basis. SEC’s
primary mission was to “protect investors and maintain the integrity of the securities markets.” SEC held
the belief that, “all investors, whether large institutions or private individuals, should have access to
certain basic facts about an investment prior to buying it.” As part of this concept, SEC disclosed all
public documents on their website (www.sec.gov) for every publicly traded company. Each year, SEC
brought between 400 to 500 civil enforcement actions against infractions like insider trading, accounting
fraud and the release of misleading and false information.

Major auditing firms had expanded into strategy consulting and information technology consulting in
the late 1970s and early 1980s in order to develop alternative revenue streams. Auditing was becoming
increasingly competitive, and as such, auditing firms started lowering prices to compete. For many
firms, consulting became more lucrative and attractive since each situation required a custom solution,
allowing the consultants more flexibility in bill-out rates.

Emmett, Orr & Peterson (EOP) LLP

Godfrey Emmett, a Harvard professor and one of his students Richard Orr, a Harvard MBA, founded
Emmett & Orr as an auditing firm in 1927. Emmett and Orr saw great opportunity with the burgeoning
U.S. stock market and believed that corporations could benefit from an objective third party opinion.
In the early days, clients were surprised at how Emmett and Orr, two men with an age difference of 20
years had managed to equally operate the firm. In a public speech at Harvard, Emmett commented on
his younger partner, “Richard [Orr] and I are equals. We both make decisions. While the circumstances
of our initial acquaintance was through the teacher-student dynamic, we have become business
partners.” In another speech, Orr talked about Emmett, “Some people find it strange that we could both
be in charge of making decisions. People, have often take me aside, tug on my coat and say, ‘no really,
the big guy makes the final call, right?’ For me, it’s been an ideal partnership…I bring hustle to the
organization and Godfrey brings calm.”

Both Emmett and Orr emphasized the importance of strict confidence with their clients. At the same
time, they never strayed from their role of giving an objective third party opinion. They recruited young,
aggressive and bright auditors and imparted a doctrine of “be respectful, show integrity and be direct.”
They sought individuals who had technical acumen and people who could interpret financial information
for management decision-making. Orr had been quoted as saying, “we train our auditors to see the forest
beyond the trees. If they need to count the number of rings of a hundred year maple tree, fine, but they
need to be able to then rise above and tell the client why that’s important.”

Emmett and Orr were extremely successful at building their organization and by the 1960s had become
one of the United States’ pre-eminent accounting firms. In 1967, Emmett passed away and the reins
were turned over to Orr. Orr promoted a young rising manager named Joshua Peterson through the ranks
and Peterson eventually became a senior partner in the late 1970s. Peterson convinced Orr to consider
moving heavily into management and information technology consulting. Peterson recalled in an
interview years later, “I saw that we were in there with top management of major multinationals. We
were already talking about confidential and future strategic decisions. I felt that we could do a lot more
than verify the numbers.”

Peterson’s strategy worked – by the mid-1980s, Emmett, Orr and Peterson had captured over 100 major
contracts accounting for over $1 billion in consulting revenues. When Orr retired at age 80 in 1982,
Peterson ran the company until 1997. Peterson was acknowledged for promoting the original founders
vision of being direct and maintaining “one face” to its customers, whether the activities were in
consulting or auditing. By the time Peterson retired, EOP was posting revenues of $6 billion, with over
half coming from consulting engagements. The presidential title was handed to Timothy Bayliss, who
had a vision of spinning off the consulting arm from the original auditing firm. In 1999, Bayliss formed
Emmet, Orr, Peterson and Bayliss Consulting and maintained the EOP name for the accounting
activities. The split was long and arduous and insiders had divided into one of the two camps.
Animosity grew within the ranks and a once seamless “one face” organization had split into two
disparate companies with distinct corporate cultures. The consulting arm was seen as aggressive and
cutthroat whereas the accounting side had retained its conservatism.
Relationship between Brown-Torrington and EOP

The relationship between the two enterprises dated back to both founders. Joseph Brown and Godfrey
Emmett were contemporaries: both were born in the same month in 1887 and both were former
professors who had broken out from their academic research to form companies. They first met in 1928
and the following year, Emmett had convinced Brown to “let him audit their books.” Brown and Emmett
were often compared in the popular press and management journals. In the late 1950s, the two even
went on a road show, visiting five of the top U.S. universities talking about how honesty, integrity and
ethical practices could translate into profitable business. In one speech, Brown commented, “Professor
Emmett and I are peas out of the same pod. We both are investigators and we both believe that
directness is the only way to build a successful enterprise.” In an interview before his death, Emmett
talked about Brown, “It’s people like Joseph Brown that have made America great. I feel fortunate to
call him a contemporary, client and friend.”

Brown-Torrington was the longest standing client of EOP. Because the relationship was of great
historical importance, EOP’s management emphasized the importance of “keeping Brown-Torrington
happy.” A former EOP auditor commented, “from day one, it was very clear. Don’t mess with Brown-
Torrington. It was like they were a sacred cow.” Another EOP employee saw it differently:

“I worked on the Brown-Torrington account for several years. They were an outstanding organization.
Yeah, sure, our management made it clear to us that it was an important relationship. But, I never felt
that anyone was saying, ‘do what they want.’ I always felt comfortable telling Brown-Torrington
management that they should change something if I didn’t feel it was appropriate.”

Brown-Torrington also used EOP as a training ground and recruitment pool. Several Brown-Torrington
finance, IT and general managers had at one time worked for EOP. An employee that had worked at
both companies commented, “it’s no secret that when you’re out on audit at Brown-Torrington, you may
also be evaluated for a job there.”

In 2002, EOP earned over $50 million from Brown-Torrington, which was weighted evenly between
consulting and auditing fees. EOP had a full-time staff of 25 individuals working at the Brown-
Torrington head office. Within that team, pressure was mounting to confront Brown-Torrington on their
treatment of off-the-balance sheet transactions and the treatment of debt of special purpose enterprises
(SPEs).

By the end of 2002, EOP had identified Brown-Torrington as a ‘maximum-risk’ client due to their
potential exposure to high debt. One internal memo from audit team lead, Alejandra Seinra to EOP’s
president Randy Mays in early 2002 read:

“We’ve been studying the SPEs of Brown-Torrington for some time now. The documentation is light in
some areas and it looks as though they have over
$1.1 billion due in the next three years. But, all of their profits have been booked to Brown-Torrington
on the net present values of drugs that are still in the pipeline. I personally feel that this is not a good
idea. They’re exposed and I think we need to convince them to show some of this exposure on their
corporate balance sheet, instead of having it hidden from public view.”

Accounting Practices at Brown-Torrington

In 1999, Brown-Torrington had established special purpose enterprises (SPEs), which were intended to
represent the development of each new “blockbuster” drug in the pipeline. Brown-Torrington had also
created other SPEs for other companies’ blockbuster drugs, with the plans that Brown-Torrington would
be in a position to produce generic drugs once their competitors’ patents expired.
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By 2002, there were approximately 20 SPEs that had been created. Brown-Torrington had been moving
the research and development expenses from the parent company to the SPEs as assets. Brown-
Torrington had been financing that development through private debt instruments, which became the
SPEs liability. Brown-Torrington then calculated the expected return in the form of Net Present Value9
of future free cash flows from each blockbuster and generic drug and booked the profits immediately.
This practice was highly speculative as Brown-Torrington was not certain which drugs would become
blockbusters. Booking profits based on future earnings inflated.
Brown-Torrington’s yearly profits from 1999 through to 2002. It was estimated that the company had
booked over $3 billion dollars in speculative revenues over the past three years. Increased profits led to
the company’s increase in share price as more investors were attracted to Brown-Torrington’s
performance.

When an EOP team member working at the Brown-Torrington head office requested a bank document
proving the assets of three SPEs in late 2001, a Brown-Torrington executive submitted three separate
letters from the same offshore bank with a statement of the SPEs holdings. The EOP team member felt
that there was no need to investigate further. However, the Brown-Torrington executive had asked his
teenage daughter to make changes to one bank letter with Photoshop, altering the amount of holdings
and the SPE name. Out of an estimated $1.2 billion in assets, there was under $25 million in actual cash
holdings. On the liabilities side, all of the SPEs carried substantial debt loads. The total exceeded $1.1
billion, which were payments due in 2004 and 2005. Exhibit 2 shows Brown Torrington’s financial
statements and Exhibit 3 shows a sample of the exposure of three of the company’s SPEs.

Events leading to the fall of Brown-Torrington

The first correspondence doubting Brown-Torrington’s accounting treatment of SPEs was within EOP
and was sent to the senior partner Randy Mays by Alejandra Seinra in February 2002. Around the same
time, Maurice Levine a Brown-Torrington finance manager and former auditor at EOP wrote an email
to Alex Yury, Brown- Torrington’s CFO, which read:
Net present value refers to a calculation that estimates the future free cash flows of a particular project
discounted at a rate reflective of market and business risk.

“Dear Alex, I would like to meet with you about some of our SPEs. I know we have the management
review coming up and I think it’s prudent to discuss moving some of the debt back to the parent
company. Is there a plan to transfer more capital to the SPEs? Do we feel that the income from Code72
[a new blockbuster drug] will offset this risk? I look forward to speaking with you about this. Maurice.”

Yury responded with an email:

“Thanks Maurice. Aaron [Wheelwright, the CEO] and I are meeting tomorrow on the SPEs and will be
discussing that very topic. I have been keeping a close eye on those SPEs to make sure that everything is
in check. And, yes, to answer your question --- Code72 is going to be our next ‘Titanic’ --- not the
sinking ship of course, but rather the cinematic blockbuster! Regards, Alex.”

After six months in August 2002, another finance manager Rajinder Lata wrote to Brown-Torrington’s
group of finance managers stating:

“Does anyone have the documents based on the asset holdings of the followingSPEs: Jenby, Gano and
Lewis? I’ve been scouring this finance department and all I can come up with is a lot of debt for those
holdings…”

Maurice Levine was the only to respond to the group email, “Hi Rajinder. I had spoken about this with
10
Alex a few months ago, and he’s looking after it. Regards, Maurice.”
In January 2003, a month after management bonuses were paid out, Alex Yury, Brown-Torrington’s CFO
resigned abruptly. One newspaper reported:

“There seems to be no apparent reason for the sudden departure of Brown- Torrington’s CFO Alex Yury.
Yury has put in fifteen successful years at the company. CEO Aaron Wheelwright was asked to
comment, ‘Alex has moved on for personal reasons.’ The departure seems out of character for the
company. Yury was not available for comment.”

Yury’s departure left the finance department frozen. Yury had maintained frequent informal
communication with all of his managers and none of the managers were able to contact him after he left
the company. Within a month, RajinderLata received an email from Brown-Torrington’s legal
department asking to see some of the SPEs assets holdings. This time, she decided to do a thorough
investigation talking with every member of the finance department and all of the EOP auditors. By
March 2003, she had found the three bank letters with asset holdings that had been given to EOP auditors
by a finance manager no longer with Brown-Torrington. She personally phoned the offshore banks and
learned that the assets did not exist. This prompted her to write an email to Brown-Torrington’s CEO
Aaron Wheelwright. Itread:

“Dear Aaron: I would like to meet with you about some of our SPEs and their asset holdings. Along with
the help of some EOP auditors, I have found letters, which I believe to be forged. They state we have
assets upto $1.2 billion. However, I have followed up with the banks and have learned that those assets
do not exist. You may know from having met with Alex before he left that our SPEs owe over $1.1
billion in the next two years. I’m attaching all of the documents for your review. Regards, Rajinder.”

Along with Maurice Levine and one of Brown-Torrington’s lawyer John D’Amico, Rajinder Lata met
with Brown-Torrington’s CEO, Aaron Wheelwright in April 2003. Lata recalled the meeting:

“Aaron seemed really open to listening to us. But, here we were telling him that we had some major debt
to repay, and I couldn’t believe how calm he was. He thanked us for bringing it to his attention and said
that he would look into it. But, the problem is, we didn’t see any action until much later.”

Legal counsel, D’Amico commented, “Aaron was really hard to read that day. I walked out of the meeting
wondering if he had understood the severity of what we were all saying.”

By the second quarter of 2003, Brown-Torrington had missed all of its sales targets and was at risk for
delivering the new blockbuster Code72 drug. The investment community responded and Brown-
Torrington’s share price slid from over $30 to $15.20. An analyst commented, “Brown-Torrington’s
sales predictions were too high for the first half of 2003. It’s unlikely they’ll be able to make up the
remainder of the year, and if they falter for even a moment on the release of Code72, then there stock will
be severely bruised.”

In late July 2003, Wheelwright resigned from Brown-Torrington as CEO. He had tried to leave graciously
by saying in a public statement, “Brown-Torrington has had some recent short-term blips. But, Code72 is
on the verge of happening, and I leave the company in an extremely good position to exceed second half
and full-year 2004 results.”

However, a newspaper reporter did not believe Wheelwright’s parting line. Through an odd connection
the reporter quoted a teenager who said, “yeah, my friend is a whiz at Photoshop. I think her dad even got
her to change bank letters for his company once. No one knew the difference.” The reporter went on to
say: “It turns out the company is actually Brown-Torrington, the pharmaceutical giant, who has recently
lost its top two senior managers to suspicious circumstances. Why? Perhaps there’s something to their
10
sudden departures. Who’s been playing in Photoshop? What are they hiding?”

Immediately after reading the newspaper, Randy Mays at EOP ordered that all documents pertaining to
Brown-Torrington’s SPEs be shred. Most of the EOP employees had not seen the article, as it took a few
weeks to be spread through the popular press.

By September 2003, the news of Wheelwright and Yury’s departure in connection to a potential fraud at
Brown-Torrington was everywhere. Brown-Torrington’s finance managers, Rajinder Lata and Maurice
Levinal so resigned. Lata commented in an Interview, “when both of key management resigns without
warning or reason, it certainly does not give you a lot of confidence in the company.” Levine said, “I kept
on thinking of Yury’s reference to the Titantic. And, I thought, I’m on a sinking ship! I had to get out.”

When interrogated in September 2003, Brown-Torrington’s former CEO Wheelwright stated, “look,
you’ve got to ask that question to Emmett, Orr and Peterson. They had blessed all of our number and all
our practices. They were well aware what was going on.”

EOP’s president Randy Mays claimed at first that he was unaware that forged bank documents existed. By
January 2004, he confirmed that he had commissioned EOP’s staff to shred documents relating to Brown-
Torrington’s SPEs. Mays had put one of his top performers Noel Jameson on the task of “sorting out
Brown-Torrington.”

But, by February 2004, it was too late. Managers at both EOP and Brown-Torrington were struggling to
sort out the problem and had realized that repaying the debt on the SPEs was going to be impossible. They
made the decision to transfer the debt to the parent company and reverse some of the profits that they had
posted in the last three years. This left them insolvent and with no other choice to file for bankruptcy.
Credit agencies downgraded the company from triple A to C, the lowest grade of a company’s debt. The
company had completely collapsed, leaving over 23,000 employees, a number of pensioners and investors
with nothing. Competitors bought the patents and development of Code72 and other products in the
pipeline. The proceeds did not even cover 5 per cent of the secured debt.

As the Securities Exchange Commission (SEC) moved in to investigate the accounting malpractice at
Brown-Torrington, the blame was moving towards EOP. Why had they shred the documents? Why didn’t
Mays act sooner when he received the email from his audit team lead Alejandra Seinra? Why didn’t EOP
speak up?

Conclusion

In March 2004, both Mays and Jameson at EOP were spending everyday trying to re- position their
company. Since admitting to the shredding of documents, they had been charged with an obstruction of
justice and lost a quarter of their client base.

As both individuals sat in the Boston office of Emmett, Orr and Peterson, they wondered what could be
done to save the company. Jameson said to Mays, “Randy, we have a criminal charge against for
obstruction of justice. How in the world can we claim to be a responsible accounting firm?”

Mays responded:

“Look, Noel, I stand behind my decision to shred those documents. If they were being forged by Brown-
Torrington employees, the documents could simply not be trusted. And, I fully intend to prove this in a
court of law. What I need is for you to get me all the facts and at the same time get on as many planes as
you can to personally visit our client base. We cannot afford to lose any more.

10
Interview, “when both of key management resigns without warning or reason, it certainly does not give you
a lot of confidence in the company.” Levine said, “I kept on thinking of Yury’s reference to the Titantic.
And, I thought, I’m on a sinking ship! I had to get out.”

When interrogated in September 2003, Brown-Torrington’s former CEO Wheelwright stated, “look,
you’ve got to ask that question to Emmett, Orr and Peterson. They had blessed all of our number and all
our practices. They were well aware what was going on.”

EOP’s president Randy Mays claimed at first that he was unaware that forged bank documents existed. By
January 2004, he confirmed that he had commissioned EOP’s staff to shred documents relating to Brown-
Torrington’s SPEs. Mays had put one of his top performers Noel Jameson on the task of “sorting out
Brown-Torrington.”

But, by February 2004, it was too late. Managers at both EOP and Brown-Torrington were struggling to
sort out the problem and had realized that repaying the debt on the SPEs was going to be impossible. They
made the decision to transfer the debt to the parent company and reverse some of the profits that they had
posted in the last three years. This left them insolvent and with no other choice to file for bankruptcy.
Credit agencies downgraded the company from triple A to C, the lowest grade of a company’s debt. The
company had completely collapsed, leaving over 23,000 employees, a number of pensioners and investors
with nothing. Competitors bought the patents and development of Code72 and other products in the
pipeline. The proceeds did not even cover 5 per cent of the secured debt.

As the Securities Exchange Commission (SEC) moved in to investigate the accounting malpractice at
Brown-Torrington, the blame was moving towards EOP. Why had they shred the documents? Why didn’t
Mays act sooner when he received the email from his audit team lead Alejandra Seinra? Why didn’t EOP
speak up?

10
Exhibit 1

Brown-Torrington’s Financials
in millions USD $

2000 2001 2002 20

Profit & Loss 03
Sales 11341.7 1458 18,700 98
COGS 5,807.0 2.0
7,261 .0
8,839. 12 6
Gross Margin 5,534.7 .8
7,320 9,860.5 .9 ,
2
Gross Margin % 48.8% .2
50.2 55 30 ,8
% 2 .3 3
9
SG&A 1894.1 2362. .
2917.2 %
22 9
7
Depreciation & Amortization 340.3 3
466.6 7
654.5 17
63 .
3
% .7 6
.
Operating Profit 3300.4 4491. 6288.8 7.
11
3 8
7. 3
Operating Margin % 29.1% 30.8 3 1.
% 3 8
2
Non-operating Income 168.0 234.0 .
456.0 %
23
Non-operating Expenses 178.9 148.9 6
247.9 .0
98
Income before Taxes 3289.5 4576. %
6496.9 4.-
Income Taxes 954.0 4
1327. 1884.1 842-
Net Income after Taxes 2335.6 1
3249. 4612.8 3.-
24
Net Income as % of Sales 20.6% 2
22.3 2 594-
4.
% 4 6
8.
6.
Stock Price 18.94 23.56 .
32.80 8
1
4.
Diluted EPS from Net 2.07 2.84 7
3.64 %-
67
Income Outstanding
Shares 1127.9 1145. %
1267.3 0.
10
9 57
45
Balance Sheet .6
Assets
Current Assets 10573.4 1195 8242.9 10
Net Fixed Assets 12348.1 6.4
1421 14632. 93
53
Total Assets 22921.5 9.8
2617 228751 .2
89
64
6.2 .2
82
Liabilities Current Liabilities .4
12314.9 1287 11273. 11
Long-term Debt 452.9 6.2
698.3 9
1294.7 27
24
Other noncurrent Liabilities 1345. 8
1678.9 3.
23
16
Total Liabilities 12767.8 14927 14247. 78
159
.3
0.2 58 .9
37
Shareholders' Equity 6.
Preferred Stock Equity 345.9 245.6 241
Common Stock Equity 10153.7 1091 8381.8 6.-
Total Equity 10153.7 0.1
1125 2
8627.4 916-
Total Liabilities and Equity 22921.5 26176 228752 40
88
64
6.2 .3
93
82
.7
.4
Net Operating Cash Flow 2837.5 3784. 4902 -
Net Investing Cash Flow -2149.3 2- -2865.4 12-
Net Financing Cash Flow -1115.8 3717.- -2345 33-
10
Net Change in Cash -427.6 2-
1636. -308.4 .2
459-
4
1569. 78
59
4 .4
20
.6
 Exhibit 2

Special Purpose Enterprises (SPEs) – Brown-Torrington

in millions USD $

YEAR 2002
Jen Gan Lew T
by o is o
Profit & Loss t
a
Sales 109.8 28.9 19.3 158.
l
COGS 95.7 23.4 13.9 0
133.
Gross Margin 14.1 5.5 5.4 1
24.9
Gross Margin % 12.8% 1 2 15.8
9 8 %
SG&A 5.5 0.6. 1.5. 7.61
Depreciation & Amortization 3.3 0.90 0.70 2
4.89
Operating Profit 5.3 4.0% 3.2% 43
12.4
Operating Margin % 4.8% 1 1 431
7.9
3 6 %
Non-operating Income . .
123.4 479.48 417.95 102
Non-operating Expenses % % 0.7
Income before Taxes -118.1 -475.4 -414.7 -
Income Taxes -34.3 -137.9 -120.3 100-
Net Income after Taxes -83.9 -337.5 -294.4 8.3-
292.
Net Income as % of Sales -76.4% - - 4-
715.
116 152 9
453.
Balance Sheet 8.0 5.6 1%
Assets % %
Current Assets 239.1 123.9 789.2 115
Net Fixed Assets 1.3 2.6 1.8 2.2
5.7
Total Assets 240.4 126.5 791 115
7.9
Liabilities Current
Liabilities Long-term Debt
290.3 285.3 529.8 110
Other noncurrent 5.4
0
Liabilities
Total Liabilities 290.3 285.3 529.8 110
5.4
Shareholders' Equity
Preferred Stock Equity
Common Stock Equity -49.9 -158.8 261.2 52.5
Total Equity -49.9 -158.8 261.2 52.5
Total Liabilities and Equity 240.4 126.5 791 115
7.9

14
15
16
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