Bain Sues Ernst & Young for $60 Million

BOSTON (CN) - Bain Capital Partners claims in court that Ernst & Young cost it $60 million by advising it to invest in a children's clothing company based on falsified financial statements that E&Y certified.

Bain Capital Partners LLC and 10 other subsidiaries of global private equity firm Bain Capital LLC sued Ernst & Young Global Limited and Ernst & Young LLP, in Suffolk County Court.

Also named as defendants are Indian accounting firms Batliboi & Associates LLP and S.R. Batliboi & Co. LLP, which are Ernst & Young member firms.

Boston-based Bain Capital, which is not a party to the lawsuit, acquires, manages, monitors and provides investment advice to private equity funds through Bain Capital Partners and other subsidiaries.

Ernst & Young, one of the "big four" accounting firms that dominate the industry, operates a global accounting business through the London-based Ernst & Young Global Limited. Ernst & Young claims to have more than 700 officers in more than 150 countries, including the United States, where Ernst & Young Global's CEO maintains an office, according to the lawsuit.

"Global audit and advisory firm Ernst & Young ('EY') was a central participant in a fraudulent scheme to induce Boston-based private equity firm Bain Capital to invest and hold its investment in Lilliput Kidswear ('Lilliput'), a children's clothing retailer in India," the complaint states. "Acting as seller's agent, EY solicited Bain to invest in Lilliput and gave Bain Lilliput's financial statements, which EY had audited and certified as presenting a true and fair view of the company. Those audited financial statements represented a thriving business with robustly growing revenues and earnings. In reality, Lilliput had deliberately falsified its financial statements to conceal its true poor performance. EY knew about the key aspects of the fraud, yet assured Bain about Lilliput's financial statements. In reliance on the false financial statements and EY's false audit opinions, Bain invested in Lilliput. For more than a year, EY continued to certify Lilliput's financial statements and provide those certifications to Bain, even as Lilliput's fraud grew with EY's active assistance. After a whistleblower alerted Bain to the fraud, Bain stopped a planned initial public offering of Lilliput's stock and confirmed that Lilliput's financial statements were fraudulent. As a result of the fraud, Bain's approximately $60 million investment was rendered worthless."

Ernst & Young, which had provided audit and advisory services to the Bain companies for years, advised Bain to invest in Lilliput in January 2010, according to the lawsuit.

Bain claims Ernst & Young served both as Lilliput's outside statutory auditor, which had a duty to check the retailer's financial information, and as seller's agent, whose compensation was based on the sale price of Lilliput's shares.

It claims the firm targeted Bain because it knew it could pay a high price for Lilliput shares, based on its long-term relationship with Bain.

Ernst & Young sent Bain audited financial statements it had prepared for Lilliput, and advertised Lilliput as a solid business with substantial growth in revenues, according to the lawsuit.

"In reality, unbeknownst to Bain, the financial information EY provided was a fiction," the complaint states. "Lilliput had systematically falsified its revenues, costs, and loans outstanding. In order to artificially inflate revenue, Lilliput added imaginary 'fake' sales on top of legitimate 'actual' sales. Lilliput tracked these fake sales in spreadsheets that openly described them as 'incre[a]se[d]' or 'additional' sales. The net result was that Lilliput's earnings before interest, taxes, depreciation, and amortization ('EBITDA') (a key metric) had not impressively increased over the preceding three years, as represented to Bain Capital; instead, Lilliput's EBITDA dropped in the period before Bain invested." (Parentheses and brackets in complaint).

Ernst & Young, which had looked at Lilliput's sales spreadsheets during audits, knew that Lilliput had inflated its sales, concealed loans, and forged bank confirmations, Bain claims in the complaint.

"EY's complicity in the fraud is further demonstrated by the breathtaking extent of its violations of the most basic requirements of Indian GAAP [generally accepted accounting principles] during its audits," the lawsuit states. "EY shared details of its planned audit procedures with Lilliput in advance and even allowed Lilliput to perform certain audit testing on itself. EY failed to conduct adequate procedures relating to the key components of the fraud including sales, inventory, cash, and loans. EY issued its unqualified audit opinions despite numerous outstanding unresolved items and then fraudulently elicited Lilliput's help to back-fill its audit work papers after it had already issued its unqualified audit opinions, to make it appear that EY had conducted various audit procedures that EY had not performed."

Bain claims the audit opinions contained false statements that contradicted Ernst & Young's own work papers.

"Based on the false financial statements EY had audited and certified, and EY's other assurances, Bain invested approximately $60 million for a non-controlling 30.99 percent interest in Lilliput in May 2010," according to the lawsuit. "EY gained financially from this scheme by earning its 'success fee' for obtaining a high valuation for Lilliput, and by continuing as Lilliput's auditor and receiving lucrative fees."

Bain claims the accounting firm maintained the fraud for more than a year by sending Bain falsified statements and helping Lilliput manipulate its financial results.

Relying on Ernst & Young's statements, Bain helped Lilliput plan an initial public offering of its stock for September 2011.

Shortly before the IPO, however, a whistleblower warned Ernst & Young about Lilliput's falsified statements, according to the lawsuit.

Bain says E&Y ignored the warning and continued to issue unqualified audit opinions that represented Lilliput as financially solid, which were meant to mislead investors.

After Ernst & Young failed to act, the whistleblower warned Bain, which investigated and confirmed that Lilliput was inflating sales, according to the complaint.

Bain says the whistleblower cautioned it not to rely on Ernst & Young for an audit, because the firm was "in [the Lilliput CEO's] pocket." (Brackets in complaint).

It claims an independent auditor confirmed the fraud despite Lilliput's attempts to obstruct the audit.

Bain claims its $60 million investment is now worthless.

It seeks punitive damages for fraud, aiding and abetting fraud, negligent misrepresentation and state law violations.

It is represented by Mark Hansen with Kellogg, Huber, Hansen, Todd, Evans & Figel of Washington, D.C.

A spokesman for Ernst & Young declined to comment on the lawsuit.

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