National Medical Transportation Network

National Medical Transportation Network (MedTrans) eventually became the largest ambulance services provider in the United States. Reaching that pinnacle was not an easy journey. In early 1992, MedTrans encountered cash flow problems that prompted the companys two owners to search for external financing. The co-owner located a company willing to invest $10 million in MedTrans. During the negotiation with that company, MedTrans auditor, Deloitte & Touche, uncovered problems in its clients accounting record. Those problems prevented Deloitte from issuing an unqualified opinion on MedTrans 1992 financial statement. After several unpleasant confrontations with MedTrans Chief executive officer, Deloitte resign as the companys audit firm. Following Deloittes resignation, the $10millon investment deal collapsed. Within the few month, MedTrans two owner sold their firm to a largest corporation. Unhappy with Deloittes lack of cooperation, medtrans former owners sued Deloitte to recover the sizeable loss they incurred on the sale of their company. Among other charges, the former owners alleged that Deloitte acted negligently by withdrawing prematurely from the 1992 MedTrans audit engagement. No doubt, Deloittes legal counsel confidently tackled the MedTrans lawsuit. The allegation that Deloitte negligently withdrew from 1992 medtrans audit engagement seemed implausible since the client had adamantly refused to make several large and necessary adjustments to its 1992 financial statement. Threatening comments made to Deloitte auditors by one of MedTrans co owners provided even stronger justification for the audit firms resifnation. Imagine then the shock and disbelief of Deloittes attorneys when the jury that heard the lawsuit agreed with MedTans former owners and imposed a multimillion-dollar judgment on the prominent accounting firm. MedTrans Seeks Help MedTrans two principal officers, Roberts and Morgan, served as the companys chief executives officer (CEO) and president, respectively, and each owned 50 percent of MedTrans common stock. Deloitte audited the company annual financial statements each year from 1988 through 1991 Medtrans fiscal years ended March 31. Apparently, Deloitte encountered few problems during those audits and issued an unqualified opinion each year on Medtrans financial statements. By the late spring of 1992. MedTrans needed cash and quickly. The company owed $2 million of payroll taxes and faced a 412 million repayment to its primary lender, which had suddenly and unceremoniously yanked MedTrans line of credit. Making matter worst, MedTrans chief financial officer (CEO) unexpectedly resign in early June 1992. That resignation triggered crisis between MedTrans and the company audit firm. Deloitte was nearing completion of its 1992 MedTrans audit and had asked the CEO to sign a letter of a representation indicating that the companys financial statement was materially accurate. The CFO told Gordon Johns, the Deloitte audit engagement partner, that he could not sign the letter of representation since he did not believe MedTrans financial statement were reliable. A few days letter, the CFO met with Johns to discuss the situation. At the meeting, Ensz (the CFO) alerted Johns to four or five matters relevan to the audit. Ensz said that upon informing Roberts (the CEO) that those matters were not properly entered in MedTranss journal, Roberts told Ensz to leave the journals as they were and lets see if the auditor

find it. Questioning Robertss character for honesty because of some things Roberts advocated in presenting financial information, Ensz also stated he lacked faith in integrity of Roberts and MedTranss financial statements. The CFOs unsettling allegations caused Deloitte to approach the remainder of the 1992 MedTrans audit with extreme caution. By the end of June 1992, the Deloitte auditors concluded that their clients financial statements contained material errors. Those financial statements reported a net income of nearly $2 million of fiscal 1992, while Deloittes audit suggested that MedTrans had suffered a loss of approximately $500,000. A large increase in MedTrans allowance for a bad debts proposed by Deloitte accounted for most of the difference between those two figures. During June and July 1992, Roberts negotiated with William Blair & Company to obtain the additional capital needed by MedTrans. In exchanges for $10 million investment in MedTrans, Roberts and Morgan offer Bair 50 percent ownership interest in the company. While mulling over this offer, Blairs executives reviewed MedTrans audited financial statements for 1992. Based largely upon the $2 million profits reported in those financial statements, Blair forecasted that MedTrans annual earnings would top $6 million by 1995. On July 27, Blairs executives tentatively agreed to invest in MedTrans. The agreement was contingent on MedTrans receiving an unqualified audit opinion on its 1992 financial statements. Roberts negotiations with Blair were periodically disrupted by an ongoing quarrel with Gordon Johns. Roberts and Johns feuded throughout the summer of 1992 over the large increase in the companys allowance for bad debts that Deloitte believed was necessary. During a July 9 meeting, Roberts warned Johns that MedTrans audited financial statements would have a significant impact on whether the Blair transaction was consummated. A very focused Roberts vocally and explicitly emphasized the importance of MedTranss pre-tax earnings because of the potential that Blair might invest in the company.Johns [then] presented Roberts with about $2.5 million in suggested adjustments involving the accounts receivable reserve account. Roberts old Johns you better not propose any adjustment that will__my deal or youll be sorry. Shortly after the July 9 meeting Johns contacted an executive. Deloitte partner in the firms New York headquarters. The executive partner told Johns that we should not be associated with companies that threaten us. Unless Roberts accepted the proposed adjustments, the executive partner recommended that Johns resign from the engagement. Johns told the executive partner that before raising the issue again with Roberts, he wanted to give him some time to analyze Med-Trans bad debt reserve and to reconsider the need for the proposed adjustment. On July 30, Roberts and Johns met again. During this meeting, Roberts reminded Johns of the impact Deloittes audit would have on the proposed Blair deal. Roberts also gave Johns a memorandum prepared by Med Trans personnel that presented a more favorable analysis of the companys bad debt reserve than the analysis developed by Deloitte. Roberts and Johns met a final time on august 13, 1992, to discuss Deloittes audit and the pending Blair transaction. At this meeting, Johns presented a memorandum containing a new set of proposed adjustments to Med Trans 1992 financial statements. Collectively, these adjustments

would have reduced Med Trans pre-audit net income even more than the adjustments originally proposed by Deloitte. During Johnss presentation, Roberts rose, threw down the memorandum and said very angrily: you are finished. Although Johns thought he had been fired, Roberts told Johns not to construe the situation that way. However, after MedTranss successive rejections of proposed adjustments to its unaudited financial statements, Johns believed the parties mutually exclusive views of those statements indicated there was no longer a basis for relationship. Thus, Johns told Roberts that if defendants [Deloitte] had not been fired, he was resigning. Roberts told Johns that youre going to finish this regardless, under court order or otherwise. Johns believed such threat destroyed any ability to continue as an independent auditor. Johns also believed resignation was necessary because MedTrans bullied Deloittes personnel and defendants were put at risk by MedTranss lack of commitment to financial statements accurately depicting the difficulties the company experienced in fiscal 1992. Deloitte formally resigned from the MedTrans engagement shortly after the August 13 meeting between Johns and Roberts. Four days later, Roberts sent a letter to Deloitte reminding the firm that its resignation would have serious repercussions for the pending Blair deal. Roberts also insisted once more that Deloitte complete the 1992 audit. Deloitte refused to be swayed and remained MedTrans former auditor. DESPERATELY SEEKING A REPLACEMENT AUDITOR William Blair & company learned of Deloittes resignation in mid-August 1992. On August 25, a Blair representative told Roberts that his firm was indefinitely postponing the planned investment in MedTrans and would not reconsider that decision until MedTrans obtained an independent audit opinion on its 1992 financial statements. The Blair official suggested that MedTrans retain Blair & Companys audit firm, Ernst & Young. Roberts immediately contacted Ernst & Young. Within a few days, Roberts sent Deloitte a letter authorizing the firm to discuss freely with E & Y the audit of MedTrans for fiscal 1992 and the facts and circumstances of Deloittes withdrawal/ resignation/ disengagement as MedTranss auditor. Gordon Johns met with representative of Ernst & young on September 3, 1992 During that meeting, Johns explained why Deloitte had resigned from the MedTrans engagement. Johns also revealed that he questioned the integrity of MedTrans senior executives. Despite the information obtained from Johns, E & Y agreed to audit MedTrans 1992 financial statements. Roberts concluded during late September that Blair was unlikely to invest in MedTrans regardless of the outcome of E & Ys audit. At that point, Roberts began searching for another potential investor to bail MedTrans out of the financial crisis it faced. Within a few days, a company contacted by Roberts, American Medical response, Inc. (AMR), expressed interest in acquiring MedTrans. Like MedTrans, AMRs principal line of business was providing ambulance services. When AMR executives recommended that MedTrans retain Peat Marwick, AMRs audit firm, to audit its 1992 financial statements, Roberts dismissed E & Y and contacted Peat Marwick. Roberts also contacted Deloitte and authorized the firm to discuss with Peat Marwick the circumstances surrounding its resignation from the MedTrans audit. After communicating with Deloitte, the San Diego office of Peat Marwick agreed to audit MedTrans 1992 financial statements. One week after

accepting the engagement, Peat Marwick resigned. Subsequent testimony revealed that a directive sent by Peat Marwicks headquarters office to the firms San Diego office prompted that resignation. Peat Marwicks refusal to audit MedTrans apparently quelled AMRs interest in the company. MedTrans finally retained another audit firm in late October 1992. This firm, identified only as Silberman in court transcripts, served as MedTrans auditor during the mid-1980s. before accepting the engagement, Silberman discussed with Deloitte the circumstances surrounding its resignation as MedTrans auditor. In December 1992, Silberman issued an unqualified opinion on MedTrans 1992 income statement reported a loss of $480,000, which was approximately the figure Deloitte had , arrived at several months earlier. Laidlaw Medical Transportation, Inc., purchased MedTrans in June 1993. Roberts and Morgan netted $3 million from the sale of their company. Under Laidlaws ownership, MedTrans soon became the largest provider of ambulance services in the nation. MEDTRANS SUES DELOITTE In August 1993, Roberts and Morgan sued Deloitte on behalf of their former company. The principal allegations against Deloitte centered on charges of professional negligence and breach of contact. Roberts and Morgan charged that Deloittes malfeasance caused Blair not to consummate the $10 million investment deal arranged by Roberts. MedTrans former co-owners requested damages equal to the difference between the amount they received from the sale of MedTrans and the amount the company allegedly would have been worth had Blair invested in the firm. The lawsuit was tried before a jury in a California state court in July 1995. MedTrans legal counsel succinctly summed up the key allegations against Deloitte in the following statement. What is the negligence that we contend occurred? What is the breach that we contend occurred? Very simply they [Deloitte] contracted over a course of years, and in connection with the year of 1992, to perform an audit and to render an opinion, they did neither, and walked away after getting payment for such services. Deloittes defense team rebutted these allegations by insisting that the accounting firm had a right to resign from the1992 audit when it lost faith in the honesty of MedTranss senior management. A CPA retained by Deloitte to serve as an expert witness testified that the firm was obligated to resign from the engagement after its independence was compromised by Robert threats. After a short trial, judge Philip sharp instructed the jurors on the illegal matters they should consider during their deliberations. The jurors reached their decision quickly, ruling in favor of MedTrans on all key issues raised during the trial. the jury ruled that Deloitte acted negligently and breached its contractual obligations to MedTrans when it withdrew from the 1992auditengagement. Additionally, the jury ruled that Deloitte negligently interfered with and disrupted MedTrans economic relationships with Blair, Ernst & Young, and Peat Marwick. This letter ruling stemmed from charges that Deloitte made defamatory statements to E & Y and Peat Marwick concerning the integrity of MedTrans former executives. Deloitte allegedly made these statements during the predecessor-successor auditor communications with those two firms following its resignation as

MedTrans auditor. After issuing their rulings on the specific complaints filed against Deloitte, the jurors awarded MedTrans former owners a $9.9 million judgment against the accounting firm. DELOITTE APPEALS JURY VERDICT Deloitte quickly appealed the jurys verdict. The accounting firm insisted that the trial judge erred when he instructed the jury prior to its deliberations. Included in judge sharps instructions to the jury was the following statement concerning an auditors right to resign from an engagement. Once an accountant has undertaken to serve a client, the employment and duty as an accountant continues until ended by consent or request of the client or the accountant withdraws from the employment, if it does not unduly jeopardize the interest of the client, after giving the client reasonable opportunity to employ another accountant or the matter for which the person [accountant] was employed has been concluded. These instructions, Deloitte maintained, gave the jury only one alternative, namely, deciding the case in MedTrans favor. The accounting firm argued that the phrase if it [auditors resignation] does not unduly jeopardize the interest of the client implies that an auditor must consider the economic impact on a client before resigning. Deloitte demonstrated during the appeal that professional auditing standards do not require auditors to consider the potential economic impact on a client of a resignation decision. The jury instructions also suggested that an auditor must give a client reasonable opportunity to retain another audit firm before resigning. Again, Deloitte established that professional standards do not impose such a responsibility on independent auditor. Deloitte argued before the appellate court that an accounting firm may resign from an audit engagement whenever it has good cause to do so. The firm also insisted that good cause in this context must be defined in reference to the professional standards of the auditing discipline. Deloitte then identified three reasons why it had good cause to resign from the 1992 MedTrans audit: MedTrans managements refusal to cooperate fully with fully with the auditors, the auditors loss of confidence in client managements integrity, and the threats that Roberts made to Johns. Deloitte claimed that Roberts threats, alone, provided sufficient justification to resign since those threats undermined its independence. MedTrans attorneys agreed that auditors could resign when they had good cause to do so but attempted to persuade the appellate court to apply a more general, legalistic interpretation to that phrase that was independent of professional auditing standards. Strengthening Deloittes good cause argument was a friend of the court filling submitted the American institute of Certified Public Accountants (AICPA). In that filling, the AICPA reiterated Deloittes assertion that Roberts threats undermined the audit firms independence. The AICPA noted that an must decide as a matter of professional judgment whether he is independent. an auditors independence may be impaired whenever the member and the members client company or its management are in threatened or actual positions of material adverse interests by reason of threatened or actual litigation. The AICPA went on to observe that an auditor who believes independences has been impaired is forbidden from issuing an audit opinion. After briefly contesting Deloittes contention that it had good cause to resign from the 1992 audit, MedTrans legal counsel adopted a second strategy during the appeal. MedTrans

attorneys argued that Deloitte forfeited its right to file an appeal predicated on the allegedly prejudicial jury instructions since the accounting firm had not offered the trial judge any alternate jury instructions. In fact, Deloitte initially challenged the jury instructions written by judge Sharp. At that point, Judge Sharp offered to consider alternate instructions developed by Deloittes legal counsel; however, the accounting firm never submitted revised jury instructions for the judges consideration. Despite Deloittes apparent oversight, the appellate court ruled that Deloitte did not forfeit its right to challenge the impact of judge Sharps jury instructions on the jurys verdict. Where as here, the trial court gives a jury instruction which is prejudicially erroneous as given, i. e., Which is an incorrect statement of law, the party harmed by the instruction need not have objected to the instruction or proposed a correct instruction of his own in order to preserve the right to complain of the erroneous instruction on appeal. JURY VERDICT OVERTURNED In early 1998, the California Court of appeal overturned the jurys verdict in the MedTrans v. Deloitte civil case. The appellate court ruled that judge Sharps instructions predisposed the jury to rule in MedTrans favor. After overturning the jurys verdict, the appellate court addressed each of the major allegations made against Deloitte by MedTrans in the original trial. First, the appellate court rejected MedTrans contention that Deloitte acted negligently when it withdrew from the 1992 audit. The court agreed with Deloitte that the auditing professions standards are the primary authoritative source in this context. Applying those standards, appellate court that Deloitte clearly had a reasonable basis for resigning from the 1992 audit. Second, the appellate court discredited the breach of contract allegation lodged against Deloitte. Recall that MedTrans management pressured Deloitte to issue an unqualified opinion on the companys original 1992 financial statements. The appellate court ruled that Deloitte cannot be held liable to MedTrans in breach of contact for having declined to issue a false unqualified audit report. The court also rejected MedTrans claim that Deloittes failure to issue an audit opinion of any kind constituted breach of contract. Finally, the appellate court dismissed MedTrans assertion that Deloittes communications with the companys successor auditors were defamatory. Defamation is an intentional tort. In any event, as discussed, the record contained ample evidence that defendants communications with potential successor auditors about their reasons for resigning from their engagement with MedTrans complied with applicable professional standards requiring open communication with potential successor auditors and were consistent with MedTranss written authorizations requesting defendants to speak freely with those potential successor auditors.