Bankruptcy Recoveries From Auditors: The Ambassador Case

Tuesday, November 1, 2005 - 00:00

Editor: Please tell our readers something about your background and career.

Whitney: I grew up in Westfield, New Jersey and graduated from law school - Case Western Reserve University - in Cleveland in 1973. I stayed in Cleveland after graduation, going immediately to Jones Day. Like most litigators in large firms, I worked as a "gofer" well down the case team on the large cases, learning from watching the more senior people, while handling smaller cases on my own. By the mid-1980s, after I had become a partner in the firm, I was heading up my own larger cases, mostly from the defense side. While all of this was going on, Jones Day was going from the strong regional Midwest firm of the early 1970s to one of the two or three largest international law firms - with a strong reputation as being a preeminent litigation firm. As a result of that growth in the scope of the firm's reach, like many of my colleagues I have litigated cases in courts all over the country, and I have, in fact, not seen the inside of the courtroom in Cleveland since the early 1980s.

Editor: You were the lead lawyer for the plaintiff in Crowley v. Chait, a Newark federal court trial last summer that resulted in a judgment on September 30 against PricewaterhouseCoopers in the amount of $183 million. The case arose out of the failure of Ambassador Insurance Company of Vermont. Given the more high profile corporate and alleged auditing failures of recent years, this case comes somewhat out of the blue. Let me start by asking you, what is the background of the case?

Whitney: Ambassador Insurance Company was a Vermont-based casualty insurer that grew in the 1970s and early 1980s to be one of the largest so-called "surplus lines" insurers. Surplus lines carriers write novel or high risk business that the standard lines companies - the Aetnas and Travelers - will not write. It was owned by a holding company, Ambassador Group, Inc., which traded on the NASDAQ. In November of 1983, the Vermont Insurance Commissioner placed Ambassador in receivership in Vermont state court, based on his conclusion that the company was insolvent. After a trial, it was ordered liquidated in March of 1987, and it has been in liquidation under the Commissioner's supervision since that time. Because Ambassador was a surplus lines writer, most of its policyholders, and people with claims covered by Ambassador policies, are not protected by state guaranty funds. It was at the time one of the largest insurance insolvencies without guaranty protection in history.

The Crowley v. Chait case was an action filed by the Vermont Commissioner against the former CEO of Ambassador, its parent company, and Coopers & Lybrand, which audited the parent company.

Editor: How did you come to be involved with a Vermont insolvency?

Whitney: Jones Day was originally hired to prosecute the Vermont Commissioner's application to liquidate Ambassador in the Vermont state court in Montpelier. After a trial in 1984, the Vermont court ruled in our favor, concluding that Ambassador was deeply insolvent and had to be liquidated. From then on, I have represented the Commissioner in his role as Ambassador's receiver in all aspects of the process of gathering assets and paying policyholder claims. And the largest of the "asset collection" cases was the suit against the former CEO and the auditor - Coopers and Lybrand - for failure to disclose Ambassador's financial decline. Coopers has, of course, since merged with Price Waterhouse and is now PricewaterhouseCoopers.

We originally filed the case in May of 1985, long before it became "fashionable" to sue the outside auditors in a business failure, and only after our experts and consultants told us it was appropriate. Ironically, one of our consultants was Price Waterhouse.

Editor: How did this case come to be tried in New Jersey?

Whitney: Although Ambassador was headquartered in Vermont, its principal place of business was in New Jersey. It wrote a lot of policies in that state. Because of the large volume of policies sold to New Jersey insureds, New Jersey actually created a "surplus lines guaranty fund" expressly to deal with its Ambassador policyholders. It's the only fund of its kind ever created.

Editor: What did you claim the former Chief Executive Officer and Coopers did wrong?

Whitney: The Commissioner took over the company in November of 1983 when his own experts advised him that Ambassador was at or near the point of insolvency. After he took it over he immediately "stopped the bleeding" by terminating the writing of new or renewal insurance policies.

What we proved at the trial was that both management and Coopers at least should have known, and probably did know, that Ambassador was insolvent or near insolvency by the end of the first quarter of 1982, 20 months earlier. If the Commissioner had been told the truth about Ambassador's financial condition in early 1982, he would have done exactly what he did 20 months later - grabbed the company and stopped its writings. Ambassador continued in business and in those 20 months continued writing policies. The compensatory damages the jury awarded - about $120 million - were the net losses incurred by the company on the business it wrote after the first quarter of 1982, plus the administrative costs of a court-ordered liquidation.

Editor: And the suit was originally filed in 1985? Why did it take 20 years to get to trial?

Whitney: First of all, auditor defendants have an ambitious discovery program in these cases, and the auditor here took more than 100 sworn depositions of fact witnesses. What made this case unique was that it was unwisely linked together with other Ambassador-related cases for pretrial purposes. The case was subjected to what is called "multi-districting," which is a procedure in which federal cases arising from the same incident or loss are consolidated in one court, supposedly to streamline pretrial procedures. Ambassador's insolvency produced a number of lawsuits involving Ambassador, its New York-based subsidiary insurer, its parent holding company and its auditors. Our case was sent to federal court in Brooklyn, consolidated with cases and parties having nothing to do with our case, and with a lot of parties who had no particular interest in advancing the cases to trial. We were stuck in that consolidated proceeding for about eight years before we finally got this case moved back to Newark. At that point we were able to move it to trial.

Editor: How was the case affected by that delay?

Whitney: It presented some unique challenges because witnesses disappear and pass away over a 20 year stretch. For that reason, the jury saw a lot of videotaped deposition testimony and actually seemed more attentive to those witnesses, who were uninterrupted by objections and argument, than to many of the live witnesses. In the end, Ambassador's estate is being compensated for having had to wait. The judgment in this case is comprised of the jury's verdict of $119.9 million and an additional award of $63 million in "pre-judgment interest," which is essentially the time value of the verdict over 20 years.

And in the end that delay had some positive benefit: Ambassador's receiver has in just the last three years received about $50 million in claims for asbestos exposure, on policies written after this company should have been shut down. If this case had been resolved even five years ago, those claimants would have been left with nothing.

Editor: What about the impact of the delay on your legal team?

Whitney: We had to do some re-staffing along the way, but there was a core group. When we first decided to bring the lawsuit in New Jersey, I brought on board a brand new lawyer in our firm named Ford Huffman. He and I worked on this together the whole way, and Ford - who today is the managing partner of our Columbus, Ohio office - handled most of the auditing witnesses at the trial. Our local counsel, Bob Stickles from Klett Rooney in Newark, was also with us all the way, and Tracy Stratford from Cleveland was with us the last seven or eight years.

Of course, on a personal level we all have unique stories to tell. When I first left for Vermont in 1984 to try the case there, I kissed my eight year old son goodbye and left him standing in the driveway crying. At the New Jersey trial 21 years later, one of my son's law school classmates cross-examined a Coopers expert.

Editor: What happens now? Will there be an appeal?

Whitney: Probably.

Editor: Do you expect to prevail on appeal?

Whitney: Yes.

Editor: Assuming the District Court judgment stands, what are the implications of this case for the accounting industry?

Whitney: The recent and high profile failures, such as Enron, Tyco, and WorldCom, have more broadly publicized the issue of auditor responsibility for the losses that are suffered by creditors and shareholders. Ambassador was one of the first of those cases and is now, reportedly, one of the largest jury verdicts for auditor malpractice. Its "implication" is that in the right case - in the right case - the independent auditor not only can be held accountable for the results of that failure but in fact can bear equal responsibility with corporate management.

Editor: And with respect to the corporate governance arena? Since the demise of Arthur Andersen as a consequence of what many commentators feel was an overreaction to the corporate scandals, a certain sympathy for the many accounting firm employees innocent of the misdeeds of the few has crept into the discussion. Shouldn't this be a concern?

Whitney: I have spent most of my career representing major corporate clients. I have also defended accountants. And I chair the finance and audit committee of a health care organization. And I do these auditor malpractice cases.

From all of those perspectives, I think that accounting firms profoundly believe that they are being wrongly "dragged into" lawsuits arising out of the business failures of their corporate clients simply because they represent a "deep pocket." And a lot of the time that is very true. A lot of the time, the management of those failed corporations doesn't belong there either.

But there are cases where the auditors do not behave appropriately, and when that happens the auditors have a duty to accept responsibility for their actions, and to address the situation in a positive way. That's not just a duty they owe their own partners and employees. They owe it to the corporate clients that they advised. Sometimes they owe it to the CEOs and CFOs and the directors of those companies. Yes, those people are the favorite targets when a company fails, but in a lot of cases they give the auditor all of the relevant information, they look to the auditor for "calls" on the GAAP issues, and they are relying on the auditor to tell them what is appropriate. The notion that the auditor is a presumptive innocent, "being forced to answer for another's business failure," doesn't always hold.

Editor: Are you currently handling any more of these accounting cases?

Whitney: I'm doing one right now, arising out of what is supposed to be the largest non-profit bankruptcy in history, involving Allegheny Health, Education and Research Foundation in Pittsburgh.

Richard B. Whitney is a Partner in the Cleveland office of Jones Day. His practice focuses on complex business litigation.

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