Adelphia & Fraud Detection

The Securities and Exchange Commission (SEC) filed suit against Adelphia Communications Corporation and several members of the Rigas family and other executives who held management positions in the firm for (1) fraudulently excluding billions of dollars in liabilities from its consolidated financial statements by hiding them in off-balance sheet affiliates; (2) falsifying operations statistics and inflating Adelphia's earnings to meet Wall Street's expectations; and (3) concealing rampant self-dealing by the Rigas Family, including the undisclosed use of corporate funds for Rigas Family stock purchases and the acquisition of luxury condominiums in New York and elsewhere.

Specifically, the Commission's complaint alleges that between mid-1999 and the end of 2001, John J. Rigas, Timothy J. Rigas, Michael J. Rigas, James P. Rigas, and James R. Brown, with the assistance of Michael C. Mulcahey, caused Adelphia to fraudulently exclude from the Company's annual and quarterly consolidated financial statements over $2.3 billion in bank debt by deliberately shifting those liabilities onto the books of Adelphia's off-balance sheet, unconsolidated affiliates. Failure to record this debt violated GAAP requirements and precipitated a series of misrepresentations about those liabilities by Adelphia and the defendants, including the creation of: (1) sham transactions backed by fictitious documents to give the false appearance that Adelphia had actually repaid debts when, in truth, it had simply shifted them to unconsolidated Rigas-controlled entities, and (2) misleading financial statements by giving the false impression through the use of footnotes that liabilities listed in the Company's financials included all outstanding bank debt.

The Commission also issued an Order that said that Deloitte& Touche, LLP, Adelphias auditors, engaged in improper professional conduct and caused Adelphia's violations of the recordkeeping provisions of the securities laws because it failed to detect a massive fraud perpetrated by Adelphia and certain members of the Rigas family. Mark K. Schonfeld, Director of the SEC's Northeast Regional Office said, "What is especially troubling here is that Deloitte recognized the risk of fraud posed by this client at the outset. When auditors turn a blind eye toward misconduct on a high-risk client and allow a fraud of this magnitude to go undetected, the consequences will be severe." Even though Deloitte identified Adelphia as one of its highest risk clients, Deloitte failed to design an audit appropriately tailored to address audit risk areas that Deloitte had explicitly identified. Specifically, Deloitte issued an audit report containing an unqualified opinion on Adelphia's financial statements for fiscal year 2000. Deloitte settled with the SEC paying $50 million and agreeing to substantive undertakings designed to address its audit of high-risk clients in the future, including the involvement of Deloitte's forensic accounting specialists in planning high-risk audits, increased training of Deloitte's audit professionals in fraud detection, increased partner involvement in review of audit work papers, and the retention of an independent consultant to review Deloitte's compliance with these undertakings.

discuss the Adelphia case and Deloittes responsibilities to design audit procedures to detect fraud in the Adelphia financial statements. Specifically, what steps should be taken if there is the risk of management override of internal controls in an audit. How much do you think that the employment of so many members of the Rigas family might have increased the inherent risk of this audit and why?