On December 13, 2012, Vertical Pharmaceuticals Inc. and an affiliated company sued Deloitte & Touche LLP in New Jersey state court for alleged accountant malpractice, claiming the firm’s false accusations of fraudulent conduct scrapped Trigen Laboratories (TLI) plans to acquire Vertical for more than $50 million.

Vertical is a privately owned company that sells niche prescription drugs geared toward women’s health and pain management. TLI, a public company, sells and markets generic drugs. Deloitte was auditing the 2011 financial statements of Vertical and TLI, which are owned by the same three partners, when it abruptly suspended that review because of supposedly troubling items that two whistleblowers brought to the firm’s attention, according to the complaint, which was filed November 21 in Morris County Superior Court.

Deloitte insisted that Vertical hire independent counsel and conduct an internal investigation with a forensic audit, the complaint said. Vertical agreed to those steps, but Deloitte eventually notified Vertical that it was resigning rather than finishing its work, according to the complaint.

“As a forensic audit later discovered—no money was being pilfered from the company. No partner was stealing money from another. No improper conduct was taking place,” the complaint said.

The revelation that Deloitte resigned from the 2011 audit and the allegations of potential criminal conduct and financial improprieties that the auditor passed on to the audit committee left the acquisition for dead, the complaint said. The public company found another pharmaceutical company to acquire.

The deal would have helped rapidly grow Vertical’s business and established a revenue stream for the company of more than $500 million, the complaint contended. “Deloitte knew the deal would be final once the 2011 audit was completed. Without Deloitte’s interference in concocting a series of false, negligent statements regarding Vertical’s financials, the 2011 audit would have been issued and the deal completed.”

Vertical has asked for $200 million or more in damages on multiple counts, including accounting malpractice and breach of fiduciary duty. Deloitte also demanded and received $120,000 for all of its invoiced services before resigning, according to the complaint, which seeks back those funds as well.

Deloitte’s allegedly slanted statements involved accusations that Vertical was pilfering company funds through two LLCs, inappropriately paying company employees through car allowances, committing fraud by having an owner’s father as tax auditor, and paying an owner’s wife off the books, according to the complaint.

The firm also falsely claimed Vertical’s books were in terrible shape and that its management was unreliable, the complaint said. “A subsequent forensic audit initially to assuage Deloitte was ultimately completed . . . which found: None of these items had merit nor did they consider any resolution items justified to engender Deloitte’s resignation; that Deloitte was well aware of the nature prior to its supposed whistleblower disclosures of the items; and that many of these items were in the process of being resolved based on advice provided by Deloitte as early as May 2011,” the complaint said.

Questions

1. Do you believe Deloitte & Touche breached its fiduciary duty to Vertical Pharmaceuticals in this case? Explain.

2. Do you believe Deloitte was guilty of malpractice as alleged by Vertical? Why or why not?

3. Could Vertical have sustained a claim that Deloitte acted recklessly in prematurely withdrawing from the engagement? Be sure to address the legal requirements to make a case that recklessness occurred by the auditor.

4. When should an auditor withdraw from an engagement? Do you believe Deloitte was justified in resigning from the Vertical Pharmaceuticals engagement? Do you believe Deloitte acted ethically in this regard?