The facts of this case are drawn from the SEC's Accounting and Auditing Enforcement
The Company Perpetrating the Fraud The case involves a fraud perpetrated by MCA Financial Corporation, which was incorporated in 1989 as a holding company for four wholly owned subsidiaries with 45 branch offices in seven states. MCA primarily was involved in the residential mortgage-banking business. MCA's fraudulent scheme was accomplished through related-party transactions and involved the following steps. MCA purchased distressed rental properties in the city of Detroit, sold them to the Related Limited Partnerships at inflated prices, advanced the Related Limited Partnerships small down payments (usually 10% or 20%), and accepted executed mortgages or land contracts for the remainder of the purchase prices.MCA established the prices at which it sold the rental properties to the Related Limited Partnerships by calculating the value each property would have after substantial rehabilitation, even though rehabilitation work had not been completed or even begun. MCA then recognized the entire gain on each sale as revenue even though MCA knew that the Related Limited Partnerships could not afford to pay for the properties because of the inflated sales prices and the prevailing rental rates. In fact, the Related Limited Partnerships failed to make most of the required loan payments to MCA for the properties.
MCA recorded the money owing from the Related Limited Partnerships as a result of advancing the down payments on the asset side of its balance sheet under the heading of "Accounts Receivable Related Parties." MCA carried those receivables without any valuation allowance despite the Related Limited Partnerships' inability to repay the receivables. MCA fraudulently sold some related-party mortgages and land contracts to the pools and carried the remainder at cost or with an inadequate allowance for loan losses under the headings of "Mortgages Held for Resale" or "Land Contracts Held for Resale" despite the Related Limited Partnerships' inability to repay and the inadequate collateral. The collateral for these mortgages and land contracts was the real estate that MCA had sold to the Related Limited Partnerships at inflated prices. As a result, MCA knew that foreclosing on the collateral would not result in MCA receiving the full principal amount of the loans. MCA did not disclose in its financial statements that a material amount of its mortgages and land contracts held for resale were related-party mortgages and land contracts.
The Auditors Grant Thornton LLP was one of two firms that jointly provided audit services to MCA and jointly signed reports containing unqualified opinions on MCA's annual financial statements from 1993 through 1998. Doeren Mayhew & Co. P.C., a Michigan accounting firm, was the other firm that jointly provided audit services to MCA and jointly signed reports containing unqualified opinions on MCA's annual financial statements from 1993 through 1998.
Peter Behrens is a CPA who served as an engagement partner for Grant Thornton's joint audits of MCA. Marvin Morris is a CPA who served as an engagement partner for Doeren Mayhew's joint audits of MCA. Benedict Rybicki is a CPA who served as the engagement manager for Doeren Mayhew's joint audits of MCA. Morris obtained personal mortgages through MCA in July 1994 for approximately
$344,000 and in July 1995 for approximately $200,000.The 1994 mortgage was discharged when the 1995 mortgage was executed. Morris did not review the auditors' work papers for several key portions of the 1998 MCA audit, including the work papers for mortgages and land contracts held for resale and gains on sale of real estate. As late as 2001, Morris stated that he had only ever read the first 13 of the approximately 150 Statements of Financial Accounting Standards. Reading the Statements of Financial Accounting Standards was not "what [Morris did] for a living." Rather, he considered himself a "salesperson." As the engagement manager, Rybicki signed a work paper in connection with the 1998 MCA audit: (a) confirming that the entire MCA engagement had been performed in accordance with professional standards; (b) confirming that related parties or unusual transactions and relationships were properly disclosed and documented in MCA's financial statements; and (c) agreeing with the issuance of the report containing an unqualified opinion. Rybicki socialized with Alexander Ajemian, MCA's controller, while Doeren Mayhew acted as one of MCA's auditors. Rybicki first met Ajemian in approximately 1987 when both were staff accountants at the Detroit office of Pannell Kerr & Forster. Rybicki and Ajemian both played on Pannell Kerr's softball team. They continued playing on the same team even after each had left Pannell Kerr, including while Ajemian was MCA's Controller and Rybicki was the engagement manager for the MCA audits. Rybicki, Ajemian, and the remainder of the softball team often ate and drank together after the games.
Between 1993 and 1998, Rybicki and Ajemian occasionally spent weekends in Petosky, Michigan, where they stayed at a lakefront condominium owned by MCA. During the same time period, Rybicki and Ajemian spoke socially on the telephone, ate together, water skied, and traveled to the Kentucky Derby. After MCA filed for bankruptcy in 1999 and Ajemian pled guilty in 2001 to federal criminal charges in connection with his conduct at MCA, Rybicki and Ajemian continued socializing. They dined together, attended sporting events, played on the same softball team, and traveled together. While acting as MCA's auditors, Doeren Mayhew and Grant Thornton personnel, including Behrens, Morris, and Rybicki, sometimes attended a party held by Ajemian annually at his home and paid for by MCA known as the "Bean Counters Bash."This party was held to celebrate the completion of the annual audit. MCA executives provided Doeren Mayhew and Grant Thornton auditors with free tickets to Detroit Red Wings hockey games and University of Michigan football games. MCA executives also invited the auditors to tailgate parties paid for by MCA at the football games. Rybicki obtained a personal mortgage through MCA for approximately $59,000 to purchase his house in the early 1990s.
During the 1998 MCA audit, Behrens, Morris and Rybicki knew that millions of dollars of the mortgages and land contracts held for resale reported in MCA's 1998 annual financial statements consisted of related party mortgages and land contracts. Behrens, Morris and Rybicki obtained this knowledge through their preparation of the 1998 MCA audit plan, their review of the 1998 audit work papers and other materials, their performance of audit procedures during the 1998 audit, their communications with MCA executives, and/or their knowledge of MCA's business from prior audits.
Specifically with respect to the workpapers, Behrens and Rybicki reviewed workpapers as part of the 1998 MCA audit which showed that MCA sold approximately $10.8 million in real estate to the Related Limited Partnerships in fiscal year 1998.Those workpapers also showed that MCA advanced the Related Limited Partnerships a small down payment for the real estate and accepted an executed mortgage or land contract for the remaining portion of the purchase price. Those workpapers further calculated that approximately $4.9 million of those related party mortgages and land contracts had not been sold as of MCA's balance sheet date and thus were included in the total mortgages or land contracts held for resale as reported in MCA's 1998 annual financial statements. Rybicki prepared, and Behrens and Morris reviewed, a work paper in connection with the 1998 MCA audit entitled "Audit Planning." In this workpaper, Rybicki assessed the audit risk on the MCA engagement as "high." Later in the workpaper, Rybicki noted that the reasons for the high risk assessment were that MCA had "significant and/or frequent difficult to audit transactions or balances" and "material, related-party transactions on a recurring basis." Behrens and Rybicki also reviewed workpapers as part of the 1998 MCA audit which contained balance sheets for the Related Limited Partnerships reflecting approximately $57.3 million in liabilities under the heading of "Mortgages and Land Contracts Payable." Behrens and Rybicki additionally reviewed workpapers as part of the 1998 MCA audit that showed that approximately $4.0 million of MCA's land contracts held for resale, those that had been pledged as collateral for one of MCA's debenture offerings, were related-party land contracts. During the 1998 MCA audit, Behrens, Morris and Rybicki read MCA's 1998 annual financial statements. Those financial statements did not disclose any related-party mortgages or land contracts held for resale or state the total amount of such mortgages and land contracts held for resale. Grant Thornton and Doeren Mayhew issued a report, dated April 28, 1998, containing an unqualified opinion on MCA's 1998 annual financial statements even though Behrens, Morris and Rybicki knew that MCA had failed to disclose material, related-party mortgages, and land contracts.

Required
a. Summarize the nature of the fraud perpetrated by MCA involving related-entity transactions.
b. Summarize the nature of the inappropriate relationships between MCA and its auditors.
c. Discuss how the concepts of auditor independence and ethics relate, with an emphasis on the facts in this case. Discuss the issue of what personal relationships are or are not acceptable between an audit firm and the client.
d. Recommend changes that these audit firms should make to improve their quality control procedures.