Becoming a partner with one of the large international accounting firms easily ranks among the most common career goals of accounting majors.1 Michael Goodbread staked out that career goal four decades ago. After graduating from college, Goodbread made the first step toward reaching his objective when he accepted an entrylevel position with Touche Ross & Company. In February 1973, Goodbread received his CPA license in the state of Florida after passing the CPA exam. Eight years later, the partners of Touche Ross selected Goodbread to join their ranks.

In December 1989, Goodbread accomplished his career goal a second time by becoming a partner with Deloitte & Touche, the firm created by the merger of Deloitte, Haskins & Sells and Touche Ross. Before the merger, Goodbread served as an audit partner in the Jacksonville, Florida, office of Touche Ross. Goodbread assumed an identical position with the newly formed Jacksonville office of Deloitte & Touche following the merger. 

The impressive salaries earned by partners of large international accounting firms provide them ample discretionary funds for investment purposes. Like many investors, Goodbread often considered local companies when making investment decisions. One local firm that caught Goodbread’s attention during the late 1980s was Koger Properties, Inc., a real estate development company headquartered in Jacksonville. Koger’s claim to fame was originating the concept of an offi ce park. According to a Koger annual report, the company opened the nation’s fi rst offi ce park in 1957 in Jacksonville. By the early 1990s, Koger operated nearly 40 offi ce parks in two dozen metropolitan areas scattered across the southern United States.

In December 1988, Goodbread purchased 400 shares of Koger’s common stock at a price of $26 per share. At the time, Koger had approximately 25 million shares of common stock outstanding. Following the December 1989 merger that created Deloitte & Touche, one of Goodbread’s first assignments with his new firm was supervising the audit of Koger Properties for its fiscal year ending March 31, 1990. Koger had previously been an audit client of Deloitte, Haskins & Sells. In his role as audit engagement partner, Goodbread oversaw all facets of the Koger audit. On February 21, 1990, Goodbread signed the “audit planning memorandum” that laid out the general strategy Deloitte & Touche intended to follow in completing the Koger audit. Several months later, on June 27, 1990, Goodbread signed the “audit report record” for the Koger engagement. At the time, the signing of that document by the audit engagement partner formally completed a Deloitte & Touche audit.

Goodbread signed Koger’s unqualified audit opinion on June 11, 1990. Almost exactly one month earlier, on May 10, 1990, Goodbread had sold the 400 shares of Koger stock that he had owned since December 1988. Goodbread sold the stock at a price of $20.75 per share. The Securities and Exchange Commission (SEC) eventually learned that Goodbread had held an ownership interest in Koger Properties while he supervised the company’s 1990 audit. The SEC charged that Goodbread’s ownership interest in Koger violated its independence rules, the Code of Professional Conduct of the American Institute of Certifi ed Public Accountants (AICPA), and generally accepted auditing standards. Most important, the SEC charged that Goodbread caused Deloitte & Touche to issue an improper opinion on Koger’s 1990 fi nancial statements. Instead of the unqualifi ed opinion Deloitte & Touche issued on those fi nancial statements, the SEC maintained that a disclaimer of opinion had been required given the circumstances.

Following its investigation of the matter, the SEC publicly censured Goodbread.

The embarrassing revelation of Michael Goodbread’s ownership interest in Koger Properties marked the beginning of a long series of problems that Deloitte & Touche encountered with that audit client. In September 1991, Koger fi led for bankruptcy.

A short time earlier, Koger’s stockholders had filed a class-action lawsuit against Deloitte & Touche. The suit alleged that the 1989 Koger audit performed by Deloitte, Haskins & Sells and the 1990 Koger audit completed by Deloitte & Touche were deficient. Those deficient audits allegedly contributed to the subsequent decline in Koger’s stock price.

A federal jury agreed with the Koger stockholders and ordered Deloitte to pay the plaintiffs $81.3 million to compensate them for damages suffered because of the 1989 and 1990 audits. In July 1997, the U.S. Court of Appeals reversed the lower court’s ruling and voided the huge judgment awarded to Koger’s stockholders. The appellate court ruled that the stockholders failed to prove that any errors made by Deloitte during the 1989 and 1990 Koger audits caused the losses they subsequently incurred.2 Another of the megafi rms created by a merger of two large international accounting firms encountered an independence problem similar to that experienced by Deloitte & Touche in the Koger Properties case. However, PricewaterhouseCoopers’ “problem” was much more severe and embarrassing. In 1999, that firm agreed to be censured by the SEC for dozens of alleged violations of the profession’s independence rules.

Questions

1. The SEC charged that Goodbread violated its independence rules, the AICPA’s Code of Professional Conduct, and generally accepted auditing standards. Explain the SEC’s rationale in making each of those allegations.

2. In your opinion, did Goodbread’s equity interest in Koger Properties likely qualify as a “material” investment for him? Was the materiality of that investment a relevant issue in this case? Explain.

3. Given that Goodbread purchased stock of Koger Properties in 1988, under what conditions, if any, could he have later served as the audit engagement partner for that company?

4. During much of the 19th century in Great Britain, independent auditors were not only allowed to have an equity interest in their clients but were required to invest in their clients in certain circumstances. Explain the rationale likely underlying that rule. Would such a rule “make sense” in today’s business environment in the United States? Defend your answer.