San Diego-based National Medical Transportation Network (MedTrans) eventually became the largest ambulance services provider in the United States. Reaching that pinnacle was not an easy journey. In early 1992, MedTrans encountered cash flow problems that prompted the company's two owners to search for external financing. The co-owners located a company willing to invest \(\$ 10\) million in MedTrans. During negotiations with that company, MedTrans' auditor, Deloitte \& Touche, uncovered problems in its client's accounting records. Those problems prevented Deloitte from issuing an unqualified opinion on MedTrans' 1992 financial statements. After several unpleasant confrontations with MedTrans' chief executive officer, Deloitte resigned as the company's audit firm.

Following Deloitte's resignation, the \(\$ 10\) million investment deal collapsed. Within a few months, MedTrans' two owners sold their firm to a large corporation. Unhappy with Deloitte's lack of "cooperation," MedTrans' former owners sued Deloitte to recover the sizable loss they incurred on the sale of their company. Among other charges, the former owners alleged that Deloitte acted negligently by "withdrawing prematurely" from the 1992 MedTrans audit engagement.

No doubt, Deloitte's legal counsel confidently tackled the MedTrans lawsuit. The allegation that Deloitte negligently withdrew from the 1992 MedTrans audit engagement seemed implausible since the client had adamantly refused to make several large and necessary adjustments to its 1992 financial statements. Threatening comments made to Deloitte auditors by one of MedTrans' co-owners provided even stronger justification for the audit firm's resignation. Imagine then the shock and disbelief of Deloitte's attorneys when the jury that heard the lawsuit agreed with MedTrans' former owners and imposed a multimillion-dollar judgment on the prominent accounting firm.

MEDTRANS SEEKS HELP

MedTrans' two principal officers, Roberts and Morgan, served as the company's chief executive officer (CEO) and president, respectively, and each owned 50 per cent of MedTrans' common stock. Deloitte audited the company's annual financial statements each year from 1988 through 1991-MedTrans' fiscal year ended March 31. Apparently, Deloitte encountered few problems during those audits and issued an unqualified opinion each year on MedTrans' financial statements.
By the late spring of 1992, MedTrans needed cash, and quickly. The company owed \(\$ 2\) million of payroll taxes and faced a \(\$ 12\) million repayment to its primary lender, which had suddenly and unceremoniously yanked MedTrans' line of credit. Making matters worse, MedTrans' chief financial officer (CFO) unexpectedly resigned in early June 1992. That resignation triggered a crisis between MedTrans and the company's audit firm. Deloitte was nearing completion of its 1992 MedTrans audit and had asked the CFO to sign a letter of representations indicating that the company's financial statements were materially accurate. The CFO told Gordon Johns, the Deloitte audit engagement partner, that he could not sign the letter of representations since he did not believe MedTrans' financial statements were reliable. A few days later, the CFO met with Johns to discuss the situation.
At the meeting, Ensz [the CFO] alerted Johns to four or five matters relevant to the audit. Ensz said that upon informing Roberts [the CEO] that those matters were not properly entered in MedTrans's journals, Roberts told Ensz to leave the journals as they were and "let's see" if the auditors "find it." Questioning Roberts's character for honesty because of some things Roberts advocated in presenting financial information, Ensz also stated he lacked faith in the integrity of Roberts and MedTrans's financial statements.'
The CFO's unsettling allegations caused Deloitte to approach the remainder of the 1992 MedTrans audit with extreme caution. By the end of June 1992, the Deloitte auditors concluded that their client's financial statements contained material errors. Those financial statements reported a net income of nearly \(\$ 2\) million for fiscal 1992, while Deloitte's audit suggested that MedTrans had suffered a loss of approximately \(\$ 500,000\). A large increase in MedTrans' allowance for bad debts proposed by Deloitte accounted for most of the difference between those two figures.
During June and July 1992, Roberts negotiated with William Blair \& Company to obtain the additional capital needed by MedTrans. In exchange for a \(\$ 10\) million investment in MedTrans, Roberts and Morgan offered Blair a 50 percent ownership interest in the company. While mulling over this offer, Blair's executives reviewed MedTrans' unaudited financial statements for 1992. Based largely upon the \(\$ 2\) million profit reported in those financial statements, Blair forecasted that MedTrans' annual earnings would top \(\$ 6\) million by 1995 . On July 27, Blair's executives tentatively agreed to invest in MedTrans. The agreement was contingent on MedTrans' receiving an unqualified audit opinion on its 1992 financial statements.
Roberts' negotiations with Blair were periodically disrupted by an ongoing quarrel with Gordon Johns. Roberts and Johns feuded throughout the summer of 1992 over the large increase in the company's allowance for bad debts that Deloitte believed was necessary. During a July 9 meeting, Roberts warned Johns that MedTrans' audited financial statements would have a significant impact on whether the Blair transaction was consummated.

A very focused Roberts vocally and explicitly emphasized the importance of MedTrans's pre-tax earnings because of the potential that Blair might invest in the company. ... Johns [then] presented Roberts with about \(\$ 2.5\) million in suggested adjustments involving the accounts receivable reserve account. Roberts told Johns: "You better not propose any adjustment that will my deal or you'll be sorry."
Shortly after the July 9 meeting, Johns contacted an executive Deloitte partner in the firm's New York headquarters. The executive partner told Johns that "we should not be associated with companies that threaten us." Unless Roberts accepted the proposed adjustments, the executive partner recommended that Johns resign from the engagement. Johns told the executive partner that before raising the issue again with Roberts, he wanted to give him some time to analyze MedTrans' bad debt reserve and to reconsider the need for the proposed adjustments. On July 30, Roberts and Johns met again. During this meeting, Roberts reminded Johns of the impact Deloitte's audit would have on the proposed Blair deal. Roberts also gave Johns a memorandum prepared by MedTrans' personnel that presented a more favorable analysis of the company's bad debt reserve than the analysis developed by Deloitte.
Roberts and Johns met a final time on August 13, 1992, to discuss Deloitte's audit and the pending Blair transaction. At this meeting, Johns presented a memorandum containing a new set of proposed adjustments to MedTrans' 1992 financial statements. Collectively, these adjustments would have reduced MedTrans' pre-audit net income even more than the adjustments originally proposed by Deloitte.
During Johns's presentation, Roberts rose, threw down the memorandum and said very angrily: "You are finished." Although Johns thought he had been fired, Roberts told Johns not to construe the situation that way. However, after MedTrans's successive rejections of proposed adjustments to its unaudited financial statements, Johns believed the parties' mutually exclusive views of those statements indicated there was no longer a basis for a relationship. Thus, Johns told Roberts that if defendants [Deloitte] had not been fired, he was resigning. Roberts told Johns that "you're going to finish this regardless, under court order or otherwise." Johns believed such threat destroyed any ability to continue as an independent auditor. Johns also believed resignation was necessary because MedTrans bullied Deloitte's personnel and defendants were put at risk by MedTrans's lack of commitment to financial statements accurately depicting the difficulties the company experienced in fiscal 1992.
Deloitte formally resigned from the MedTrans engagement shortly after the August 13 meeting between Johns and Roberts. Four days later, Roberts sent a letter to Deloitte reminding the firm that its resignation would have serious repercussions for the pending Blair deal. Roberts also insisted once more that Deloitte complete the 1992 audit. Deloitte refused to be swayed and remained MedTrans' "former" auditor.........

Questions
1. Following his resignation, MedTrans' former CFO met with Gordon Johns, the Deloitte audit engagement partner. Did the CFO have a responsibility to inform Johns of the errors in MedTrans' 1992 financial statements? Defend your answer.
2. What courses of action were available to Johns following his meeting with MedTrans' former CFO? Which of those options would you have selected? Why?
3. How did the threats Roberts made to Johns impair Deloitte's independence? The AICPA maintained that an audit firm is "forbidden" from issuing an audit opinion when it believes its independence has been impaired. Identify three circumstances, unrelated to this case, that would threaten an audit firm's independence.
4. Did Deloitte have a responsibility to be totally candid with MedTrans' prospective successor auditors? Explain. Under present auditing standards, what questions should a prospective successor auditor pose to a predecessor auditor?
5. The jury in the MedTrans v. Deloitte lawsuit ruled that the accounting firm negligently resigned from the 1992 audit, breached its contract with the client, and made defamatory statements regarding MedTrans' former executives during the predecessor-successor auditor communications. The appellate court reversed these rulings. Provide an example of each alleged type of misconduct for which an audit firm likely would be held legally responsible.