EY (the erstwhile Ernst & Young) is expected to pay Bain Capital about $35 million to settle claims that EY aided accounting fraud by an Indian clothing manufacturer in which Bain had invested.
The claim, made in a lawsuit filed in Massachusetts state court, joins a growing list of high-profile implosions by private equity investments in India, an attractive high-growth destination with significant fraud risk.
The case is also a good example of the troubles faced by some investors who rely on international accounting firms operating in India.
Bain’s troubles started in 2010 when it invested $60 million for a non-controlling 30.99% share in New Delhi-based Lilliput Kidswear. Liliput was an apparently fast-growing manufacturer and retailer of children’s clothing. Private equity and venture capital investors have been pursuing consumer-oriented and scalable investments in India. India has plenty of children and a growing middle class that is comfortable with spending on branded clothes.
However, Lilliput turned out to have Gulliver sized problems.
Problems arose in 2012 in the run-up to a planned IPO. An anonymous phone call to the investors suggested that Liliput had been inflating revenues, and that EY knew about it and helped cover it up.
This must have been particularly galling to Bain. Bain was reportedly a client of EY for years. However, the consulting giant not only acted as statutory auditor for Lilliput, but acted as the company’s agent in soliciting an investment from Bain.
According to the complaint, EY specifically targeted Bain because the firm knew Bain would pay a higher purchase price than other potential investors.
Bain’s accusations include claims for work done by EY’s local affiliate, S.R. Batliboi & Associates LLP, an Indian accounting and consulting firm. The complaint accuses EY and Batliboi of “breathtaking” violations of basic Indian GAAP, including Liliput falsifying audit papers and issuing an unqualified opinion.
The investors filed legal actions in India, where lawyers and other representatives of the investors were allegedly targeted by protests and threats. Despite news stories and discussion in the marketplace about a proposed settlement, the case remains pending in Massachusetts.
It’s natural to rely on global relationships when entering a foreign market. However, as Bain found out to its detriment, reliance on labels has its hazards too.
EY joins its colleagues in the Big Four by having a tough time in India. While each of the Big Four have very large back office operations in India, their domestic accounting services have been at the center of a number of significant scandals.
Deloitte Touche Tohmatsu India Pvt. Ltd, issued a valuation report for an Indian company that allegedly helped an Indian politician obtain an elevated price for his shares.
Auditors for KPMG and its local audit affiliate were charged with helping the local executives of Reebok defraud the company of more than $160 million.
Two PWC partners were convicted of helping in the scandal surrounding Satyam Computer Services Ltd., “India’s Enron.” In that case, the SEC fined PwC $6 million, the largest penalty against a foreign based accounting firm, and ordered it to undergo training and be subject to a monitor for four years.
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Russell Stamets is a Contributing Editor of the FCPA Blog. He was the first non-Indian general counsel of a publicly traded Indian company and was general counsel for a satellite broadcasting joint venture of a large Indian business house. Russ can be contacted here.
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