Federal prosecutors in Manhattan are investigating PricewaterhouseCoopers (PwC) in connection with undisclosed bonuses paid to former executives of Tyco International Ltd. A report by the Wall Street Journal suggests that prosecutors may be trying to make a criminal case against PwC as Tyco's auditor.

The Journal said the probe is focusing on three questions:

1. Did PwC uncover the secret bonuses in the course of its audit work?
2. Was PwC aware of the improper accounting techniques used to hide the bonus payments?
3. Did PwC know that Tyco's annual proxy filings were incorrect and fail to do anything about it?

The improper accounting techniques referred to in question 2 involve booking bonuses against reserve accounts, instead of expensing them. For example, the company expensed only $45 million of a special unapproved $96 million bonus. The remainder was charged to unrelated reserve accounts, including a $41 million offset to accrued federal income tax.

The proxy filings referred to in question 3 improperly excluded the bonuses from the executive compensation tables. Although auditors have no responsibility for approving proxy filings, legal experts say prosecutors could argue under New York laws that PwC may have been committing securities fraud by helping Tyco make incomplete disclosures.

A PwC spokesperson told AccountingWEB, "We have no reason to believe we are anything other than a witness... We are cooperating with the Manhattan District Attorney on the basis that the firm is simply a witness -- a provider of information -- in these proceedings."

Reuters reported that PwC may also face investigations by the SEC.

-Rosemary Schlank