Bankrupt Airline Sues Ernst & Young for Accounting Fraud

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Ernst & Young defrauded creditors of bankrupt airline Tower Air by helping the airline inflate profits and understate losses, a lawsuit claims.

The creditors, who are seeking more than $380 million in damages, allege that the auditors hid the airline's debts and improper business practices, formed a too-close relationship with the CEO and destroyed evidence in the case, the Baltimore Business Journal reported.

The creditors include Fleet Business Credit, General Electric, the Port Authority of New York and New Jersey, and Annapolis-based aviation firm ARINC. The trial is set to begin later this month.

“The jury is going to hear a tale of a very strange, intimate relationship" between Tower and Ernst & Young, said attorney Robert Weltchek of Weiner & Weltchek, arguing on behalf of the creditors in a hearing last week. An Ernst & Young spokesman said, "These charges have no merit, and we will vigorously defend ourselves in court."

Court papers say that Ernst & Young's accounting failures led Tower Air to report a pretax profit of $4.6 million in 1998, when it actually lost about $17 million. And Tower Air's reported $3.9 million loss in 1997 was actually at least $41 million larger, the suit states. It goes on to say that the firm never reconciled Tower Air's payroll account, failed to disclose that Tower Air owed $9 million in back excise taxes, and failed to book $2.75 million of travel agents' commissions as an expense.

Ernst & Young became the airline's independent auditor in 1993. The airline was founded 10 years earlier to fly international routes for government and military officers, but went public in 1993. Ernst & Young had done accounting work for the firm and president Morris Nachtomi since the airline's inception and performed lucrative financial advisory work for the firm since the late 1990s, the suit says.

Tower Air initially planned to restructure its debts and continue operating, but at the end of 2000 converted its Chapter 11 bankruptcy to a Chapter 7, meaning the company's assets are liquidated to pay debts.

Peter Henning, a law professor at Wayne State University in Detroit, told the newspaper that it is common for investors to sue a company's auditors if they believe they were defrauded by too-optimistic financial projections – especially when the company has no money to pay claims. But it is very rare for such cases to go to trial. Most such cases settle, Henning said.

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