Cary Spivak – Milwaukee Journal Sentinel

As investigators, attorneys and accountants sift through the aftermath of the $31 million alleged embezzlement at Koss Corp., a question lingers:

Where was Grant Thornton, the national auditing firm that collected more than $625,000 from 2004 through 2009 to audit the books of the small Milwaukee headphone manufacturer?

“That fraud is so large, in relation to the size of the company, that I have got to believe that is going to make it very difficult for Grant Thornton to prove that they conducted an audit in accordance with generally accepted auditing standards,” said Richard Brown, a veteran of 36 years with accounting firm KPMG, who now teaches accounting at the University of Wisconsin-Milwaukee and Concordia University.

“I’d hate to be in their shoes right now,” said Brown – not because he’s convinced Grant Thornton did anything wrong, but because of the public perception that the auditors must have missed something.

There has been no suggestion that the auditors or Koss’ senior management had any inkling that millions of dollars were being misappropriated. But the question that likely will be dealt with in courthouses and in law firm conference rooms is whether the auditors should have caught the embezzlement that investigators believe ran for at least seven years.

“Are they responsible? I can’t say,” said Joel Joyce, a partner at Milwaukee accounting firm Reilly, Penner & Benton LLP. “Do they have a tough row to hoe? Absolutely.”

Asked repeatedly for comment on the matter, a Grant Thornton spokesman sent an “off the record” e-mail refusing to discuss it.

The federal indictment charges the embezzlement was committed by Sujata “Sue” Sachdeva, a high-ranking financial executive at Koss who enjoyed immense trust from Michael Koss, the firm’s top executive and son of the company founder.

In addition to questioning whether Grant Thornton, the nation’s sixth-largest accounting firm, should have caught the fraud, Brown said members of the Koss board, senior managers and lower ranking employees who may have been aware of the fraud should not be given a pass when blame is assessed.

“It’s just staggering to me that nobody noticed something was amiss,” said Brown, who was running the KPMG Milwaukee office when he retired about four years ago.

Two veteran assistants to Sachdeva – Tracy Malone and Julie Mulvaney – were fired by Koss after the misappropriations were discovered.

American Express blew the whistle on the scheme when it contacted Michael Koss and told him that it suspected that Sachdeva illegally was spending millions of company dollars.

The FBI arrested Sachdeva in December after she told agents she had taken millions of dollars, spending a chunk of it on high-end clothing, jewelry and other merchandise, some of which was delivered to her Koss office.

The FBI investigation is continuing as agents try to determine whether any other Koss workers were involved. Lawyers who have filed – or are considering filing – lawsuits on behalf of shareholders also are investigating.

Of the handful of lawsuits filed so far, one names Grant Thornton as a defendant. That suit – known as a derivative action because it asks a judge to order Koss Corp. to pursue the litigation – also names Koss executives and board members as defendants. The Koss family controls nearly three-quarters of the company, which employs about 70 people and had sales of about $38 million last year.

“It’s hard to imagine what service (Grant Thornton) provided,” said Jeremy Levinson, who along with a San Diego law firm filed the suit. If the company had performed a thorough audit, he said, “wouldn’t that have prevented the embezzlement of vast amounts of money?”

For Grant Thornton, the legal question isn’t whether it found the fraud, but whether it properly conducted the audits it was paid to conduct.

“Grant Thornton’s exposure could be zero,” said Brian Daugherty, who teaches accounting at UWM and hopes to use the Koss embezzlement as part of a case study involving corporate oversight and regulations. “They were not engaged to issue an opinion on internal controls.”

An internal-controls audit is a more expensive review designed to prevent and find fraud. Larger public companies are required to conduct that audit, but for Koss, whose chief executive was an outspoken critic of increased federal corporate regulation, it was optional – and the company opted not to conduct one.

Things could get dicey for Grant Thornton, however, if the matter makes its way to a court, said Daugherty, who spent more than 15 years at Arthur Andersen, leaving before what was then the biggest accounting firm in the nation closed down in the aftermath of the Enron Corp. scandal.

“If it goes to litigation, especially if there is going to be a jury – who knows?” Daugherty said.

Even though Grant Thornton was not hired to do the more expensive internal-controls audit, it is not off the hook, according to Daugherty, because industry standards require auditors to have a “professional skepticism” and be aware of the possibility of fraud.

A 2003 article in the Journal of Accountancy, published by the American Institute of Certified Public Accountants, makes clear how tightened rules put auditors on alert. The institute sets industry standards and ethics.

“The new standard aims to have the auditor’s consideration of fraud seamlessly blended into the audit process and continually updated until the audit’s completion,” the article said.

The article goes on to note that audit teams are required to have brainstorming sessions to discuss the possibility of fraud and to be wary of everybody – even the executives who hired them.

“The mere fact the engagement team has a serious discussion about the entity’s susceptibility to fraud also serves to remind auditors that the possibility does exist in every engagement – in spite of any history or preconceived biases about management’s honesty and integrity,” the Journal stated.

But Brown, the retired KPMG partner, noted that those standards “stop short of saying they should find fraud,” but instead require auditors to find the risk of fraud.

“An audit is really limited to checking the math and checking the application of accounting rules,” said Tracy Coenen, owner of Sequence Inc., a forensic accounting firm in Milwaukee. “I know people want them to find fraud. They almost never do.”

So who does find fraud in a company?

“It’s usually not found by auditors, but by whistleblowers,” Brown said. “Internal whistleblowers.”

No matter how the Sachdeva case is resolved, accounting industry experts agree that Grant Thornton is paying a price.

The obvious cost will come in paying lawyers to defend the firm against any lawsuits. Then there is the hit to the firm’s public image, plus possible morale problems and loss of clients.

One local company, Strattec Security Corp., fired Grant Thornton as its auditor this year but said it had no issues with the firm. Until this year, Michael Koss was the chairman of Strattec’s audit committee.

Brown said the steepest price will be incurred when the company seeks to recruit new clients – a difficulty he said could last for a year or two, based on his experiences at KPMG.

“Whether they did a bad audit or not, we don’t know, but that’s going to be presumed by some,” Brown said. “They’re going to spend more money defending themselves than they ever got in fees.”