LIBERTY UNIVERSITY SCHOOL OF BUSINESS
Case 2.5 Lipper Holdings, LLC.
Discussion Board
Submitted to Professor James Shelton,
In partial fulfillment of the requirement for the completion of
ACCT 622: Advanced Auditing (B02)
By
Lubov Beliveau-Dubois
February 3, 2024
Case Summary:
This case is about Kenneth Lipper and his influence in Hollywood and Wall Street. Lipper was
born in 1941 to working-class family in New York. Lipper decided at a young age that he was
going to have a career on Wall Street. Lipper was academically savvy with an undergraduate
degree from Columbia university, law degree from Harvard and master’s degree from New York
University School of Law, and a post-graduate degree from University of Paris. Through his
travels and academia, he made friends with well connected and wealthy friends. At the young
age of 25, Lipper married into a wealthy family, which helped fast-track his career on Wall
Street. At the age of 32, he was the youngest partner at Lehman Brothers. In 1975, he became
partner and managing director of Salomon Brothers. His Wall Street career his an all low when
the SEC accused him of aiding and abetting violations of the Federal Securities laws, attempting
to take over a public company. He settled the SEC charges and only received minor sanctions.
He ended up in Hollywood as a technical advisor to Oliver Stone, screen writer, and film
producer. Through his Hollywood connections, his hedge fund enterprise grew dramatically. He
was the President and CEO of Lipper Holding, LLC where his clients were Julia Roberts, Disney
CEO, Sylvester Stallone, amongst many others. He was their financial advisor. These wealthy
people entrusted their wealth to Lipper Holdings, Inc. Lipper had three large hedge funds:
Lipper Convertibles, Lipper Convertibles Series II, and Lipper Income Fund. These three hedge
funds were managed by Edward Strafaci, Executive VP of Lipper Holding, Inc. Those hedge
funds were not registered with the SEC based on their structure according to Investment
Company Act of 1940. The Investment Company Act of 1940 was intended to protect the public
interest by requiring investment companies disclose key information concerning their financial
health, structure, investment policies and objectives using Form N-SAR. Under this Act,
investment companies with more than 100 investors are required to register with the SEC
(Merrill, 2023). The Securities Exchange Act of 1934, required Lipper Holdings, LLC to file
annual audited financial statements with the SEC. To protect investors,ACongressAcrafted a
mandatory disclosure process designed to force companies to disclose information that investors
would find pertinent to making investment decisions. In addition, the Exchange Act regulates
theAexchangesAon which securities are sold.ARegulation FDAis the primary section of the
Exchange Act which discusses disclosures. “Under Section 13(a) of the Exchange Act (codified
inA15 U.S.C. § 78m), companies with registered publicly held securities and companies of a
certain size are called "reporting companies," meaning that they must make periodic disclosures
by filing annual reports (called aAForm 10-K) and quarterly reports (called aAForm 10-Q).
Reporting companies must also promptly disclose certain important events (called aAForm 8-K).
These periodic reports include or incorporate by reference types of information that would help
investors decide whether a company's security is a good investment. Information in these reports
includes information about the company's officers and directors, the company's line of business,
auditedAfinancial statements, and the management discussion and analysis section” (Cornell,
2023). Strafaci increased the rates of return causing the rates to be higher than what was earned
in the investment portfolios. Strafaci used financial leverage, which is the use of borrowed
money to finance the purchase of assets with the expectation that the income or capital gain from
the new asset will exceed the cost of borrowing (CFI, 2023). Strafaci intentionally overstated the
hedge funds’ reported market values. Strafaci caused an internal investigation due to his sudden
resignation from Lipper Holding, LLC, which lead to the discovery of fraudulent scheme.
Strafaci laid all the blame on Lipper yet in 2004 plead guilty to fraud, where he received a six-
year prison sentence and to pay restitution in the amount of $90 million.
PricewaterhouseCoopers (PwC) was the audit firm that received a lot of scrutiny from federal
prosecutors as they should have uncovered the overstated values of the investments. Lipper had
chosen PwC because of their extensive experience with dealing with hedge funds and hard-to-
price securities. Larry Stoler, partner at PwC, was the audit engagement partner to Lipper
Holdings, LLC and it’s three hedge funds. According to the SEC, Stoler knew that Lipper had
weak internal controls and that Strafaci supervised the marking to market versus having a third
party perform the formal review. PwC’s working paper stated that year-end market values were
overstated. Due to the extensive overstatement of the funds’ assets, the SEC rules that the 2000
unqualified audit reports by PwC were unjustified. With SEC’s finding, the three Lipper hedge
funds were liquidated by Lipper Holdings, Inc resulting in hundreds of millions of dollars in
losses to investors, which led to civil lawsuits filed by investors.
Q1. Identify specific fraud risk factors present during PwC’s audits of the Lipper hedge
funds. Explain how PwC should have responded to the fraud risk factors that you
identified.
1- Overstatement of funds and inconsistent audit reports.
2- Weak internal controls by Lipper Holdings, LLC.
3- Internal controls were not in accordance with GAAS.
4- Market analysis done by the auditors did not match Lipper Holdings, LLC prices.
It was PwC’s job to make sure that Lipper Holdings, LLC was in compliance with GAAS
standards and recommendations should have been made pertaining to their weak internal
controls. PwC should have performed their own tests and audit analysis that would have helped
them identify the overstatement of the funds. If they had performed testing and applied due-
diligence to the audit, they would have recommended corrections of the overstatements. In this
particular case, the risk factors were lack of integrity (false advertising and overstatement),
motive (compensation tied to performance), and opportunity (lack of internal control, i.e.,
segregation of duties presented an opportunity for fraud). PwC faced securities fraud lawsuit by
investors who accuse it of missing red flags when it audited a hedge fund (Reuters, 2013).
Q2. Provide examples of important audit objectives for complex financial instruments and
transactions. For each audit objective that you identified, list one or more audit
procedures that could be used to accomplish that objective.
When conducting an audit, an audit company needs to have objectives that are followed by
procedures. One of the objectives would be to study a firm’s internal controls and validate its
weaknesses as well as it’s strengths. This objective would be followed by procedures such as
validating that the internal controls have the appropriate controls in place to measure liabilities
and assets properly and validate that the mechanisms in place are in accordance with GAAS.
Another objective would be to determine if the financial reports are in accordance with GAAS
which would consist of verifying that the financial reporting is in compliance with GAAS
accounting standards. Another objective would be to test the financial data which would be
testing through deeper analysis of the financial data and perform floor checks and interviews of
key personnel (external sources that are reliable). Another objective would the audit report
where the proper procedures would be to highlight the concerns with remarks and
recommendations within the final report. While there are many issues with how PwC performed
their audit, the biggest issue with Lipper Holdings, LLC was lack of internal controls which
allowed the manipulation and misstatement of the financial reports. “Good internal controls are
essential to assuring the accomplishment of goals and objectives. They provide reliable financial
reporting for management decisions. They ensure compliance with applicable laws and
regulations to avoid the risk of public scandals” (Office of Internal Audit- University of Florida,
2019).
Q3. Identify the factors that may have contributed to the alleged flaws in the audit
procedures that PwC applied in testing the year-end market values of the Lipper hedge
funds’ investments. Discuss specific measures that audit firms can employ to reduce the
likelihood that such factors will undercut the quality of their audits.
In my opinion the contributing factors in the audit procedures were lack of due diligence, lack of
competence, lack of proper and precise communication, and lack of oversight by the partners.
Due diligence: The audit team should have investigated the misstatements of Lipper Holdings,
LLC’s financial reports and sought better insight into the grotesque misstatement- it requires
examination and validation of information.
Competence: Competence is crucial in auditing as it’s the ability to apply required knowledge
and skills. Junior accountants were put in charge of information and evidence gathering. If they
are not competent enough or seasoned enough in their jobs, they wouldn’t necessarily know what
to look for and where to look for it.
Communication: communication is key to pretty must anything in general. If the junior
accountants are not well practiced in the world of auditing, their might lack the proper
communication skills where their reporting or communication with client might be ambiguous or
vague in working versus specific and accurate.
Oversight: According to Greenline Financial, “audit oversight refers to the verification and
checking of the reported financial results of an organization by external and internal review”
(Greenline, 2024). AnAauditAis an independent examination of the books and other documents of
an organization to determine if their financial statements present a true and fair view. It was the
ultimate job of the audit management partners to review and sign off on the audit reports and
question the validity of the report and/or the concerns brought forth.
Christian World View:
The most common form of greed has to do with material wealth, an excessive desire to acquire
materiality of some sort. Kenneth Lipper and his associates that were involved were eager for
wealth. Ecclesiastes 5:10-13 states, “He who loves money will not be satisfied with money,
nor he who loves wealth with his income; this also is vanity. When goods increase, they
increase who eat them, and what advantage has their owner but to see them with his eyes?
Sweet is the sleep of a laborer, whether he eats little or much, but the full stomach of the
rich will not let him sleep. There is a grievous evil that I have seen under the sun: riches
were kept by their owner to his hurt” (ESB, 2016). Proverbs 21:5 states, “The plans of the
diligent lead surely to abundance and advantage, but everyone who acts in haste comes
surely to poverty” (ESB, 2016). Due diligence means being honest, trustworthy, reliable
and willing to speak out against injustice and wrongdoing. PwC lacked due diligence in this
specific case.
References:
CFI Team. (2023, November 27). Financial leverage. Financial Leverage: The use of borrowed
funds to acquire assets. https://corporatefinanceinstitute.com/resources/commercial-lending/
financial-leverage/
Cornell. (2023, October). Securities exchange act of 1934. Cornell Law School.
https://www.law.cornell.edu/wex/securities_exchange_act_of_1934
English Standard Bible.A(2016). https://esv.literalword.com/ (Original work published 2001)
Greenline Financial. (2024). What is audit oversight. Greenline Financial.
https://greenline.financial/resources/what-is-audit-oversight/#:~:text=Audit%20Oversight
%20Defined,by%20external%20and%20internal%20review.
Knapp, M. C. (2022).AContemporary auditing: Real issues & cases. (12thAed.). Cengage.
Office of Internal Audit- University of Florida. (2019, March 15). The importance of good
internal controls. Office of Internal Audit. https://www.oia.ufl.edu/home/information-and-
resources/internal-controls/the-importance-of-good-internal-controls/#:~:text=Good
%20internal%20controls%20are%20essential,the%20risk%20of%20public%20scandals.
Reuters. (2013, November 8). PWC ordered to face fraud claim over Lipper Hedge Fund
Collapse: Business Information & News: Westlaw. Practitioner Insights News & Analysis.
https://content.next.westlaw.com/Document/I66e8e6b048a511e38cec9ed6d509fd7a/
View/FullText.html?contextData=%28sc.Default%29&transitionType=Default
Powered by TCPDF (www.tcpdf.org)
