CASE 1.13
AA CAPITAL PARTNERS, INC.
Synopsis
In February 2002, John Orecchio and Paul Oliver teamed together to establish an investment
advisory firm, AA Capital Partners, Inc. The two Chicago businessmen had all of the necessary
investments due to embezzlement and mismanagement. Orecchio, who was married with three
children, squandered a large portion of the $24 million that he embezzled on his mistress, a young
exotic dancer.
This case focuses on Ernst & Young’s 2004 audits of AA Capital Partners and the four private
equity funds organized by that firm. During those audits, the Ernst & Young audit team discovered
$1.92 million of suspicious cash payments made to John Orecchio that were characterized as “tax
transfers” or “tax loans” by the client. In fact, those payments represented a small slice of the $24
million of funds that Orecchio had embezzled. Both the SEC and a federal judge concluded that
inadequate audit procedures prevented the AA Capital audit team from discovering the true nature of
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AA Capital Partners, Inc.—Key Facts
1. John Orecchio and Paul Oliver founded AA Capital Partners in 2002; due to Orecchio’s strong
credentials in investment management, he took responsibility for the firm’s day-to-day operations.
2. By the end of 2004, Orecchio had persuaded six labor unions to place their collective $200
million of pension fund assets under the management of AA Capital.
3. The Chicago office of Ernst & Young audited AA Capital and the four private equity funds that
4. McNeeley and her subordinates discovered $1.92 million of unusual cash payments made to
5. McNeeley attempted to obtain more information regarding the suspicious payments but the chief
6. McNeeley discovered additional suspicious payments to Orecchio during the subsequent period
8. During the 2005 AA Capital audits, the audit manager who replaced McNeeley discovered the
9. In February 2010, John Orecchio pleaded guilty to embezzling approximately $24 million from
10. The SEC identified numerous oversights that the auditors had made during the 2004 AA Capital
11. A federal judge ultimately ruled that Gerard Oprins was not responsible for the audit “failures”
during the 2004 engagement because Wendy McNeeley had not properly apprised him of the
suspicious tax transfers; McNeeley received a one-year suspension from practicing before the SEC.
12. John Orecchio received a prison sentence of nine years and four months for his indiscretions; his
sentence was significantly shortened because he agreed to cooperate in a “sting operation” intended
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Instructional Objectives
1. To examine the responsibility of auditors to thoroughly investigate large and unusual client
transactions.
3. To determine the nature and purpose of “subsequent period” audit procedures.
Suggestions for Use
An instructional case is only as “good” as the sources from which it is developed. For this case,
there was an excellent source of insightful and “inside” information regarding Ernst & Young’s AA
Capital audits. This latter source was the 41-page opinion written by Judge Robert Mahony. That
opinion was effectively a summary of the two–week hearing presided over by Judge Mahony that
was intended to determine whether the sanctions recommended by the SEC for Gerard Oprins (AA
Suggested Solutions to Case Questions
1. A) The fact that both McNeeley and Oprins were “new” to the AA Capital engagement almost
certainly resulted in a learning curve effect for each of them. For example, because
McNeeley didn’t have a “history” with Mary Beth Stevens, she did not have a baseline
against which to evaluate Stevens’ competence, candor, and willingness to cooperate.
B) The fact that Ernst & Young was auditing five entities (AA Capital and its four private
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The PCAOB’s quality control standards provide broad guidelines and recommendations that
accounting firms can use to ensure that the professional services they provide are competent. QC
20.03 mandates that a CPA firm “shall have a system of quality control for its accounting and
auditing practice.” QC 10.14 notes that an accounting firm’s quality control system should include
policies and procedures that address the following five elements: independence, integrity, and
objectivity; personnel management; acceptance and continuance of clients and engagements;
engagement performance; and monitoring.” (Note: the quality control standards included in the
at least suspending, the 2004 audits. Of course, during the 2005 engagement, Ernst & Young did
suspend the AA Capital audits after the new audit manager (Jennifer Aquino) suggested that
sufficient information had not been provided by the client to audit the suspicious tax transfers.
In terms of engagement performance, there are several measures that might have mitigated the
impact of the six “problem” facets of the 2004 AA Capital audits listed previously. For example,
given that long list of problems, it seems reasonable in retrospect that the 600-hour time budget for
the 2004 AA Capital engagement should not have been considered a major constraint. Here was a
situation when the auditors were probably justified in taking as much time as necessary to complete
the audits and saying “to heck” with the time budget. (Note: another facet of the case that I didn’t
2. Both the AICPA and PCAOB auditing standards mandate that auditors obtain and document
their understanding of an audit client’s internal controls. However, in either an audit of a private or
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public company, an auditor may decide not to rely on the client’s internal controls. Why? One
3. Note: AU-C Section 550, “Related Parties,” includes the AICPA’s auditing standards for related
parties and related-party transactions. AU Section 334, “Related Parties,” within the PCAOB’s
Interim Standards discusses that agency’s auditing standards for related parties and related-party
transactions. These two sets of standards are very similar.
In this particular case, the “tax transfers” were, by definition, related-party transactions given
their nature. Once an auditor has identified related-party transactions, the professional auditing
standards suggest a litany of specific procedures that may be applied to those transactions to
corroborate the relevant management assertions related to them. Listed below are representative
examples of audit procedures that could be applied to an identified related-party transaction:
a. determine whether the transaction has been approved by the board of directors
b. examine invoices, executed copies of agreements, contracts and other pertinent documents,
Would any of the above audit procedures if applied to Orecchio’s “tax transfers” have resulted in
the auditors discovering that the transactions were fraudulent? Probably. For example, if the
auditors had insisted on obtaining all relevant IRS documents related to the alleged tax “problem” of
Orecchio (procedure “b”), they would have discovered that there were no such documents.
Likewise, they could have, with Orecchio’s approval, communicated with the IRS regarding the
4. Note: AU-C Section 560, “Subsequent Events and Subsequently Discovered Facts,” includes the
AICPA Professional Standards for “subsequent period” audit procedures. AU Section 560,
“Subsequent Events,” within the PCAOB’s Interim Standards discusses that agency’s corresponding
auditing standards for subsequent period audit procedures.
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statements.
Among other procedures applied to identify relevant subsequent period “information,” auditors
may review minutes of post-balance sheet board of directors meetings, inquire of client legal counsel
5. When I first read that statement, I was surprised because I had always assumed that audit
engagement partners had such a responsibility. However, after some reflection, Ellingsen’s assertion
seems extremely reasonable (recall that he was Deloitte’s senior audit technical partner and that he
served on the Auditing Standards Board for several years).
Given the fact that the audit engagement partner is not “in the trenches” and in many cases is only
deeply involved in an audit on the “front end” and “back end,” it is not reasonable to hold him or her