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PricewaterhouseCoopers in Tyco Spotlight

BOSTON/NEW YORK (Reuters) – Tyco International Ltd. has become a headache for its outside auditor PricewaterhouseCoopers, whose work is under the microscope of a small army of investigators poring over several controversial deals that happened on the accounting firm's watch.

PricewaterhouseCoopers (PWC) on Monday said it was cooperating as an “information provider” with the Manhattan district attorney's office on its probe of Tyco. A spokesman for the firm declined to comment on the information requested by investigators.

Tyco also confirmed on Monday that the conglomerate's accounting treatment of nearly $100 million in secret loans is part of the second phase of an internal investigation led by lawyer David Boies. PwC said it is cooperating and assisting that internal investigation also.

One key question for the Boies team, which includes forensic accountants, is whether audits by PwC uncovered about $96 million in unauthorized payments for a group of employees that included indicted former Chairman Dennis Kozlowski.

The Wall Street Journal reported on Monday that Manhattan prosecutors are investigating whether the accounting firm knew about the secret bonuses and the methods used to hide them.

“The story is inconsistent with our understanding,” a PwC spokesman said about the Journal article. “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 … We have no reason to believe we are anything other than a witness.”

LATEST DISCLOSURE

Richard Scalzo, the PricewaterhouseCoopers partner who oversees the Tyco account, did not return a phone call seeking comment.

The scandal at Tyco is just the latest disclosure proving to be an embarrassment for PricewaterhouseCoopers.

In July, the firm agreed to pay $5 million to settle charges brought by the Securities and Exchange Commission that its auditors approved improper accounting and that it violated independence standards for several clients in the past. It was the second-largest payment ever by an accounting firm to the market's top regulator.

During Kozlowski's tenure, Tyco became a lucrative client for PricewaterhouseCoopers, which collected $50.1 million in fees from the conglomerate in 2001. Before his indictment, Kozlowski also served as chairman of the audit committee at U.S. defense contractor Raytheon Co. (RTN), which paid PricewaterhouseCoopers $84 million in fees in 2001, out of which only $4 million was for auditing services.

The bulk of that amount, $58 million, was for consulting on the design and implementation of a new financial information system at Raytheon.

Kozlowski resigned from Tyco and Raytheon's board in June.

He and former finance chief Mark Swartz are accused of running a criminal enterprise that looted and defrauded Tyco out of about $600 million. The men have pleaded not guilty.

A senior official at the SEC told Reuters that the relationship between Tyco and PricewaterhouseCoopers could merit further scrutiny from agency investigators.

The SEC official, who requested anonymity, said agency investigators would want to know the substance of discussions, if any, between PricewaterhouseCoopers leaders and Tyco executives over the secret loan payments, for example.

FRAUD INVESTIGATION NOT THEIR JOB

Accounting and securities law experts cautioned, however, that accounting firms aren't in the business of uncovering fraud but rather are given a short period of time to ensure that a company's activities are accounted for accurately on their books.

“Unfortunately, the easiest job in the world is criticizing an accounting firm,” said Michael Young, a lawyer at Willkie Farr & Gallagher, who frequently represents accounting firms. “All the critic has to say is that the accounting firm should have done more … Keep in mind that accounting fraud almost always involves deception of the auditor.”

Kozlowski and Swartz used hundreds of acquisitions during the past decade to build Tyco into a sprawling conglomerate that makes everything from trash bags to electronics.

Though never substantiated, Tyco's former senior leadership is accused of artificially boosting earnings by having acquisition targets prepay expenses to lower cash flow and earnings before the deal closes. But once in Tyco's fold, the acquired business would resume normal payments terms, boosting earnings and cash flow while Tyco slashed costs and employees, according to Tyco's critics.

Tyco spokesman Gary Holmes confirmed that Tyco's accounting treatment for its 1998 acquisition of U.S. Surgical also will be part of the second phase of the Boies investigation.

In an industry already under fire for receiving hefty consulting fees from the clients they audit and perceived as too close to the companies they are supposed to keep a check, the Tyco scandal stands to hurt the reputation of PricewaterhouseCoopers, accounting experts said.

That in itself is a blow for the accounting firm, since an auditor's stamp of approval on corporate books holds little value without strong credibility attached to the name. The investigations could also add fuel to the efforts of shareholders to sue the accounting firm, said James Cox, a professor of securities law at Duke University.

“The short answer is, no auditor likes to be associated with a company in trouble,” said Dennis Beresford, a former head of the Financial Accounting Standards Board and now a professor at the University of Georgia.

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