MIT WPU’s School of Management ( PG)

CASE STUDY #1 ON

Brown-Torrington and Emmett, Orr & Peterson

One Giant Down…the other to fall?

Introduction

“I don’t think you understand. This could be the end of us,” said Noel Jameson, senior
partner of Emmett, Orr & Peterson LLP, to the president, Randy Mays. Mays responded,
“Not necessarily Noel. We can recover.”

In early March 2004, Emmett, Orr & Peterson LLP (EOP), a leading U.S. auditing firm was
under question for not stepping in to prevent the accounting malpractice that had led to the
bankruptcy of Brown-Torrington, a Fortune 500 pharmaceutical company. The events
leading up to the collapse of Brown-Torrington shocked the investment community as well
as regulators who had heralded Brown-Torrington as a well-respected and ethical leader in
the pharmaceutical industry. The downfall was ignited when Brown-Torrington
management was found to have accounted for special purpose enterprises (SPEs) off the
balance sheet. These SPEs had a high level of debt, which was not fully transparent to
Brown-Torrington’s shareholders. After a series of top management fled from Brown-
Torrington, it became obvious that something had ran amok. Within weeks, Brown-
Torrington’s share price plummeted leaving shareholders and pensioners with worthless
stock and the company with a mountain of debt.

When the accounting issues at Brown-Torrington arose, the spot light was immediately
turned on the accounting firm EOP. On January 25th, 2004, EOP management admitted to
shredding important documents that contained details about Brown-Torrington’s suspicious
off-the-balance sheet transactions. EOP was now on the precipice of disaster. Was it their
responsibility for what had happened at Brown- Torrington? Could they have prevented the
malpractice? What should be done to maintain their client base?

Pharmaceutical Industry

The pharmaceutical industry was one of the largest industries in the world with estimated
global sales of $300 billion USD per year. While the industry had experienced strong
growth throughout the 1990s, the rate of increase had slowed to about five per cent per year
in 2003. Even though there was tremendous opportunity with an aging population in North
America, Western Europe and Japan (the world’s three largest markets), many
pharmaceutical companies were struggling to allocate research and development dollars and
develop the next “blockbuster” drug. Governments, health insurance companies and
consumers had all put downward price pressure on new drugs being released into the
marketplace.
The process of introducing new drugs was an exhaustive process sometimes exceeding ten
years and costing up to $300 million USD per drug. In order to develop new drugs,
pharmaceuticals allocated up to 15 per cent of their sales in research and development.
Although this allocation was considerable, pharmaceutical companies were not necessarily
guaranteed that their developed drugs would hit the marketplace. This process was
frequently referred to as the “pipeline” which had three major phases: pre-clinical, clinical
testing and the drug approval and registration. The pre- clinical phase took approximately
four years and before moving into the clinical testing phase, pharmaceuticals took out a 20-
year, non-renewable patent. This meant that pharmaceutical companies had to be mindful of
the time in the preceding two stages. The second stage of clinical testing involved a series of
tests on humans. The phase typically lasted five to six years. Finally, if the drug had made it
through the other two stages, it was ready for approval and registration. The governing body
for pharmaceuticals in the U.S. was the Food and Drug Administration (FDA), who required
that companies demonstrate the superiority of their product over existing drugs. The
approval process took approximately 18 months. Delays were costly to pharmaceutical
companies with some industry observers estimating that each day cost $1 million USD in
lost sales.

Once a drug’s patent expired, other pharmaceutical companies were permitted to produce a
“generic” version of the same drug, often at a 30 per cent price discount. This was
considered to be the last part of the drug’s life cycle from a profit perspective. Thus, it was
vital that the large pharmaceuticals continued developing their “pipeline” for future
blockbusters.

Ethical considerations in the Pharmaceutical Industry

The pharmaceutical industry was heavily regulated by the government. Governments levied
regulations on the testing, content, pricing and relationships that pharmaceuticals had with
the rest of the health care industry. A number of major ethical debates existed within the
bioscience industry. The first involved scientific and testing issues such as genetically
modifying foodstuffs, testing on animals, prematurely releasing a drug by skipping testing
phases and the treatment of human embryos and the human genome.

The second central issue involved the actual business practices of companies participating in
the bioscience or pharmaceutical industry. Several scandals had come to light in recent years
such as insider trading at ImClone, misleading business statements by Biopure, charges of
fraudulent activity at AstraZeneca and Merck- Medco and the questionable marketing
practices of ‘fen-phen’, a diet drug produced by Wyeth-Ayerst.

An on-going debate in the industry was the extent to which physician incentives should be
provided by pharmaceutical companies. A study conducted in 2002 by the Kaiser Family
Foundation discovered that 61 per cent of doctors received free meals, travel and entrance to
events in exchange for prescribing new drugs to their patients.
The industry had also been prone to pharmaceutical companies offering kickbacks to
doctors for using their drugs. In response to rising pressure, the Pharmaceutical Research
and Manufacturers of America (PhRMA) put forth a voluntary Code on Interactions with
Healthcare Professionals that stipulated appropriate expenses for the purpose of marketing
to physicians.
History of Brown-Torrington

Brown Pharma was founded in 1926 by Joseph Raymond Brown. Brown was a leading
academic and scientific researcher from Northwestern University. He was one of the first
pharmaceutical academics to form his own company and build a stand- alone research staff.
By the Second World War, the U.S. government became more involved in drug research.
Brown was credited as forging positive relationships with the U.S. government, developing
an anti-malarial drug in the 1940s and being on the forefront of commercially viable
penicillin in the 1950s.4 Brown’s undying dedication towards pharmaceutical development
was the cornerstone of his organization. He had instilled strong academic principles, while
pushing his company’s scientists towards drugs that would be profitable. When he died in
1974, Brown had left behind a highly successful scientific-driven enterprise.

Under new management the company flourished throughout the late 1970s and 1980s, until
it was investigated in 1986 by the U.S. government for its pricing practices. The company
had priced a number of new drugs by claiming incorrect categories that allowed for higher
prices. Industry observers felt that Brown Pharma had made a grave error, which would cost
them their company. However, the company paid out compensation, decreased its prices and
reduced its overhead by cutting back on its oversized sales department. By the late 1980s,
the company had returned to profitability through the release of a “blockbuster” drug. By
1994, its problem was quite different – it had plenty of cash but it had no other blockbuster
drugs in the pipeline. It targeted Torrington Stills for atakeover.
Torrington Stills had been founded by a group of pharmaceutical and agricultural scientists
in 1967. The company was quite different to Brown Pharma in that it had fostered group
activities in its development, marketing and sales approaches. The company had become
known as an alternative to the larger corporate pharmaceuticals. By the early 1990s
however, some industry observers felt that the company was part of the mainstream.
Although it was credited in recognizing new trends in drug development and having a strong
research arm, the company had had several problems with late releases. Analysts questioned
Torrington Stills’ ability to compete in the industry, since industry players were constantly
cutting out time in the development process to bring new drugs to the market. By 1994,
Torrington Stills was highly leveraged and could not meet its loan payment requirements,
making it ripe for atakeover.

In November 1994, Brown Pharma purchased Torrington Stills and Brown- Torrington was
the new name given to the merged entity. The challenge of the merger was to integrate
Brown Pharma’s expertise in marketing, sales and production, while utilizing the group
development process at Torrington Stills. The integration process was long and taxing. One
senior manager from Brown Pharma who participated on the integration team commented,
“Just because they’re a bunch of long-lost hippy scientists, does not mean that everything
can be effectively done in a group. There’s no accountability. They don’t seem to
understand the dynamics in getting a product’s cost down and getting it out into the market.”
A member from the Torrington Stills team recalled the integration process, “the Brown
Pharma side was very demanding and a little too quick. Contrary to popular belief, we’re
very aware of the importance of getting products out quickly. However, that should not
come at the cost of developing a quality drug. It may cost $1 million per day for every day,
but that’s a lot better than several million if the drug proves to beharmful!”

Brown-Torrington had overcome its integration challenges and by 1997, it was considered
to be one of the fastest growing companies in the pharmaceutical industry. The company
posted superb financial results from 1998 through to 2002, growing at a compound annual
growth rate of 21 per cent at a time when industry growth had slowed to five per cent. In
early 2001, an analyst report stated: “We feel that Brown-Torrington is well positioned.
They have some great blockbusters and have sorted out their pipeline problem that plagued
them a few years ago. The company has managed to innovate and build production
capabilities to take advantage of making generic drugs. We believe that they will continue to
outperform their earnings per share (EPS) estimates.”

In 2002, the company had posted record revenues of $18.7 billion USD and profits of
$4.6 billion. The company’s stock price had soared to $32.80 from the previous year’s level
at $23.56. Credit agencies rated the company’s debt instruments as triple A. Financial
success was not its only strong point – the company had been selected by the popular press
as one of the Top 100 best companies to work for in the U.S. Scientific organizations,
management consultants and business schools all studied the company’s unique
development process and how it had managed to leverage the expertise of its merged
companies and innovate successfully. The company’s CEO and Chairman Aaron
Wheelwright was credited with much of the firm’s vision and was handed several awards
for one of the best CEOs in theU.S.

The Auditing Industry

Auditing rose to prominence in the 1930s as companies looked to independent firms to

evaluate their public financial statements on an objective basis. The role of auditing firms
was to provide technical expertise and objectivity in interpreting generally accepted
accounting principles (GAAP). Accounting was not deemed to be an exact science. GAAP
provided a framework for companies to prepare their financial statements and for auditing
firms to ensure that the financial statements were reliable. Exhibit 1 shows a list of GAAP
definitions. The reach of auditors work was wide as banks, creditors and investors all made
decisions based on a particular company’s financial statements. This objectivity and
coherence to a set of principles was particularly important to instill confidence in the general
investing public who chose to buy and sell shares on security markets. In fact, the growth of
the worldwide stock markets was often credited to auditing, which had worked to allay the
fears of the investing public by providing an objective view of financial performance.

The Securities Exchange Commission (SEC) was the governing body in the United States
responsible for the public trading of securities. SEC required that any company engaged in
public trading of stocks, bonds or any type of security, submit a set of audited financial
statements on an annual basis. SEC’s primary mission was to “protect investors and
maintain the integrity of the securities markets.” SEC held the belief that, “all investors,
whether large institutions or private individuals, should have access to certain basic facts
about an investment prior to buying it.” As part of this concept, SEC disclosed all public
documents on their website (www.sec.gov) for every publicly traded company. Each year,
SEC brought between 400 to 500 civil enforcement actions against infractions like insider
trading, accounting fraud and the release of misleading and false information.

Major auditing firms had expanded into strategy consulting and information technology
consulting in the late 1970s and early 1980s in order to develop alternative revenue streams.
Auditing was becoming increasingly competitive, and as such, auditing firms started
lowering prices to compete. For many firms, consulting became more lucrative and
attractive since each situation required a custom solution, allowing the consultants more
flexibility in bill-out rates.

Emmett, Orr & Peterson (EOP) LLP

Godfrey Emmett, a Harvard professor and one of his students Richard Orr, a Harvard MBA,
founded Emmett & Orr as an auditing firm in 1927. Emmett and Orr saw great opportunity
with the burgeoning U.S. stock market and believed that corporations could benefit from an
objective third party opinion. In the early days, clients were surprised at how Emmett and
Orr, two men with an age difference of 20 years had managed to equally operate the firm. In
a public speech at Harvard, Emmett commented on his younger partner, “Richard [Orr] and
I are equals. We both make decisions. While the circumstances of our initial acquaintance
was through the teacher-student dynamic, we have become business partners.” In another
speech, Orr talked about Emmett, “Some people find it strange that we could both be in
charge of making decisions. People, have often take me aside, tug on my coat and say, ‘no
really, the big guy makes the final call, right?’ For me, it’s been an ideal partnership…I
bring hustle to the organization and Godfrey brings calm.”

Both Emmett and Orr emphasized the importance of strict confidence with their clients. At
the same time, they never strayed from their role of giving an objective third party opinion.
They recruited young, aggressive and bright auditors and imparted a doctrine of “be
respectful, show integrity and be direct.” They sought individuals who had technical acumen
and people who could interpret financial information for management decision-making. Orr
had been quoted as saying, “we train our auditors to see the forest beyond the trees. If they
need to count the number of rings of a hundred year maple tree, fine, but they need to be
able to then rise above and tell the client why that’s important.”

Emmett and Orr were extremely successful at building their organization and by the 1960s
had become one of the United States’ pre-eminent accounting firms. In 1967, Emmett
passed away and the reins were turned over to Orr. Orr promoted a young rising manager
named Joshua Peterson through the ranks and Peterson eventually became a senior partner
in the late 1970s. Peterson convinced Orr to consider moving heavily into management and
information technology consulting. Peterson recalled in an interview years later, “I saw that
we were in there with top management of major multinationals. We were already talking
about confidential and future strategic decisions. I felt that we could do a lot more than
verify the numbers.”

Peterson’s strategy worked – by the mid-1980s, Emmett, Orr and Peterson had captured
over 100 major contracts accounting for over $1 billion in consulting revenues. When Orr
retired at age 80 in 1982, Peterson ran the company until 1997. Peterson was acknowledged
for promoting the original founders vision of being direct and maintaining “one face” to its
customers, whether the activities were in consulting or auditing. By the time Peterson
retired, EOP was posting revenues of $6 billion, with over half coming from consulting
engagements. The presidential title was handed to Timothy Bayliss, who had a vision of
spinning off the consulting arm from the original auditing firm. In 1999, Bayliss formed
Emmet, Orr, Peterson and Bayliss Consulting and maintained the EOP name for the
accounting activities. The split was long and arduous and insiders had divided into one of
the two camps. Animosity grew within the ranks and a once seamless “one face”
organization had split into two disparate companies with distinct corporate cultures. The
consulting arm was seen as aggressive and cutthroat whereas the accounting side had
retained its conservatism.

Relationship between Brown-Torrington and EOP

The relationship between the two enterprises dated back to both founders. Joseph Brown
and Godfrey Emmett were contemporaries: both were born in the same month in 1887 and
both were former professors who had broken out from their academic research to form
companies. They first met in 1928 and the following year, Emmett had convinced Brown to
“let him audit their books.” Brown and Emmett were often compared in the popular press
and management journals. In the late 1950s, the two even went on a road show, visiting five
of the top U.S. universities talking about how honesty, integrity and ethical practices could
translate into profitable business. In one speech, Brown commented, “Professor Emmett and
I are peas out of the same pod. We both are investigators and we both believe that directness
is the only way to build a successful enterprise.” In an interview before his death, Emmett
talked about Brown, “It’s people like Joseph Brown that have made America great. I feel
fortunate to call him a contemporary, client andfriend.”

Brown-Torrington was the longest standing client of EOP. Because the relationship was of
great historical importance, EOP’s management emphasized the importance of “keeping
Brown-Torrington happy.” A former EOP auditor commented, “from day one, it was very
clear. Don’t mess with Brown-Torrington. It was like they were a sacred cow.” Another
EOP employee saw it differently:

“I worked on the Brown-Torrington account for several years. They were an outstanding
organization. Yeah, sure, our management made it clear to us that it was an important
relationship. But, I never felt that anyone was saying, ‘do what they want.’ I always felt
comfortable telling Brown-Torrington management that they should change something if I
didn’t feel it was appropriate.”

Brown-Torrington also used EOP as a training ground and recruitment pool. Several Brown-
Torrington finance, IT and general managers had at one time worked for EOP. An employee
that had worked at both companies commented, “it’s no secret that when you’re out on audit
at Brown-Torrington, you may also be evaluated for a job there.”

In 2002, EOP earned over $50 million from Brown-Torrington, which was weighted evenly
between consulting and auditing fees. EOP had a full-time staff of 25 individuals working at
the Brown-Torrington head office. Within that team, pressure was mounting to confront
Brown-Torrington on their treatment of off-the-balance sheet transactions and the treatment
of debt of special purpose enterprises (SPEs).

By the end of 2002, EOP had identified Brown-Torrington as a ‘maximum-risk’ client due
to their potential exposure to high debt. One internal memo from audit team lead, Alejandra
Seinra to EOP’s president Randy Mays in early 2002 read:

“We’ve been studying the SPEs of Brown-Torrington for sometime now. The
documentation is light in some areas and it looks as though they have over $1.1 billion due
in the next three years. But, all of their profits have been booked to Brown-Torrington on
the net present values of drugs that are still in the pipeline. I personally feel that this is not a
good idea. They’re exposed and
I think we need to convince them to show some of this exposure on their corporate balance
sheet, instead of having it hidden from public view.”

Accounting Practices at Brown-Torrington

In 1999, Brown-Torrington had established special purpose enterprises (SPEs), which were
intended to represent the development of each new “blockbuster” drug in the pipeline.
Brown-Torrington had also created other SPEs for other companies’ blockbuster drugs, with
the plans that Brown-Torrington would be in a position to produce generic drugs once their
competitors’ patents expired.

By 2002, there were approximately 20 SPEs that had been created. Brown-Torrington had
been moving the research and development expenses from the parent company to the SPEs
as assets. Brown-Torrington had been financing that development through private debt
instruments, which became the SPEs liability. Brown-Torrington then calculated the
expected return in the form of Net Present Value9 of future free cash flows from each
blockbuster and generic drug and booked the profits immediately. This practice was highly
speculative as Brown-Torrington was not certain which drugs would become blockbusters.
Booking profits based on future earnings inflated Brown-Torrington’s yearly profits from
1999 through to 2002. It was estimated that the company had booked over $3 billion dollars
in speculative revenues over the past three years. Increased profits led to the company’s
increase in share price as more investors were attracted to Brown-Torrington’s performance.

When an EOP team member working at the Brown-Torrington head office requested a bank
document proving the assets of three SPEs in late 2001, a Brown-Torrington executive
submitted three separate letters from the same offshore bank with a statement of the SPEs
holdings. The EOP team member felt that there was no need to investigate further.
However, the Brown-Torrington executive had asked his teenage daughter to make changes
to one bank letter with Photoshop, altering the amount of holdings and the SPE name. Out
of an estimated $1.2 billion in assets, there was under $25 million in actual cash holdings.
On the liabilities side, all of the SPEs carried substantial debt loads. The total exceeded $1.1
billion, which were payments due in 2004 and 2005. Exhibit 2 shows Brown Torrington’s
financial statements and Exhibit 3 shows a sample of the exposure of three of the company’s
SPEs.

Events leading to the fall of Brown-Torrington

The first correspondence doubting Brown-Torrington’s accounting treatment of SPEs was

within EOP and was sent to the senior partner Randy Mays by Alejandra Seinra in February
2002. Around the same time, Maurice Levine a Brown-Torrington finance manager and
former auditor at EOP wrote an email to Alex Yury, Brown- Torrington’s CFO, which read:
Net present value refers to a calculation that estimates the future free cash flows of a particular
project discounted at a rate reflective of market and business risk.
“Dear Alex, I would like to meet with you about some of our SPEs. I know we have the
management review coming up and I think it’s prudent to discuss moving some of the debt
back to the parent company. Is there a plan to transfer more capital to the SPEs? Do we feel
that the income from Code72 [a new blockbuster drug] will offset this risk? I look forward to
speaking with you about this. Maurice.”

Yury responded with an email:

“Thanks Maurice. Aaron [Wheelwright, the CEO] and I are meeting tomorrow on the SPEs
and will be discussing that very topic. I have been keeping a close eye on those SPEs to make
sure that everything is in check. And, yes, to answer your question --- Code72 is going to be
our next ‘Titanic’--- not the sinking ship of course, but rather the cinematic blockbuster!
Regards, Alex.”

After six months in August 2002, another finance manager Rajinder Lata wrote to Brown-
Torrington’s group of finance managers stating:

“Does anyone have the documents based on the asset holdings of the followingSPEs: Jenby,
Gano and Lewis? I’ve been scouring this finance department and all I can come up with is a
lot of debt for those holdings…”

Maurice Levine was the only to respond to the group email, “Hi Rajinder. I had spoken about
this with Alex a few months ago, and he’s looking after it. Regards, Maurice.”
In January 2003, a month after management bonuses were paid out, Alex Yury, Brown-
Torrington’s CFO resigned abruptly. One newspaper reported:

“There seems to be no apparent reason for the sudden departure of Brown- Torrington’s CFO
Alex Yury. Yury has put in fifteen successful years at the company. CEO Aaron Wheelwright
was asked to comment, ‘Alex has moved on for personal reasons.’ The departure seems out
of character for the company. Yury was not available for comment.”

Yury’s departure left the finance department frozen. Yury had maintained frequent informal
communication with all of his managers and none of the managers were able to contact him
after he left the company. Within a month, RajinderLata received an email from Brown-
Torrington’s legal department asking to see some of the SPEs assets holdings. This time, she
decided to do a thorough investigation talking with every member of the finance department
and all of the EOP auditors. By March 2003, she had found the three bank letters with asset
holdings that had been given to EOP auditors by a finance manager no longer with Brown-
Torrington. She personally phoned the offshore banks and learned that the assets did not
exist. This prompted her to write an email to Brown-Torrington’s CEO Aaron Wheelwright.
Itread:

“Dear Aaron: I would like to meet with you about some of our SPEs and their asset holdings.
Along with the help of some EOP auditors, I have found letters, which I believe to be forged.
They state we have assets upto $1.2 billion. However, I have followed up with the banks and
have learned that those assets do not exist. You may know from having met with Alex before
he left that our SPEs owe over $1.1 billion in the next two years. I’m attaching all of the
documents for your review. Regards, Rajinder.”
Along with Maurice Levine and one of Brown-Torrington’s lawyer John D’Amico, Rajinder
Lata met with Brown-Torrington’s CEO, Aaron Wheelwright in April 2003. Lata recalled the
meeting:

“Aaron seemed really open to listening to us. But, here we were telling him that we had some
major debt to repay, and I couldn’t believe how calm he was. He thanked us for bringing it to
his attention and said that he would look into it. But, the problem is, we didn’t see any action
until much later.”

Legal counsel, D’Amico commented, “Aaron was really hard to read that day. I walked out of
the meeting wondering if he had understood the severity of what we were all saying.”

By the second quarter of 2003, Brown-Torrington had missed all of its sales targets and was
at risk for delivering the new blockbuster Code72 drug. The investment community
responded and Brown-Torrington’s share price slid from over $30 to $15.20. An analyst
commented, “Brown-Torrington’s sales predictions were too high for the first half of 2003.
It’s unlikely they’ll be able to make up the remainder of the year, and if they falter for even a
moment on the release of Code72, then there stock will be severely bruised.”

In late July 2003, Wheelwright resigned from Brown-Torrington as CEO. He had tried to
leave graciously by saying in a public statement, “Brown-Torrington has had some recent
short-term blips. But, Code72 is on the verge of happening, and I leave the company in an
extremely good position to exceed second half and full-year 2004 results.”

However, a newspaper reporter did not believe Wheelwright’s parting line. Through an odd
connection the reporter quoted a teenager who said, “yeah, my friend is a whiz at Photoshop.
I think her dad even got her to change bank letters for his company once. No one knew the
difference.” The reporter went on to say:

“It turns out the company is actually Brown-Torrington, the pharmaceutical giant, who has
recently lost its top two senior managers to suspicious circumstances. Why? Perhaps there’s
something to their sudden departures. Who’s been playing in Photoshop? What are they
hiding?”

Immediately after reading the newspaper, Randy Mays at EOP ordered that all documents
pertaining to Brown-Torrington’s SPEs be shred. Most of the EOP employees had not seen
the article, as it took a few weeks to be spread through the popular press.

By September 2003, the news of Wheelwright and Yury’s departure in connection to a

potential fraud at Brown-Torrington was everywhere. Brown-Torrington’s finance managers,
Rajinder Lata and Maurice Levinal so resigned. Lata commented in an Interview, “when both
of key management resigns without warning or reason, it certainly does not give you a lot of
confidence in the company.” Levine said, “I kept on thinking of Yury’s reference to the
Titantic. And, I thought, I’m on a sinking ship! I had to get out.”

When interrogated in September 2003, Brown-Torrington’s former CEO Wheelwright stated,

“look, you’ve got to ask that question to Emmett, Orr and Peterson. They had blessed all of
our number and all our practices. They were well aware what was going on.”

EOP’s president Randy Mays claimed at first that he was unaware that forged bank
documents existed. By January 2004, he confirmed that he had commissioned EOP’s staff to
shred documents relating to Brown-Torrington’s SPEs. Mays had put one of his top
performers Noel Jameson on the task of “sorting out Brown-Torrington.”

But, by February 2004, it was too late. Managers at both EOP and Brown-Torrington were
struggling to sort out the problem and had realized that repaying the debt on the SPEs was
going to be impossible. They made the decision to transfer the debt to the parent company
and reverse some of the profits that they had posted in the last three years. This left them
insolvent and with no other choice to file for bankruptcy. Credit agencies downgraded the
company from triple A to C, the lowest grade of a company’s debt. The company had
completely collapsed, leaving over 23,000 employees, a number of pensioners and investors
with nothing. Competitors bought the patents and development of Code72 and other products
in the pipeline. The proceeds did not even cover 5 per cent of the secured debt.

As the Securities Exchange Commission (SEC) moved in to investigate the accounting

malpractice at Brown-Torrington, the blame was moving towards EOP. Why had they shred
the documents? Why didn’t Mays act sooner when he received the email from his audit team
lead Alejandra Seinra? Why didn’t EOP speak up?

Conclusion

In March 2004, both Mays and Jameson at EOP were spending everyday trying to re-
position their company. Since admitting to the shredding of documents, they had been
charged with an obstruction of justice and lost a quarter of their client base.

As both in dividuals sat in the Boston office of Emmett, Orr and Peterson, they wondered
what could be done to save the company. Jameson said to Mays, “Randy, we have a criminal
charge against for obstruction of justice. How in the world can we claim to be a responsible
accounting firm?”

Mays responded:
“Look, Noel, I stand behind my decision to shred those documents. If they were being forged
by Brown-Torrington employees, the documents could simply not be trusted. And, I fully
intend to prove this in a court of law. What I need is for you to get me all the facts and at the
same time get on as many planes as you can to personally visit our client base. We cannot
afford to lose any more.

Exhibit 1 Brown-Torrington’s Financials in millions USD$

Profit & Loss 2000 2001 2002 2003

Sales 11341.7 14582.0 18,700.0 9812.9
COGS 5,807.0 7,261.8 8,839.5 6,839.6
Gross Margin 5,534.7 7,320.2 9,860.5 2,973.3

Gross Margin % 48.8% 50.2% 52.7% 30.3%

SG&A 1894.1 2362.3 2917.2 2217.7

Depreciation & Amortization 340.3 466.6 654.5 637.8

Operating Profit 3300.4 4491.3 6288.8 117.8
Operating Margin % 29.1% 30.8% 33.6% 1.2%
Non-operating Income 168.0 234.0 456.0 23.0
Non-operating Expenses 178.9 148.9 247.9 984.2
Income before Taxes 3289.5 4576.4 6496.9 -843.4
Income Taxes 954.0 1327.1 1884.1 -244.6
Net Income after Taxes 2335.6 3249.2 4612.8 -598.8
Net Income as % of Sales 20.6% 22.3% 24.7% -6.1%

Stock Price 18.94 23.56 32.80 4.67

Diluted EPS from Net Income 2.07 2.84 3.64 -0.57
Shares Outstanding 1127.9 1145.9 1267.3 1045.6

Balance Sheet
Assets
Current
Net Fixed Assets
Assets 10573.4
12348.1 11956.4
14219.8 8242.9
14632.1 1093.2
5389.2

Total Assets 22921.5 26176.2 22875 6482.4

Liabilities
Current Liabilities 12314.9 12876.2 11273.9 11273.9

Long-term Debt 452.9 698.3 1294.78 2423.3

Other noncurrent Liabilities 1345.7 1678.9 1678.9

Total Liabilities 12767.8 14920.2 14247.58 15376.1

Shareholders' Equity
Preferred Stock Equity 345.9 245.6 246.6

Common Stock Equity 10153.7 10910.1 8381.82 -9140.3

Total Equity 10153.7 11256 8627.42 -8893.7

Total Liabilities and Equity 22921.5 26176.2 22875 6482.4

Net Operating Cash Flow 2837.5 3784.2 4902 -1233.2

Net Investing Cash Flow -2149.3 -3717.2 -2865.4 -109
Net Financing Cash Flow -1115.8 -1636.4 -2345 -4578.4
Net Change in Cash -427.6 -1569.4 -308.4 -5920.6
 Exhibit 2 Special Purpose Enterprises (SPEs) –Brown-Torrington in Mn USD $

YEAR 2002 Jenby Gano Lewis Total

Sales 109.8 28.9 19.3 158.0
Profit & Loss
COGS 95.7 23.4 13.9 133.1
Gross Margin 14.1 5.5 5.4 24.9
Gross Margin % 12.8% 19.0% 28.0% 15.8%
SG&A 5.5 0.6 1.5 7.612
Depreciation & Amortization 3.3 0.9 0.7 4.8943
Operating Profit 5.3 4.0 3.2 12.4431
Operating Margin % 4.8% 13.8% 16.5% 7.9%

Non-operating Income
123.4 479.4 417.9 1020.7
Non-operating Expenses
Income before Taxes -118.1 -475.4 -414.7 -1008.3
Income Taxes -34.3 -137.9 -120.3 -292.4
Net Income after Taxes -83.9 -337.5 -294.4 -715.9
Net Income as % of Sales -76.4% -1168.0% -1525.6% -453.1%

Balance Sheet
Assets
Current Assets 239.1 123.9 789.2 1152.2
Net Fixed Assets 1.3 2.6 1.8 5.7
Total Assets 240.4 126.5 791 1157.9
Liabilities
Current Liabilities
Long-term Debt 290.3 285.3 529.8 1105.4
Other noncurrent Liabilities 0
Total Liabilities 290.3 285.3 529.8 1105.4
Shareholders' Equity
Preferred Stock Equity
Common Stock Equity -49.9 -158.8 261.2 52.5
Total Equity -49.9 -158.8 261.2 52.5
Total Liabilities and Equity 240.4 126.5 791 1157.9