Bankruptcy of an Accounting Firm:
Causes and Consequences of the Laventhol & Horwath Failure
Frederic M. Stiner, Jr. Fairleigh Dickinson University
ABSTRACT
Laventhol and Horwath (L&H) was the seventh largest American public accounting firm when it failed in November 1990. Prior to its bankruptcy it had expanded rapidly, with a growth rate averaging 30% per year. During the 1980s, the firm=s aggressive leadership grew the firm largely through undertaking more than 65 mergers.
L&H became the largest and most expensive collapse of a partnership in U.S. history to that time. There were two causes of the failure: litigation and poor management policy choices concerning the danger of litigation. L&H was self-insured and had an aggressive policy of litigation, preferring court action to settlement. In its final year, 1990, one lawsuit was settled for $10.5 million and litigation expenses were approximately $1 million per month when a $73 million judgment was entered in the Westheimer case. Another large, sensational lawsuit was pending: televangelist Jim Bakker and the PTL Ministry. At a partners= meeting in Dallas on Nov. 16, 1990, the partners were faced with two choices: either put in $15 million from their own assets or file for bankruptcy. The firm filed for bankruptcy on Nov. 19, 1990.
There was enormous impact on employees, retirees, partners, clients, creditors, the profession and financial markets. For the 3,400 employees, there was no severance pay, and all insurance ceased immediately. L&H had no funded retirement plan, so for retirees, all monthly income payments and health insurance also ceased immediately. All partners from January 31, 1984 onward were brought into the bankruptcy, even if they had retired or resigned from the firm. Principals in the firm were also added to the lawsuit by the bankruptcy judge.
Economics & Business Journal:
Inquiries & Perspectives 1 Volume 3 Number 1 October 2010
Bankruptcy of an Accounting Firm: Laventhol & Horwath
Stiner
In the capital markets, hundreds of publicly-traded companies suddenly needed a new auditor for year-end. The SEC issued emergency instructions. Most of the public audit clients changed to one of the then Big Six firms. As a result of the L&H failure, there was a lobbying effort to limit partner liability by legislation; so eventually most states permitted the creation of a new business entity, Limited Liability Partnerships (LLPs). The second lobbying action was a lobbying effort to curtail class-action securities lawsuits. After contentious debate and an initial presidential veto, the U.S. Congress passed the Private Securities Litigation Reform Act of 1995. There are several lessons for firm management. First, growth through merger is extremely risky. Partners run the risk of merging into a lawsuit. Second, self-insurance does not work when there is a risk of ruin. Third, rapid growth through merger creates problems with quality control, resulting in an enormous cost in staff training. Another partnership failure such as L&H, with personal liability to all partners, cannot happen again, since all the major firms, including Arthur Andersen, converted to LLPs.
I. INTRODUCTION
Public accounting firms in the United States have operated in a litigious environment for decades. Failure of any publicly-traded company usually results in litigation where the auditors are joined as one of the defendants. For one such auditor, Laventhol and Horwath (L&H), this litigation caused the collapse of the firm. When it collapsed, it became the largest professional- services firm ever to fail (Cowan 1990b) until the failure of Arthur Andersen. Now that the litigation surrounding the bankruptcy is settled, it is possible to examine the causes of the collapse and the consequences to the employees, retirees, partners, clients, creditors, the accounting profession and the financial markets.
L&H was the seventh largest American public accounting firm when it failed in November 1990 (Table 1). There were 3,400 employees at the time of the failure, the largest
1
Laventhol and Horwath originated with two firms (Ferst and Lott 1983). Horwath & Horwath was one of the original firms, founded in Philadelphia in 1915 by two Hungarian immigrants. The other firm was Laventhol and Krekstein, founded in 1923. The two firms grew internally and through mergers, and in 1967 the two firms merged to create Laventhol, Krekstein, Horwath and Horwath, later shortened to Laventhol & Horwath. The firm was
1 L&H had two offices in Philadelphia: one for the national headquarters at 1845 Walnut St., on Rittenhouse Square, and the other for the real estate practice at 11 Penn Center.
Economics & Business Journal:
Inquiries & Perspectives 2 Volume 3 Number 1 October 2010
office being the headquarters in Philadelphia, with 460 employees (Burke 1990).
bankruptcy, L&H had expanded rapidly, growing from $67 million in revenues in 1980, to $345 million in its final year, 1990 ($218 million in 1980 dollars). During the 1980s, the firm’s aggressive leadership grew the firm largely through undertaking more than 65 mergers. At the time of the failure, there were 51 offices.
Prior to its