An American hedge fund wants damages from EY Switzerland for alleged failures in one of the largest bankruptcy cases since the demise of Swissair. An action for information was successful in the first instance. The auditing company is likely to appeal the decision before the Federal Court.
According to US authorities, the Uzbek president’s daughter Gulnara Karimova was considered a key figure behind Zeromax. She has been in prison in Tashkent since 2019.
Almost 14 years have passed since the billion-dollar bankruptcy of the conglomerate Zeromax GmbH. Gulnara Karimova, the key figure behind the company and daughter of the former Uzbek president, has fallen from grace in her home country and has been in prison in Tashkent since 2019.
But even for Zeromax’s former auditor, EY Switzerland, the case is anything but closed.
The NZZ has learned from a reliable source that the Zug Cantonal Court ordered the auditing company to hand over the audit documents from the Zeromax mandate at the end of May this year. It’s about contracts, email correspondence, internal working papers and other documents.
EY defended itself against this with all its might and hired legal luminaries as private experts to prevent publication, and has now been defeated in the first instance. The auditing company has taken the case to the Zug Higher Court. The decision is not expected until next year at the earliest.
Daughter of the Uzbek ruler played a central role
The EY client Zeromax was not just any Zug GmbH, but rather had close connections to the family of the now deceased Uzbek long-term ruler Islam Karimov. The group earned its money from a wide variety of businesses: oil, gas, textiles, beverages, but also gold mining.
According to the US authorities, Karimova, the president’s daughter, was significantly involved in the company and is said to have used millions of dollars from the company over the years to finance jewelry, luxury real estate and hospital stays.
EY took over the audit mandate for the GmbH in 2005 after Zeromax moved its headquarters from the American state of Delaware to Baar in the canton of Zug.
When Zeromax filed for bankruptcy in August 2010, creditors were left with outstanding bills totaling more than 5 billion francs. It was one of the largest bankruptcy cases since the collapse of Swissair. The list of victims ranges from small craft businesses to Brazilian soccer star Rivaldo.
The role of the expectation gap
The Zeromax case became a problem for EY a decade after the bankruptcy, when the American hedge fund Lion Point Capital paid the conglomerate’s creditors 2 million francs in 2019 for the right to sue EY as the legal successor for damages.
The hedge fund speculates that the audit firm did not look closely enough in the Zeromax case and thus contributed to the bankruptcy being delayed. In a first step, the lawyers want to use the information lawsuit to gain access to EY’s working documents. As part of a second lawsuit that has already been filed, they want to oblige the auditing company to pay compensation.
Of course, for auditing companies like EY, it is part of the business that their work is questioned and criticized when customers go bankrupt. The auditors even have a term for when the public expects more from their work than they can and must actually deliver: expectation gap. In the audit report they only ensure that the balance sheet and the income statement do not contain any material misstatements. They are not responsible for the business strategy and the success or failure of the company.
In the case of Zeromax, however, Lion Point Capital’s lawyers are convinced: This is not an example of the gap in expectations, but a case of breach of duty that will force EY to potentially pay over 1 billion francs in damages.
From the hedge fund’s perspective, the most serious accusation is not that EY watched as the ruler’s daughter Karimova used large sums of millions for private purposes. Rather, they accuse the auditing company of negligently accepting the emerging over-indebtedness and the damage to creditors – and doing nothing about it.
They see an indication of this in the fact that after Zeromax moved to Switzerland, EY only audited the annual financial statements for 2005/06 and 2007. The auditing company no longer issued a certificate for the years 2008 and 2009, but continued to be paid. According to NZZ information, transfers amounting to 2.4 million francs to various EY national companies between 2006 and 2009 are documented in Zeromax’s internal accounting. Over 700,000 francs are attributable to the year before bankruptcy. The hedge fund hopes that the information lawsuit, which has now been successful in the first instance, will provide evidence for its suspicions.
EY suspects a “fishing expedition”
EY Switzerland unsuccessfully argued to the court that the American hedge fund was conducting evidence research, a “fishing expedition”.
In the current proceedings, the auditing company is taking the position that it would set a dangerous precedent if auditors had to hand over their work documents to the audited companies in the future. There are fears in the industry that this would endanger the independence of auditing companies and allow conclusions to be drawn about the working methods used. This would make it easier for audited companies to manipulate their financial statements or even put their auditors under pressure.
With a few exceptions, however, the court ruled in favor of the American hedge fund’s lawyers. EY may neither delete nor destroy the disputed documents until the proceedings have been completed.
A dangerous precedent?
So far, EY has remained calm about the Zeromax case. According to NZZ information, the auditor would have had the option of buying the damages claims against her own company from the creditors and deliberately chose not to do so.
The auditing company is likely to fight the information lawsuit and any damages proceedings, if necessary, all the way to the Federal Court. A years-long legal tug-of-war is likely.
However, looking back, the company has to ask itself the question of why it accepted Zeromax as a customer in the first place and did not submit the mandate earlier. According to NZZ information, after completing the 2007 annual financial statements, EY no longer received sufficient documents from Zeromax to carry out an audit.
When asked, an EY spokesman writes: “We have taken note of the decision of the Zug Cantonal Court of May 31, 2023 (. . .), in which we, as the former auditors of a Swiss company, were sentenced to release working papers.” The company did not agree with the reasons for this first-instance judgment and has referred the decision to the higher court of the canton of Zug. It is not possible to comment further due to the ongoing proceedings. Lion Point Capital’s lawyers declined to comment when contacted.
2023-11-28 15:26:14
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