Baptist Foundation of Arizona, BFA

This memorandum highlights the issues related to the Baptist Foundation of Arizona, BFA, its related parties: ALO and New Church, and Arthur Anderson LLP. BFA was known to be a nonprofit organization. It was founded in 1948 to raise and provide financial support for the Southern Baptist Convention. In 1999, BFA filed for bankruptcy due to its fraudulent behaviors. This collapseled BFA to be the largest collapse of a religious financial institution in U.S. history. Like in Enron case, Arthur Anderson was once known as a major player of the Big 5 accounting firms. This case assignment was involved in many illegal activities that led to the collapse. In this case, it contains useful information. For instance, the relationship between an audit client’s risk strategy and inherent risk assessment, to evaluate if the existence of related parties are designed in a good faith, not to perpetrate fraudulent activity. Moreover, it provides us to point out things that investors should take under their consideration before making an investment, and evidences that auditor should collect and determine whether its properly meet the regulation.

This case study fully emphasizes all the important issues that happened in Baptist Foundation Organization of Arizona. The BFA scandal was revealed in 1999 that led to the bankruptcy of the organization. The case focuses on the BFA’s decision to invest heavily in the Arizona real estate market and to develop two related affiliates: ALO and New Church Ventures that were one of the main reason for the collapse. Furthermore, there are many questionable activities that occurred in the case.

According to the paragraph 7 of PCOB AS No.8, inherent risk refers to “the susceptibility of an assertion to a misstatement, due to error or fraud, that could be material, individually or in combination with other misstatements, before consideration of any related controls.” Moreover, the important part of auditor’s inherent risk assessment process is to understand BFA’s business model that includes: its products and services in both financial statement level and at the assertion level. According to paragraph 8 of PCAOB AS No.12, “auditor should evaluate whether significant changes in the company from prior periods, including changes in its internal control over financial reporting, affect the risks of material misstatement.” Based on the case, it shows that BFA began to invest heavily in the Arizona real estate market. This is one of the factors about BFA that cause me to raise inherent risk. Next, management team also decided to establish the number of related parties that were each controlled by an individual with close tied to BFA. Last but not least, BFA put a lot of effort to sell investment agreements to church members.

According to paragraph .04 of AU Section 334, “the auditor should be aware of the possible existence of material related party transactions that could affect the financial statement.” Additionally, paragraph .05, “…with respect to possible transactions with related parties, the auditor should obtain an understanding of management responsibilities and the relationship of each component to the total entity….” Referring to the paragraph .06, “In the absence of evidence to the contrary… The auditor should, however, be aware of the possibility that transactions with related parties may have been motivated solely….”
I strongly believe that related party transactions deserve special attention from auditors. Auditing standards emphasize that the existence of related parties presents additional risks to an auditor. Hence, auditors need to pay extra attention to these related party transactions. Auditors may concern if the related party transactions are completed on a basis other than an arm’ length basis. In most frauds, the transaction is being used as a tool to perpetrate a fraud. Like BFA case, the BFA’s book and income statement would be misstated if its affiliates have not designed to repay their debts. Moreover, BFA did not fully disclose the important information in its footnote. BFA only described its related parties by their titles rather than by their names.

As an investor in BFA, the information I would be interested in reviewing before making an investment in BFA is the same type of information that I would like to review in other organizations. For instance, financial statement would be the main source I would look at. Moreover, the additional pieces of information that provide me to assess the ability of the management team would be considered as well. I would pay close attention while revising the financial statement since the management team prepares this specific information and misstatement might possibly occur. If BFA happened to be a publicly traded company, I would spend more time reviewing the 10-K before making the investment.

Since BFA is a religious organization, some regulations may not apply like the regular banks. Allen stated that, “BFA won a religious exemption from both Arizona statutes governing securities and banking law. Still it functioned much like a financial institution, raising fund through sale of investment agreement….” It shows that BFA and bank organizational structures were principally the same and their tasks engage in the same activities. Thus, BFA should have not been exempt from Arizona banking laws. The reason is that investors are subjected to the same risks even though the interest rate given out to its investors is more favorable than the bank. Because of its status, it allows them to act in ways that potentially harmless to investors. This might be the reason that many people trusted the organization and relied fully on its financial statement. Later, everything revealed which make investors realized that their financial security is an illusion. Everything that happened were just a trick of the eye. More importantly, this is also harm to a for-profit organization, where conducting the same activities and functions, in many different ways. For instance, they might subject to more regulations simply because they are not being categorized as religious organizations.

Paragraph 7 of PCAOB AS No.9 states that, “The nature and extent of planning activities that are necessary depend on the size and complexity of the company, the auditor’s previous experience with the company, and changes in circumstances that occur during the audit. “As an auditor, individual should conduct the audit effectively by collecting all sufficient evidences to ensure whether BFA was meeting the treasury regulations for nonbank passive trustees of IRA accounts. After conducting all those necessary procedures, auditor must evaluate and determine the inherent risk associated to the client. If a result shows elevated inherent risk, the auditor should offer further audit attention to the regulations that concern to BFA’s ability to oblige as a nonbank passive trustee of IRA accounts.

The additional risk may arise due to its related party transactions. Auditor should also pay attention on these transactions to prevent unpredictable circumstance. According to the case, Arthur Anderson had reviewed the notes due to BFA and know knew that ALO was the largest single creditor. In this case, auditor should request ALO’s balance sheet to see and make sure that the asset valuation of these companies’ balance sheets were stated fairly. Surprisingly, in 1994, it showed a $14 million loss on the balance sheet. Additionally, BFA case is also known as a classic Ponzi scheme since it generates returns for older investors by acquiring new investors.

In conclusion, this case study makes me realize that we should not solely rely upon the financial statement only. As an investor, individual should read and make decision after truly understand the company structure since its complexity may vary than others. To be a professional auditor, each person should have a deep understanding about all type of risks (risk of material misstatement), the related party transactions, the nature and extent of planning activities and regulations associated to the client case.

Two year earlier than Enron scandal, the Baptist foundation of Arizona also failed. This caused a lot of people, more than 11,000 investors, to lose their life savings ($550 million). In the case, it claims that Arthur Anderson gave investors a false sense of security after giving out Anderson issued a clean audit in order to attract new investors. As a result, BFA filed for Chapter 11 bankruptcy. Anderson ended up settles a class-action lawsuit with BFA investors for $217 million after not warning investors of corrupt accounting practices in the firms it was hired to audit. Donald Dale, Senior Vice President and Controller, was sentenced to four years prison and a fine of $150,000,000. BFA president, Crotts, was sentenced to eight years in prison and Grabinski was sentenced to six years and a fine of $159,000,000.
Work Cited : MLA format

http://www.parentadvocates.org/nicecontent/dsp_printable.cfm?articleID=7081
https://www.azag.gov/victim-services/bfa
http://pcaobus.org/Standards/Auditing/Pages/Auditing_Standard_12.aspx#understandingcompany
http://www.ethicsdaily.com/baptist-foundation-of-arizona-case-has-similarities-with-enron-cms-6900

http://www.investopedia.com/terms/i/inherent-risk.asp
http://www.investopedia.com/terms/a/armslength.asp
http://www.fraudnewsamerica.com/fraud-news-america-articles/fraud-history-the-500-million-pyramid-how-william-crotts-bankrupted-the-baptist-foundation-of-arizona/8/
http://www.ethicsdaily.com/baptist-foundation-of-arizona-case-has-similarities-with-enron-cms-6900
https://en.wikipedia.org/wiki/Baptist_Foundation_of_Arizona

 

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