Bain Capital sues auditing & consulting giant EY in the US over Lilliput Kidswear

Private equity giant Bain Capital Partners has revived its fight to recover its now written-off investment worth around $59 million in kid’s apparel retailer Lilliput Kidswear and has sued auditing and consulting major EY (formerly Ernst & Young) in the US, over its alleged role in the four-year-old deal which went bad.

This is arguably the most high-profile alleged accounting fraud on one of the Big Four firms since PricewaterhouseCoopers found itself under the limelight for certifying accounts of IT major Satyam Computers, later confessed to be false by its founder and chief B Ramalinga Raju.

Bain is bringing the action against EY for "fraud, aiding and abetting fraud, negligent misrepresentation, and unfair and deceptive trade practices based on EY's involvement in the scheme to defraud Bain."

It pointed out false claims on sales, outstanding debt, investments, cash balance with banks among many other lapses in auditing records of the Indian firm.

Emails and messages sent to Bain Capital, EY and Lilliput did not elicit any response till the time of filing this news report.

In its 75-page complaint filed in a US court reviewed by VCCircle, Bain has made serious allegations against EY, whose member firm S R Batliboi & Co. was involved in auditing accounts of Lilliput Kidswear before its investment, as well as its India chief Rajiv Memani.

It has also alleged the consulting arm of E&Y, which was running the mandate to bring on board a new investor, misrepresented facts about Lilliput which ultimately induced Bain to invest in the company.

In particular it has pointed out the conflict of interest of EY as an auditor of the Indian firm as also its financial advisor to bring in new investors.

Bain said the agreement involved EY being paid 1.25 per cent of the transaction amount if the new deal valued Lilliput at under Rs 600 crore and 2.5 per cent of the transaction value if it put a tag of over Rs 650 crore on the apparel retailer, with a minimum success fee of Rs 1.25 crore.

Eventually EY received Rs 2.2 crore as fee for brokering the deal, which valued the company at around Rs 855 crore post-money.

The US law suit alleges that Bain, which has a longstanding global relationship with EY, was specifically targeted by EY to invest in Lilliput because the Boston-based firm had the resources to pay a higher investment price and the prestige and knowledge to take the company to an initial public offering.

It alleges that Bain invested in Lilliput because it relied on false financial statements and EY's false audit opinions, and that EY continued to certify Lilliput financial statements "even as Lilliput's fraud grew with EY's active assistance".

Bain and TPG had co-invested to pick 45 per cent stake together in Lilliput Kidswear in 2010. In particular Bain invested Rs 265 crore ($59 million) to buy 31 per cent of which Rs 114 crore was invested in the company and the rest was acquired by previous PE investor Everstone Capital.

Bain and TPG Capital were alerted to problems with the accounts at Lilliput by an unnamed whistleblower, who is believed to be a former senior executive at Lilliput. The whistleblower had apparently approached EY but the red flag was dismissed and the auditor certified the company’s accounts once again.

Thereafter the unnamed person approached Bain Capital. The PE firm has claimed in its law suit that when it approached Lilliput chief Sanjeev Narula with more concrete evidence of the alleged accounting fraud, he acknowledged the same.

The board nominees of the PE investors in the company took an unusual step and did not approve the annual accounts of the company in a board meeting held in September. The incident put a spanner in the proposed initial public offer (IPO), aimed at generating resources for the company.

Lilliput promoter Narula then counter-alleged that the PE firms were looking to take over the control of the company by derailing the public issue as they did not want to dilute their holdings.

Lilliput filed a case against the PE investors in Delhi High Court on October 3, seeking an ad-interim relief to stop them from obstructing the operations of the company or harming the image of the firm.

The court restrained the PE firms “directly or indirectly, from acting contrary to the minutes of the Board Meeting dated 28.09.2011” and forbade the investors from giving adverse publicity to Lilliput. The order was later modified to include Lilliput as well, from acting contrary to the minutes of the previous board meeting and giving adverse publicity.

In the judgment dated November 4, 2011, it was decided that SS Kothari Mehta & Company would be appointed to carry out an independent audit and both the parties would give their points of reference to the audit firm. Both the sides also agreed to resolve all their disputes and differences, claims and counter-claims at an arbitral tribunal. Thereafter, former Supreme Court judge H S Bedi was appointed as the presiding arbitrator.

Bain in its filing to the US court has said the Indian court appointed auditor also found several discrepancies in the accounting by EY.

Separate media reports suggested that the two sides had decided to resolve their differences with the PE firms writing off the investment. Lilliput’s Narula had previously told VCCircle that he now owns 100 per cent of the company.

Lilliput later tried to rope in other investors and had also hired Centrum Capital as a banker for a proposed IPO, which is yet to materialise.

Read our previous related stories

TPG Growth Joins Bain Capital In Lilliput Deal

Lilliput Promoters Looking To Bring New Investor To Buy Out TPG, Bain

Tata Capital Files Winding Up Petition Against Lilliput Kidswear

Chinatrust Commercial Bank Takes PE-backed Lilliput Kidswear To Court

Lilliput revives IPO plan, offers shares to vendors for outstanding payments

Lilliput Kidswear hires banker for $74M IPO

(Edited by Joby Puthuparampil Johnson)

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