Pooh Audit May Be Tainted By Conflict Of Interest

by Joe Shea

In one development, Los Angeles Superior Court Judge Ernest Hiroshige called famed attorney Daniel J. Petrocelli into his chambers after a lengthy accounting hearing last summer and told the lawyer he did not want the Gursey, Schneider & Co. forensic accounting firm to be used in future litigation before him.

The firm was the court-appointed forensic accountant in a dispute over hundreds of millions of dollars in royalties that has been proceeding under seal for more than a decade. Disney has been fined $90,0000 and sanctioned by Judge Hiroshige for destroying at least 40 volumes of records that were sought by the plaintiffs.

In an another development, the American Reporter has learned that Arthur Andersen senior partner Christopher Paskach is named as the author of a memo on the Disney royalty audit in papers filed by Disney with the court. Paskach did not return numerous calls for comment. Andersen is currently charged with approving the destruction of key documents that might have explained the sudden collapse of the $83 billion Enron energy trading firm last year.

The controversial, long-running, long-secret case -- the oldest active case in the Los Angeles County court dockets -- pits the Walt Disney Co. against Stephen Slesinger, Inc., a small Tampa, Fla., firm that granted commercial rights to the beloved and best-selling Winnie The Pooh characters to Disney in 1961.

In a widely-reported talk to investors that signaled a sea change for the accounting industry, Disney chairman Michael Eisner announced about a month ago that outside auditors would no longer be used as consultants on technology and other issues. But while Eisner referred to other accounting relationships, he made no mention of Arthur Andersen & Co.'s apparent role in more than a dozen hearings before Judge Hiroshige, after which Disney admitted destroying documents it had been ordered to preserve.

A decision is reportedly near in the audit facet of the case, involving some $35 million in Pooh merchandise that was sold in Disney theme parks, Disney stores and elsewhere for which the right to royalties was not in dispute. A trial on remaining issues -- mostly on royalties for rights that the plaintiffs claim to own and Disney says it owns -- is likely to involve hundreds of millions of dollars, and could result in Disney's loss of the lucrative rights. The trial is expected to begin later this year.

Because it it admitted to destroying documents after a court order to preserve them, Disney will be prohibited from arguing to a jury that its executives did not promise to pay royalties on videocassettes and computer software to the Slesinger firm. Disney claims in court papers that videocassettes are motion pictures, for which it was not required to pay the Slesingers.

There may have been at least the appearance of a conflict of interest in the accounting reference, as that part of the case is called, although it is not clear whether that was the cause of Judge Hiroshige's alleged ire.

The issue is extremely sensitive, and sources on both sides of the matter reacted with anger when apprised of this story. Confronted with evidence that Arthur Andersen & Co. was involved in the audit, Petrocelli initially said that story was "false," and confronted with this story, a Slesinger family spokesperson angrily demanded its retraction. However, the issue has been simmering beneath the surface of the case in closed hearings for some time.

John Costello, the Pooh court-appointed accounting referee who was formerly at Ernst & Young, a rival accounting firm, allegedly introduced Paul Donovan -- Disney's attorney at Skadden, Arps, Slate, Meagher & Flom, which represented the studio in the matter for almost 10 years -- to the Gursey, Schneider accountants who handled Donovan's divorce, sources familiar with the matter say.

They also say the "irrepressible" Donovan was vigorous in supporting the Gursey, Schenider appointment by Judge Hiroshige. The discovery referee in the case, former California Supreme Court Associate Justice David Eagleson, suggested in court documents that it could cost the parties some $500,000, most of it payable to Gursey, Schneider. An earlier accounting in the case cost just $5,100, Disney attorney Janet Dhillon said in court papers.

As head of West Coast litigation for Skadden, Arps, the lawyer would likely prove a lucrative client to an accounting firm charged with determining the division of community property under California's restrictive laws. There is frequently a finder's fee for such introductions, accounting professionals say, although no record of such a payment has surfaced in the Donovan divorce. That fee can range from as little as one percent in some matters to half of the firm's revenues from a case in others.

Now, Disney is asking the court to keep records of Donovan's divorce sealed, according to papers filed as part of the studio's effort to keep portions of the case under seal after March 1. It is unclear from the heavily redacted record made available to the press why that unusual step was taken. Donovan has not responded to numerous requests for comment.

In a reply brief filed Feb. 21, Disney attorney Carla Christofferson writes, "Disney also seeks to keep sealed private financial information related to the divorce proceedings of former counsel -- a proceeding irrelevant and unrelated to this case. ... [D]isclosure of this information to the public cannot be said to further the policy considerations underlying the public's right of access."

Sources say Costello "brought the Pooh case with him" when he left Ernst & Young, the original forensic accountants, and came to Gursey, Schneider. Disney attorneys led by Donovan urged Hiroshige to appoint Gursey, Schneider, and Costello as the new accounting referee in the case, and the judge did so. But it is unknown whether Judge Hiroshige's alleged comments to Petrocelli about Gursey, Schneider were based on any perceived conflict of interest.

Costello, apparently relaying Disney's stance on the issue, would not permit a Slesinger accountant to sit in on the special accounting audit, according to testimony last summer. The Florida firm made a major issue of its exclusion when Judge Hiroshige held a four-day hearing to resolve royalty accounting issues on undisputed product categories last August. Six months later, he still has not ruled on that matter.

At the end of the accounting hearing, Gursey, Schneider accountants found few discrepancies in Disney's royalty payments to Slesinger. Both parties sought to have the accounting set aside and to conduct a new one.

That was attributed by the plaintiffs to the destruction of documents in the case. Donovan and Skadden, Arps were forced to drop the studio as a client when Slesinger's attorneys moved to call them as witnesses in the document drestruction.

Disney lawyers said at a 2000 hearing on the destruction that Donovan "is irrepressible, maybe," but would never deliberately order the destruction of documents sought by opponents in any litigation.

Meanwhile, the California Supreme Court is expected to rule on Disney's appeal of the sanctions on Feb. 28, according to officials. California's Second Appellate District rejected the studio's petition for a writ to suspend the sanctions in December. Its jurisdiction in the matter ends on March 7.