Cornfeld then invited King to make a presentation during a Fund of Funds board of

directors meeting in Acapulco, Mexico. Following that presentation, Cornfeld and King
reached an agreement. Fund of Funds would establish a natural resource property account
(NRPA) for investment in oil and gas properties to be purchased from King Resources.
Although the two men never signed a formal contract, the minutes of the Fund of Funds
board of directors meeting documented the intended relationship between the two companies:

The role of King Resources with respect to the contemplated Natural Resources
Propertary Account would be that of a vendor of properties to the proprietary
account, with such properties to be sold on an arm's length basis at prices no
less favorable to the proprietary account that prices charged by King its 200-
odd industrial and other purchasers.¹

A Fund of Funds executive later tedtified he understood that King Resources would sell natural
resources properties to Fund of Funds at cost plus a “reasonable markup" of 7 to 8 percent.

Initially, Cornfeld agreed to purchase $10 million of oil and gas properties from King
Resources. By the end of 1969, however, the overbearing King had convinced Fund of Funds'
officers to purchase more than $100 million of oil and gas properties from his company.
Unfortunately for Fund of Funds' stockholders, King took unfair advantage of the mutual fund's
executive, who knew little about the oil and gas industry. Court records later revealed that
King often bought relatively inexpensive oil and gas properties and then immediately sold those
properties on Fund of Funds for as much as 50 tome what he has paid for the properties a few
days earlier.

Within a few years, fallung stock prices and the weight of the poor investments made
for Fund of Funds by King forced the mutual fund into bankruptcy. Among the defendants in
the tangle of civil lawsuits stemming from Fund of Funds' colapse was Arthur Andersen &Co.,
the audit firm of both Fund of Funds and King Resources. Arthur Andersen was sued by John
Orr, w Touche Ross partner appointed to serve as Fund of Funds' bankruptcy trustee. Orr
alleged that Arthur Andersen failed to disclose to the officers of the mutual fund that they were
being defrauded by King Resources. When the verdict in the subsequent trial was handed down,
Arthur Andersen became the victim of the largest court-ordered judgement ever imposed on a
public accounting firm at the time.

ARTHUR ANDERSEN’S DUAL RELATIONSHIP

WITH FUND OF FUNDS AND KING RESOURCES

There Arthur Andersen office were involved in each annual audit of Funds. The
Genevea coordinated the audits of all the IOS mutual funds and paid particular attention to the
Fund of Funds audit, given the size, promonance, and complexcity of that fund. The New York
City office assumed primary responsibility for the Fund of Funds audit. Finally, Andersen’s
Devender office performed selected aidit procedures each year on the Fund of Funds' NRPA.
The Denver office also audited King Resources, which was headquartered in Denver. In fact,
the partner in charge of the King Resources audit and the principal manager assigned to that
audit supervised the NRPA segment of the Fund of Funds audit.

A central issue in the suit filed against Arthur Andersen by the Fund of Funds'
bankruptcy trustee was Andersen’s awareness of the exessive price King Resources charged
the mutual funds and paid particular attention to the Fund of Funds' audit. Finally, Andersen’s
Denver office performed selected audit procedures each year on the Fund of Funds NRPA. The
Denver office also audited King Resources, which was headquartered in Denver. In fact, the
partner in charge of the King Resources audit supervised the NRPA segment of the Fund of
Funds audit.

A central issue in the suit filed against Arthur Andersen y the Fund of Funds’
bankruptcy trustee was Andersen’s awareness of the excessive price King Resources charged
the mutual fund for oil and gas properties. Arthur Andersen’s Fund of Funds workpapers noted
that King Resources had “carte blanche authority to buy oil and gas properties” for the NRPA.
The Denver office of Arthur Andersen also had complete accesss to King Resources’
accounting data tjat documented the cost of the properties sold to Fund og Funds and the profit
margins on those sales.

A final issue addresed at length in the Fund of Funds civil suit Arthur Andersen’s
awareness of, and involvement in, several so-called revalution transactions arranged by King
Resources for Fund of Funds. Because Fund of Funds was open-ended mutual fund, on a daily
basis it revalued its entire portfolio. To compute its net assets value (NAV), Fund of Funds
established a market value for each of its investments, including its natural resource properties.
This collective market value was then devided by the number of outstanding mutual fund shares
to arrive at the NAV. Mutual funds use their NAV to distribute proceeds to shareholders
electing to redeem their shares. The illiquid nature of Fund of Funds to establish a fair market
value for the residual portions of those properties retained by the mutual fund. Alternatively,
King Resources would sell a portion of its own equity interest in yhese properties to establish
a fair market value for Fund of Funds’ NRPA investments.²

Evidance presented durung the Fund of Funds trial demonstrated that many of the
revaluatiom transactions arranged by King Resources were Fraudulent In at least two cases,
King Resources found a third party that agreed to buy a small portion of either Fund of Funds
or King Resources’ interest in an oil and gas property at a price consi6higher that iys fair market
value. Unknown to Fund of Funds' officials, King Resources made secret “side agreements"
with the purchasers of these properties. These side agreements obligated King Resources to
compensate the purchasers for any losses they subsequently incurred on these properties.
Because of these side agreements, the revaluation transaction to convince Fund of
Funds’executives that the natural resource investment were profitable. Since these transaction
grossly inflated the NAV of Fund of Funds' shares, the investors who redeemed their shares
following these transactions profited from them. On the other hand, these transactions
adverselu affected thosr investors who retained their mutual funf shares indefinitely.

ARTHUR ANDERSEN’ 1968 AND 1969 AUDITS OF FUND OF FUNDS

Court records in the Fund of Funds trial documented that Arthur Andersen considered
the IOS and Fund of Funds audits high-risk engagements. The hihghest-risk financial
statement items in the 1968 and 1969 Fund of Funds audits were the largr investments in
natural resource properties. During the Fund of Funds trial, plaintiff counsel established that
Arthur Andersen had “repeated serious difficulties with King as a client at least since 1961”
and had expressed concern regarding several of King's questionable business practices. These
prior difficulties with John King placed Arthur Andersen om noticr that the Fund of Funds-
King Resources transactions needed to be scrutinized closely.

During the 1968 Fund of Funds audit, Arthur Andersen personnel in the Denver office
compiled King Resources’ sales data for its natural resource propertie. These data revealed that
King Resources realized much higher gross profit margins on properties sold to Fund of Funds
that it did on pr4sold to other customers. The accounting firm documented the following gross
profit percentages for five of the sales made King Resource to Fund of Funds: 98.7, 98.6, 85.6,
58, and 56.7 percent. These gross profit percentages appeared particularly excessive since most
of the properties had been ownef only a short time by King Resources before being sold to
Fund of Funds. The court reached the following conclusion regarding Arthur Andersen’s
knowledge of the prices charged Fund of Funds by King Resources: “It is reasonable to find
that AA knew whay FOF paid fot the [ natural resource ] interest purchased in 1968, that AA
knew what King Resources paid for them, and that AA knew King Resources’ profits [ on these
transactions] prior to February 5, 1969, when the FOF audit report was filed.”

During the trial in the Fund of Funds case, a lengthy debate ensued regarding the client
confidentiality rule. That debate focused on whether the confidentiality rule precluded Arthur
Andersen from using the sales data obtained from King Resources to audit Fund of Funds’
natural resource investment. Clouding this issue was the close linkage between the Fund of
Funds and King Resources audits.

The NRPA audits was performed by using the records of King Resources, and sometimes AA
staffers would work on the King Resources and NRPA audits contemporaneously.
Thus, AA's understanding of the ongoing business relationship between FOF and the
King group can be determained from documents found in AA files for King Resources
or NRPA and from testimony regarding the actual conduct of the audits.

Another critical issue Arthur Andersen faced during the Fund of Funds audits was the
validity of the revalution transactions. In December 1968, John King arrangerd for Fund of
Funds to sell 10 percent of a natural resource property to Fox-Raff, a seattle brokerage firm
audited by Arthur Andersen.