A class action complaint has been filed Ernst & Young (Bermuda) and others in the United States on behalf of investors in a hedge fund for which it was auditor.

The action was filed at the US District Court for the District of Connecticut on Monday this week by Susan Quinn, who claims to have invested approximately $1.8 million in Stewardship Credit Arbitrage Fund LLC.

The complaint alleges that E&Y failed to detect that 60 percent of the assets reflected in the Fund financial statements "were a complete and total sham", as reported by KYC News' OffshoreAlert online newsletter.

More than half the assets of the fund were invested with Thomas J. Petters and Petters Worldwide, which were found by US federal agents to be running an alleged $3 billion Ponzi scheme, based on fictitious sales of flat-screen televisions and other electronic goods.

The defendants in the case are Ernst & Young LLP, a Delaware partnership based in New York, NY; Ernst & Young Ltd., in Bermuda; Stewardship Credit Arbitrage Fund LLC, Stewardship Investment Advisors LLC, and Acorn Capital Group LLC, all Delaware corporations based in Greenwich, Connecticut; and Marlon Quan, an investment manager believed to reside in Connecticut and the founder and principal officer of both SIA and Acorn. The causes of action against all defendants are breach of fiduciary duty and negligence.

The Stewardship Credit Arbitrage Fund is managed by Marlon Quan and his company, Stewardship Investment Advisers.

"During the class period, defendants caused a material share of the investment capital of the Fund (approximately 60 percent) to be invested with Thomas J. Petters and Petters Group Worldwide, LLC, and its subsidiaries and affiliates.

"During September 2008, a federal investigatory task force assembled in the District of Minnesota uncovered a massive fraudulent Ponzi scheme perpetrated by Petters. Petters and their co-conspirators have been charged with multiple federal felonies and more charges are expected. At present, the total estimate involved in the swindle approaches a staggering $3 billion.

"The essence of this scam was the completely fictitious sale of high-definition flat screen television sets and other expensive electronic consumer products by the Petters organisation to retail wholesale clubs, including Sam's Club, Costco Wholesale, and BJ's Wholesale Club. Phony purchase orders and invoices were prepared and provided to persons who loaned money to the Petters Group, including numerous investment funds, which had in turn obtained money from private investors as their fiduciaries."

The complaint said that FBI agents took the phony purchase orders and invoices directly to Sam's Club and Costco Wholesale were told they were bogus.

Petters is a merchandise distributer which buys excess high-quality, consumer merchandise inventory arising, for example, from manufacturing overruns, at distressed prices and selling the merchandise to retailers at a profit.

"While a simple telephone call to any of Petters' supposed 'retailer customers' would have immediately revealed that the subject notes were entirely bogus, defendants performed no due diligence whatsoever, despite their fiduciary duties to plaintiff and the other class members," the complaint states.

"Defendants' abject failure to conduct any procedures to verify the legitimacy of the notes and the transactions underlying them is all the more egregious given that Petters was the only distribution company in which the Fund had invested plaintiff's and other class members' money."

The court documents state that Ernst and Young, LLP, and Ernst and Young Ltd. Bermuda served as the Fund's primary outside auditors during the class period.

"When a certified public accounting firm audits a client's financial statements, it has a duty to exercise due professional care, professional scepticism and objectivity, and to develop and follow procedures, analyses, and tests to verify the legitimacy and accuracy of the client's assets, liabilities, operations, and cash flow," the complaint states.

"E&Y, which is among the largest accounting firms in the world, failed in these duties when it conducted its audits that were so superficial and perfunctory that it failed to detect that approximately 60 percent of the assets reflected in the Fund's financial statements were a complete and total sham.

"Had E&Y done its job, plaintiff and the other members of the class would not be in the dire financial straits in which they find themselves today."

Efforts to contact an Ernst & Young Bermuda partner for comment after the story broke last night were unsuccessful by press time.