"Unusual" accounting: Inside a Trump business audit

NEW YORK -- In a three-sentence letter on April 22, 1987, Donald Trump signed off on a series of accounting changes that allowed his first hotel to shortchange New York City nearly $3 million in rent, city auditors later concluded.

A decade before, Trump struck a unique deal freeing the hotel of $160 million in property taxes over the course of 40 years, while guaranteeing the city a small financial stake in its success: New York City received annual rent payments tied to the Grand Hyatt’s profits. In 1986, the hotel had its best year, raking in nearly $80 million. City officials expected to receive at least as much as the $3.7 million paid the year before.

But a month after Trump and his partners signed off on the accounting changes, the city was paid just $667,155.

What followed was a two-year-long saga in which city auditors said they were met with stonewalling, disorganization and obfuscation at every turn. Thirty years later, as the Republican nominee for president cites an IRS audit while refusing to release his tax returns, the Grand Hyatt case offers rare insight into what an audit of a Trump business can look like.

Experts asked by CBS News to examine the city auditor’s report, which was completed in 1989, described the behavior of hotel and Trump Organization officials as “unusual” and “unheard of.”

Karen Burstein, who was the city’s auditor general at the time, told CBS News she never forgot the case.

“Something was fishy there,” Burstein said referring to the hotel’s owners. “This was not the behavior of an innocent party. I think that’s what became evident to us.”

The experts who examined her report say it detailed failures in basic bookkeeping, the seemingly sudden adoption of irregular accounting methods, and efforts to stymie officials.

Stonewalling

It was more than a year before city officials were allowed to step inside the Grand Hyatt. On one occasion, a date was agreed on for the audit to begin, but cancelled the day before by hotel lawyers. That law firm, Dreyer and Traub, represented Trump throughout the 1980s.

Certified public accountant Robert Tobey said auditors rarely face such delays.

“It’s one of those things you want closure on. Why would you want this hanging over your head?” said Tobey, a partner at Perelson Weiner LLP, which audits corporations, hedge funds, private equity funds and non-profits. “Stonewalling auditors is not a common practice. You want to make them go away.”

Yet Dreyer and Traub challenged city officials before they even got started, arguing that the city did not have a right to examine the hotel’s records. Eventually, the law firm reversed course, but it was an early warning sign that this would not be a normal audit, experts said.

Accountants are typically in charge in the early stages of an audit, and attorneys only show up at the end, if there’s a dispute, said certified public accountant John Lieberman, also of Perelson Weiner.

“It appears in this case, the attorneys came in almost with guns blazing, and said, ‘You’re not allowed to audit,’ which is a very, very unusual thing,” Lieberman said. “I would say in 35 years I have never seen that type of thing.”

But it was what the city’s auditors discovered when they got inside the hotel that most surprised forensic accountant Rumbi Petrozzello.

Missing books

The amount of financial information simply missing was staggering.

For just the year 1986, the hotel, which was managed by the Hyatt Corporation, was unable to produce:

  • Seven of 12 monthly ledgers
  • Three of 12 detailed ledgers
  • 25 of 87 income journals
  • One of five payroll cycles
  • 26 of 84 expense vouchers

“That’s the stuff you’re expected to hold on to, for various reasons,” said Petrozzello, of Rock Financial Forensics, who along with Lieberman and Tobey, is a member of the New York State Society of Certified Public Accountants. “Even if it’s for an IRS audit, what are you going to say, ‘I don’t keep scraps of paper.’”

But “scrap of paper” is exactly what the hotel called its guest checks, food receipts and other financial records in correspondence with auditors.

Keeping such basic information would be a “Herculean task” the hotel wrote in its response to the city’s audit. The hotel also argued that its contract with the city did not require it to keep those records.

Auditors were most concerned about the missing monthly ledgers, the records that should have detailed more than half a year of income and expenses.

The hotel said the ledgers were stored off-site, in a room in New Jersey that had been flooded. Computerized records had been sent to an office in Chicago, where they were lost, the hotel said.

“Just inexcusable,” said Burstein.

Auditors also discovered that the hotel maintained “two capitalization policies in the same year,” allowing its accountants -- a soon-to-be bankrupt firm named Laventhol and Horwath -- to produce an in-house estimate of profits that was drastically different than what the city was given.

Generally Unacceptable Accounting Principles

Businesses typically calculate their revenues and expenses using one of two accounting methods, cash or accrual. This is one of the marquee concepts of the Generally Accepted Accounting Principles (GAAP), a set of standards that guide the field.

Donald Trump (right), father Fred Trump and boxing promoter Don King in 1987, when the younger Trump's Grand Hyatt hotel project changed how it accounted for profits -- an unusual move that sparked a lengthy audit battle with New York City.

AP

In 1987, the Grand Hyatt decided to retroactively use both for the year before -- accounting for revenues on a cash basis and expenses on an accrual basis.

Auditors said the decision allowed the hotel to misrepresent its profits, an accusation the hotel denied, arguing that its contract with the city didn’t require it to follow GAAP.

“Until now, I have never come across a mixed method of income and expenses, where one is cash and the other is accrual,” said Petrozzello. “It doesn’t make sense to work that way, because then your numbers are just misleading, in a way.”

That January, Laventhol and Horwath first calculated and certified the rent due to New York City, known as the percentage rental, at $3.3 million, roughly in keeping with the amount the Grand Hyatt had paid previously during the 1980s.

But days after they arrived at the $3.3 million figure, the hotel’s ownership partners -- Trump’s Wembley Realty and Grand Hyatt’s Refco Properties -- requested the accounting firm suggest ways to lower their tax and rent payments, according to a letter from Laventhol and Horwath included in the auditor’s final report.

The key was to argue that the hotel had profited less, even while revenues had increased.

The importance of profit in calculating the rent was explained by Burstein in a 1989 memo to then-Mayor Ed Koch:

Laventhol and Horwath started by throwing out GAAP.

Using the mismatched cash and accrual methods, the accountants were able to lower the hotel’s reported profits enough to cut $1.1 million from the $3.3 million they originally certified.

But that wasn’t enough.

The firm then suggested a series of changes in the way the hotel expensed assets, such as furniture.

The hotel’s furnishings had always been regarded as having an eight-year lifespan, but suddenly the accountants changed that figure to six years. The result was that the hotel could expense 25 percent more for every single fixture inside the massive, 26-floor building.

Similar changes were made for expensing freight charges, sales taxes, and labor costs.

Ultimately, Laventhol and Horwath needed to revise the hotel’s 1986 financial report three times before it was able to lower the total rent to $667,155, and the Trump-Hyatt partnership were finally willing to approve it for sending to the city.

Then Laventhol and Horwath violated GAAP one last time, the auditors said.

Accountants are supposed to certify financial reports when they are totally complete and no more changes are made. Laventhol and Horwath sent its altered report in May 1987, but kept the original January certification date.

“The January date is therefore false; however, the accountants may have thought it protected them from questions about later recalculations that vary significantly from generally accepted auditing standards,” Burstein wrote in her memo to Koch.

Lawyers for New York City would later call the decision to keep the January certification date “a deliberate attempt “ to conceal accounting changes and “a fraud against the public,” a claim both the accountants and the Trump Organization denied.

Dealing with Trump’s people

Burstein said Trump Organization personnel actively engaged with her auditing team throughout the process.

“It was his people who were calling us all the time. It wasn’t anybody from Hyatt,” Burstein said.

City correspondence with the hotel’s ownership partners was sent to the Trump Organization, according to court documents. And hotel officials tried to keep the audit from being made public, she said.

“They said, but this is Donald Trump ... I have to say they made an enormous fuss about it,” Burstein said.

In a letter written after the audit was completed, the hotel’s controller, Stan Blagojevic, wrote that he believed the auditors’ focus on the hotel “may relate to the presence of Donald Trump as one of the owners.”

Blagojevic wrote that his management company had been “extremely reluctant” to work in New York City, “a classic example of urban decay and municipal neglect,” until they “were persuaded to do so by the extraordinary vision of Donald J. Trump.”

Blagojevic, who passed away in 2004, was harshly critical of the audit.

“Rather than an objective and professional discussion of the audit’s findings and conclusions, the draft report is replete with diatribes, hyperbole and histrionics,” Blagojevic wrote.

The accountants who reviewed Burstein’s work for CBS News all had a different take.

“It was probably one of the best reports I’ve ever read,” said Lieberman. “You didn’t have to know anything about this backstory except to read what they did. The history, the background, the principles, what happened, it’s all very clear.”

Trump said in a statement to CBS News that he doesn’t recall the audit.

“I sold the hotel many years ago for a tremendous profit. By building the hotel I created thousands of jobs, saved the Grand Central area, and helped to revive a dying, at the time, New York City,” Trump said. “The city was extremely happy with that development and you’re now bringing up something thirty years later that I’ve never heard about.”

hyattexterior.jpg

The Grand Hyatt on New York's East 42nd Street in 2008, a decade after Donald Trump sold his stake in the hotel.

BluesandViews

The Hyatt Hotels Corporation declined to comment for this story.

Soon after Burstein’s report was filed, the Office of the Auditor General was among several city agencies shuttered as part of a series of budget cuts. She went on to be a state court judge, before running as a Democratic candidate for state attorney general in 1994, when she lost to Republican Dennis Vacco.

State officials reviewed Burstein’s report in late 1989 and determined it was accurate. They ordered the hotel to pay New York City about $2.9 million. A month later, in January 1990, a Trump Organization official signed for the ownership partners on a lawsuit against the city and state.

The government filed a countersuit, and added Laventhol and Horwath as a defendant. A year later the accounting firm filed for bankruptcy. A judge ordered the case stayed during the bankruptcy proceedings, but a city clerk accidentally marked the case as disposed, according to court documents.

The city forgot about the case until 2000, when another clerk noticed the mistake. In a new series of filings, the city and hotel -- which was no longer owned by Trump, who sold his stake in 1996 -- argued about whether the case could be continued. Ultimately it was, and in 2004 the two sides reached a settlement. Its terms were not disclosed.

For the years after 1986, however, the percentage rental paid to the city again rose into the $3 million range, and continued to increase through 1999, when the hotel paid about $6.8 million.

Elizabeth Skoski contributed reporting for this story.