Laurel Valley Estates

In 1978, Two California businessmen, Claude Trout and Harry Moore, formed a real estate development company, which they named Laurel Valley Estates.1 The partnership agreement signed by Trout and Moore stated that the two partners would make equal capital contributions to the new firm and would share equally in its profits. Trout’s initial capital contribution was a 400-acre parcel of undivided land appraised at $640,000; Moore contributed an equal amount of cash. From 1978 through the end of 1981, Trout supervised the subdivision of the 400-acre property into residential lots and the addition of improvements. During that same period, Moore negotiated with several construction companies to build expensive tract homes on the property.

Near the end of 1981, Moore became restless with the slow progress being made in developing the Laurel Valley property. Moore questioned whether Trout was properly managing the partnership’s dwindling cash funds and whether those funds would be depleted before the completion of the project. To allay his concerns, Moore decided to retain Newby & Company, an accounting firm that he had employed in previous business ventures, to review the partnership’s books. After learning of Moore’s decision, Trout told Moore that he had no objection to Newby & Company’s reviewing the partnership’s accounting records. In fact, Trout offered to engage Newby & Company as the partnership’s permanent accounting firm. Moore accepted Trout’s offer. A few days later, Trout notified Douglas & Michaels, the partnership’s accounting firm since its inception in 1978, of the decision to switch to Newby & Company.

In early December 1981, Jay Kent Newby, a staff accountant with Newby & Company and the son of the firm’s founder, arrived at the Laurel Valley offices to review the partnership’s books. Newby asked Trout for a listing of all tangible assets held in the partnership’s name, as well as the partnership’s general ledger, cash receipts and cash disbursements journals, and check register.

Late in the afternoon of his second day on the Laurel Valley engagement, a visibly upset Newby stormed into Trout’s office, interrupting a conversation between Trout and his secretary. Newby told Trout that he had uncovered major problems in the partnership’s financial records. The most serious problem involved the property that Trout had allegedly contributed to the partnership. That property was listed as an asset in the firm’s general ledger; however, Trout had never transferred the legal title of the property to Laurel Valley Estates. Newby implied that Trout intended to claim, at some point in the future, that the property was his alone. Newby also charged that over the past three years, Trout had squandered most of the cash invested in the partnership by Moore. According to Newby, Trout had paid exorbitant amounts to contractors he had retained to develop the Laurel Valley