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The U.S. federal bank insurer is seeking damages against PricewaterhouseCoopers LLP in an ongoing trial for an allegedly negligent audit of a bank that failed during the financial crisis.
Depending on the outcome of the trial—which attorneys say could stretch into November—the case could affect how auditors can be held accountable in detecting fraud. It also might help clarify a contentious area of audit oversight.
In the trial that began Sept. 18, the Federal Deposit Insurance Corporation, which sued PwC in 2012, alleges “negligent and grossly negligent conduct” by PwC, the external auditor of the parent of failed Colonial Bank, of Montgomery ( FDIC v. PricewaterhouseCoopers LLP, M.D. Ala., No. 2:12-cv-00957, trial started 9/18/17 ).
FDIC also faulted PwC’s allegedly “wanton conduct” in not following accounting rules on securitizations of loans. The agency, along with the bankruptcy trustee of the bank’s holding company, criticized the audit firm for allegedly lax scrutiny of transactions that included selling pools of worthless mortgages to Colonial.
Colonial Bank’s collapse was one of the largest bank failures in U.S. history. The action by the FDIC marks its first suit against an auditor for work in checking the books of a bank that failed during the financial crisis of 2008-09.
Estimated losses at the bank that the FDIC seeks to recover range from $1.2 billion to more than $2.1 billion, with the latter figure recorded in a pre-trial document. At the time it failed in 2009, Colonial was one of the 25 largest banks in the U.S., according to the Department of Justice.
In August 2016, PwC settled a similar suit—based on a set of circumstances involving Colonial and a top client, a Florida mortgage lender—brought in a Florida state court in Miami.
PwC said in a prepared statement that it stands by its work as external auditor for Colonial BancGroup, the holding company of Colonial Bank. The fraud committed against Colonial was hidden, the Big Four firm also said.
Matthew Brewer, a partner with PwC outside counsel Bartlitt Beck Herman Palenchar & Scott LLP, Chicago, told Bloomberg BNA Oct. 2 that the Big Four firm has been consistent in sounding two themes.
First, “the downfall of the bank had nothing to do with accounting and auditing,” said Brewer. “Second, PwC complied with generally accepted auditing standards.”
The case brought by the FDIC is being tried by turns in U.S. District Courts in Washington and Montgomery, Ala. The trial will be decided by a judge.
The bankruptcy trustee for Colonial BancGroup also brought a similar suit against PwC. That suit is joined with the FDIC suit as the lead case.
A separate trial with PwC as defendant, to be decided by a jury, is set for January in Washington.
The splitting of the cases stems from provisions in PwC’s audit contracts with Colonial and the absence of jury trial waivers in the audit engagement papers governing 2006 and 2007 audits of Colonial BancGroup.
The bank holding company trustee and FDIC also list accounting firm Crowe Horwath LLP as a defendant in their suits. Court documents identify Crowe as Colonial Bank’s provider of internal audit services.
Attorneys expect the trial focusing on Crowe’s work to start in November in Montgomery, Ala.
The negligent conduct that FDIC alleged PwC had carried out stems from failure of the Big Four firm to uncover the fraud committed in 2002 through 2009 against Colonial by a defunct Florida mortgage company, Taylor, Bean & Whitaker Mortgage Corp., according to the suit brought by the FDIC.
Colonial Bank insiders also were involved in the fraud, which led to criminal convictions and prison sentences for executives and other employees of both the Ocala, Fla., mortgage company and the Montgomery, Ala., bank.
Taylor, Bean & Whitaker and Colonial Bank both imploded in 2009. The mortgage company was the bank’s largest client. Taylor, Bean once was the twelfth largest U.S. mortgage lender.
Rules of the Public Company Accounting Oversight Board, the writer of U.S. auditing rules, state that the auditor has a duty “to plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether caused by error or fraud.”
That means auditors should obtain sufficient evidence to determine whether the financial statements are materially misstated “rather than merely looking for evidence that supports management’s assertions,” according to PCAOB rules.
A similar lawsuit in Miami, brought against PwC by the bankruptcy trustee of Taylor, Bean, ended in PwC settling in August 2016. Settlement terms haven’t been disclosed.
In that case, Taylor, Bean bankruptcy trustee Neil Luriaalleged in the suit, “PwC failed to do its job as a public watchdog by failing to detect a massive, multi-billion-dollar fraud and by giving its seal of approval to Colonial’s grossly misstated financial statements.”
In its prepared statement in the FDIC and Colonial BancGroup trustee suit, PwC stressed that fraud at Colonial and Taylor, Bean wasn’t in the open.
“The fraud was so well hidden that the Bank, its internal auditors, its risk and compliance groups, and even state and federal regulators, including most notably the FDIC itself, all failed to find it,” the Big Four firm said.
A Crowe spokeswoman declined comment on the suits against it. An FDIC spokeswoman declined comment, citing the pending lawsuit.
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