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A federal court decision against PricewaterhouseCoopers LLP will intensify pressure on audit firms to search for and detect financial fraud and possibly drive up the costs that public companies will pay for their audits.
A federal judge ruled July 2 that PwC must pay the Federal Deposit Insurance Corp. $625 million in damages for its negligent audits that failed to uncover mortgage fraud at Colonial Bank. Once among the 25 largest banks in the country, the Alabama-based bank failed during the financial crisis in 2009.
If the decision stands on appeal, it would expose auditors to greater legal liability for the work that they do—or fail to do.
Auditors will have to “turn over a whole lot more rocks” than they have until now to ensure the accuracy of a company’s financial reports, said Jim Langdon, a partner with Dorsey & Whitney LLP in Minneapolis who handles financial services sector class actions.
“That’s going to take more people and it’s going to cost probably a lot more money,” Langdon told Bloomberg Tax.
He called the monetary damages decision “enormous.” Although the ruling represents a huge financial blow to PwC, the lasting impact in the form of more expensive and cumbersome audits will be shouldered by companies and their shareholders, Langdon said.
“It creates a burden on the entire system,” Langdon said.
In a statement to Bloomberg Tax, PwC said the ruling wouldn’t alter how the firm conducts audits or its ability to serve clients. Since the audits in question, which date back to 2003, the firm has invested in—and remains focused on enhancing—audit quality.
If the ruling stands, audit firms could face bearing the risk for losses stemming from failed banks, the firms said.
PwC said that the firm plans to appeal, arguing that the FDIC isn’t entitled to any damages because of the court’s finding that Colonial Bank employees actively interfered with its audits. The firm also contends that it should be able to use the same defenses against the FDIC as it did against the Colonial BancGroup Inc., the publicly traded holding company that unsuccessfully sued the firm.
The decision will require auditors to “up their game” when it comes to designing their audit plans, especially how they set up tests to detect fraud, said Bob Cox, former assistant director of the Division of Enforcement and Investigations at the Public Company Accounting Oversight Board, which regulates audits in the U.S.
Firms are already facing more scrutiny from the PCAOB. Board members have said publicly that firms have plateaued in terms of meeting auditing standards. And the board is considering how to increase compliance.
Even the Securities and Exchange Commission is watching. Chief Accountant Wes Bricker in May admonished auditors to do more to earn the public’s trust.
“There’s going to be increased pressure on the accounting firms to improve audit quality,” said Cox, who joined Briglia Hundley PC in Tysons Corner, Va., in December.
As one of the few judgments related to auditor liability—most cases settle out of court—the decision will be cited in future auditing cases, especially by plaintiffs in suits against auditors, he said.
PCAOB standards require auditors to plan and perform an audit so they can provide reasonable assurance that the financial statements are free of material misstatements, whether by error or fraud.
In her opinion, U.S. District Judge Barbara Rothstein relied on those standards to find that it is the auditor’s duty to design audit procedures to detect fraud, Cox said.
According to court documents, PwC didn’t design its audits to do that. PwC auditors also didn’t collect sufficient evidence to sign off on audits for 2003, 2004, 2005, and 2008, including not inspecting any loan files with its largest customer, Taylor Bean & Whitaker Mortgage Corp.
From 2002 to 2009, Taylor Bean sold mortgage loans to Colonial Bank that had already been committed or sold to other investors.
Rothstein said in her opinion that had PwC adhered to auditing standards, the auditors would have uncovered the fraud years sooner.
The case is FDIC as Receiver for Colonial Bank v. PricewaterhouseCoopers LLP and Crowe Horwath LLP , M.D. Ala., No. 2:12-cv-957, July 2, 2018 .
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