September 13, 2016


9/13/16 REUTERS LEGAL 10:00:01
Copyright (c) 2016 Thomson Reuters

This article is reprinted from Reuters Legal News on Westlaw with permission of Thomson Reuters.

September 13, 2016

Dena Aubin

(Reuters) – Accounting firm Crowe Horwath must face claims by the Federal Deposit Insurance Corp that it negligently failed to detect a fraud that led to at least $1 billion in losses at the now-defunct Colonial Bank, a federal judge in Alabama has ruled.

In a decision on Friday, U.S. District Judge Barbara Rothstein rejected the accounting firm’s argument that its audit work for Montgomery, Alabama-based Colonial was done solely for the bank’s parent, Colonial BancGroup, and that the FDIC had no right to rely on it in bringing its lawsuit.

Although Crowe’s audit agreements stated the audit was meant for the parent and not for other parties, a dispute remains over whether those terms apply in the FDIC’s case, Rothstein said.

The FDIC sued Crowe in 2011 as receiver for Colonial, which filed for bankruptcy in 2009. The lawsuit seeks to recover more than $1 billion in losses suffered by the FDIC’s insurance fund.

The FDIC’s complaint accused Crowe of negligence and breach of contract by overlooking the defrauding of Colonial by Taylor Bean & Whitaker, a now defunct mortgage lender and one of the bank’s largest customers. Taylor Bean effectively stole from the bank by borrowing money secured by worthless or nonexistent mortgage loans, the complaint said.

One of the largest private mortgage lenders to fail during the financial crisis, Taylor Bean collapsed in 2009 after its fraud was discovered by federal investigators. Its former chairman Lee Farkas was sentenced to 30 years in prison in 2011 for his role in the fraud.

The FDIC’s lawsuit also named PricewaterhouseCoopers (PwC), which served as Colonial’s independent outside auditor. Crowe served as an internal auditor, working under Colonial’s direction to help check its financial controls and plan the bank’s internal audits. Claims against PwC are still pending.

PwC recently settled a related case brought by the bankruptcy trustee for Taylor Bean.

The FDIC said Crowe “consistently overlooked serious internal control issues,” never realizing that hundreds of millions of dollars of purported assets did not exist.

Lawyers for Crowe did not immediately respond to a request for comment.

In a motion filed last year, lawyers for Crowe asked for a judgment in the accounting firm’s favor, saying their agreement with Colonial’s parent expressly prohibits other parties from relying on Crowe’s work.

Courts around the country have held that similar prohibitions bar negligence-based claims by third parties, such as those asserted by the FDIC, the lawyers said.

The FDIC countered that, under Alabama law, an accounting firm may be liable for supplying inaccurate information to a third party it knew would receive it. When Crowe published its audits, it knew Colonial Bank, not only its parent, would receive the reports and rely on them, the FDIC said.

In Friday’s opinion, Rothstein agreed. A reasonable jury could conclude Crowe gave the audit to Colonial and the FDIC, standing in Colonial’s shoes, could rely on the report and sue Crowe for negligence, the judge said.

The case is Colonial BancGroup Inc v PricewaterhouseCoopers and Crowe Horwath, No 11-cv-746

For the plaintiffs: Anthony Kirkwood, Clint Latham, David Mullin and John Brown at Mullin Hoard & Brown

For the defendant: Jonathan Medow, Justin McCarty and Mark Ryan at Mayer Brown