Big Accounting Gets Its Turn In The Dock

For those of you wondering when the accountants of a failed bank were finally going to get their ticket to ride, wait no longer. As Kevin LaCDroix reported on his blog a couple of weeks ago, the FDIC has sued both the internal and external audit firms of the failed Colonial Bank. Connoisseurs of fine FDIC litigation knew it was only a question of time before the FDIC attempted to grab the tails of big accounting firms' malpractice insurance policies and hitch a ride to the promised land. Colonial Bank provided a good couple of ponies to ride.

The complaint alleges that while Taylor Bean was carrying out its “increasingly brazen” fraud, PwC “repeatedly issued unqualified opinions” for Colonial’s financial statements, and Crowe “consistently overlooked serious internal control issues” – and, more the point, both failed to detect the fraud. The complaint alleges that if the firms had detected the fraud earlier, it would have prevented losses or additional losses that the bank suffered at the hands of Taylor Bean. The complaint asserts claims against the firms for professional negligence, breach of contract, and negligent misrepresentation. The complaint alleges that in the absence of the firm’s wrongful acts, the Taylor Bean fraud would have been discovered by 2007 or early 2008, and “losses currently estimated to exceed $1 billion could have been avoided.”

Giving credit to Thompson Reuters' Alison Frankel, Kevin raises a potential hitch in the FDIC's giddyup.

As Alison Frankel discusses in her On the Case blog (here), the accounting firms are likely to raise the in pari delicto defense, “which holds that one wrongdoer can't sue another for the proceeds of their joint misconduct” The FDIC has anticipated this defense in its complaint, alleging that the two bank employees that facilitated the Taylor Bean fraud were “rogue employees” who acted our of their own self-interest and not at the direction of or to the benefit of the bank, but rather to the detriment of the bank.

According to Frankel, counsel for PwC doesn't think much of that approach.

PwC is represented by Elizabeth Tanis of King & Spalding, who took issue in a statement with the FDIC's assertions. "The Colonial Bank executive who spearheaded the fraud on the Colonial Bank side has testified that her actions were motivated by a desire to prevent loss to the bank and to save an important client relationship. She further testified that (Taylor Bean) was paying Colonial Bank $20 million to $30 million per month in interest," Tanis said. Moreover, Tanis said, auditors can't be expected to have uncovered a fraud that was "so well-concealed that neither the FDIC nor the OCC discovered it, even when they performed targeted exams of the mortgage warehouse lending division, where the fraud occurred."

I think that we all know that what the FDIC is doing here has little to do with what it thinks it can ultimately get away with if this case ever makes it to trial. No, they understand that big accounting firms and their insurers make decisions with a bean-counting mentality. If they can buy their way out of this litigation for an amount that eliminates the crapshoot of litigation, avoids paying defense counsel's kid's annual tuition at Cornell, and passes the "spit-up-a-little-in-my-mouth" thresh hold, they'll likely elect to pay off the FDIC, regardless of whether or not they think the accountants actually committed malpractice. The FDIC needs to survive a motion to dismiss and its prospects will look worthwhile. Unless, of course, PwC decides to give Ms. Tanis & Co a chance to win the suit on summary judgment.

From a personal standpoint, I'd like to see the court rule on the in pari delicto defense. Then again, it's not my money at risk.