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The largest-ever lawsuit against an auditing firm is set to open Monday in a Miami-Dade County Circuit Court, pitting Big Four firm PwC against a trustee of the defunct Taylor, Bean & Whitaker Mortgage Corporation.
At stake: $5.5 billion.
The lawsuit was filed in 2013 by a trust formed following the bankruptcy of Ocala-based Taylor, Bean & Whitaker, which in the early 2000s was one of the nation’s largest mortgage companies. The firm was raided by federal agents in 2009 for its part in a seven-year, multibillion-dollar fraud scheme with Colonial BancGroup.
According to the lawsuit, the fraud went undetected by PwC, the independent public auditor in charge of auditing Colonial, as a result of “gross negligence.”
PwC maintains that it, too, was duped.
The $5.5 billion action is one of a wave of suits against major auditing firms, including PwC, in the aftermath of the 2009 banking crisis. Most have alleged faulty work, said Jonathan Perlman, equity partner at Miami-based firm Genovese Joblove & Battista, who has prosecuted several cases against auditing firms. A majority of the cases have settled, including a suit brought against PwC for the alleged negligent auditing of failed brokerage MF Global Holdings Ltd. PwC paid $65 million in a settlement.
Few of the suits have gone to trial, Perlman said.
Still, Steven Thomas, lead trial lawyer for the trust, said he is confident this suit will succeed.
Thomas, who has has obtained several multimillion-dollar settlements and verdicts in cases involving negligent audits, said PwC’s alleged negligence is the “worst” of any case he’s had.
As early as 2002, six top executives at Taylor, Bean & Whitaker, including chairman Lee Farkas, colluded with two executives at Colonial to sign off on mortgage sales that didn’t exist. Colonial financed Taylor, Bean & Whitaker’s mortgages, but in order to bypass the federal lending limit, Colonial started registering loans from the mortgage company as sales instead.
Circumventing the lending limits allowed the fraud to grow exponentially as executives at each company worked to falsify documents and computer entries and shift money between Colonial bank accounts. Both Colonial and Taylor, Bean & Whitaker were raided on Aug. 3, 2009, and later filed for bankruptcy, leading to the sixth-largest banking failure in U.S. history.
Farkas was sentenced to 30 years in federal prison. Catherine Kissick at Colonial, who worked most closely with Farkas, received eight years in prison as part of a plea deal.
Public auditors are public watchdogs and they should be the first line of defense against [fraud] Steven Thomas, lead trial lawyer for the trust
After the raid, 7,000 people lost their jobs at the two entities, Thomas said.
“When you talk about real people getting hurt, this was pretty direct for those people,” Thomas said. “Public auditors are public watchdogs and they should be the first line of defense against this.”
The lawsuit claims PwC, which has offices in Brickell, was in a position to catch and stop the fraud, but failed to do so through negligent reporting, including relying on an intern who certified information without allegedly verifying its existence. According to court documents, the trustee alleges that PwC missed multiple red flags during the seven years of fraud.
But PwC has countered in court documents that because of the level of collusion among executives, there was no way for the firm to catch the fraud, and that other internal auditors at each company also failed to discover it. PwC also argues that the illegal actions by Taylor, Bean & Whitaker bar the trustee from even bringing forth a case.
As the professional audit standards make clear, even a properly-designed and executed audit may not detect fraud, especially in instances when there is collusion, fabrication of documents, and the override of controls, as there was at Colonial Bank Elizabeth Tanis, PwC’s lead trial counsel
“With regard to the services performed for Colonial Bancgroup, one of the targets of Taylor Bean’s fraud, PricewaterhouseCoopers did its job,” said Elizabeth Tanis, PwC’s lead trial counsel, via email. “As the professional audit standards make clear, even a properly-designed and executed audit may not detect fraud, especially in instances when there is collusion, fabrication of documents, and the override of controls, as there was at Colonial Bank.”
PwC has maintained in court documents that its responsibility is to follow accounting principles — which might not necessarily detect fraud.
But in a pretrial brief issued by the trustee, former PwC chairman Dennis Nally is quoted in a 2007 Wall Street Journal article saying that the “audit profession has always had a responsibility for the detection of fraud.”
Whether PwC pays billions of dollars hinges on how the court ultimately defines the auditor’s role. In addition to $5.5 billion in specified damages, the suit also seeks punitive damages that could significantly raise the amount.
With so much money at stake, Perlman said he expects the suit likely will be settled. If the trustee wins, it could drive PwC out of business, making it unable to pay the damages from the case, he said.
“Everybody knows there’s a reason to settle and there is only so much blood that you can get out of a stone,” Perlman said. “But obviously right now, they haven’t been able to agree on a number and it’s a little bit like playing poker. It’s up to each side to decide if we are better off settling now or [later].”
PwC is also facing two suits filed by a Colonial BancGroup trustee and the Federal Deposit Insurance Corp. in federal court in Alabama. The cases are slated for trial in February 2017.
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