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PwC should have done more to avert one of the biggest bank collapses in US history, according to a US federal judge, at the end of a case that shone new light on the responsibility of auditors to detect fraud.
The world’s second-biggest professional services firm by annual revenues had been accused of failing to catch a multibillion-dollar conspiracy between executives at Taylor, Bean & Whitaker, a defunct mortgage firm, and counterparts at Colonial Bank, an Alabama-based lender that supplied TBW with loans.
When Colonial collapsed in August 2009, there was a $2.8bn cost for the Federal Deposit Insurance Corporation, which sued PwC. The firm had given the bank’s parent, Colonial BancGroup, a clean audit for years before it emerged that huge chunks of Colonial’s loans to TBW were secured against assets that did not exist.
PwC argued — and the judge accepted — that it was duped by a determined gang of fraudsters. Lee Farkas, TBW’s founder and chairman who skimmed millions of dollars to buy a private jet, vacation homes and vintage cars, was jailed in 2011 for 30 years. Several other senior executives at TBW and Colonial were sentenced to long stretches in prison for their roles in a seven-year scam that grew to $2.3bn.
But PwC fell short nonetheless, wrote Barbara Jacobs Rothstein, US District Judge, in her judgment delivered last week. She cited professional standards, saying that the firm failed to perform adequate checks that Colonial’s financial statements were fairly stated.
She will now consider separately whether damages should be imposed on PwC, and how much. One pre-trial document put a figure as high as $2.1bn.
In a statement, PwC noted that the judge rejected four of the five main claims made by the FDIC and Colonial, and that numerous employees at the bank “actively and substantially interfered” with its audit.
“PricewaterhouseCoopers looks forward to the damages phase where the FDIC will bear the burden of proof on what remains of their inflated damages claim,” it said.
The suit brought by the FDIC is one of a number of high-profile actions arising from the financial crisis and its aftermath, which have put auditors in the dock.
The verdict comes more than a year after PwC settled a $5.5bn case brought against it by the bankruptcy trustee of TBW, in the biggest accounting negligence lawsuit ever to go to trial. The decision to settle — for a confidential sum — came four weeks into proceedings in a state court in Miami.
In March last year, PwC settled a $3bn malpractice suit with the administrator of its former client MF Global, a collapsed futures brokerage, halfway through a high-profile court battle in New York.
A jury had been asked to decide whether PwC made critical mistakes, including approving an accounting treatment that allowed MF Global to amass billions of dollars of European government bonds without recognising them on its balance sheet.
Jim Peterson, a former Arthur Andersen partner turned author, said the cases have exposed the fragility of the global professional services partnership model, whereby collections of firms operate more or less independently, with limited reserves for settling lawsuits.
“However the damages phase comes out, the claims here are within PwC’s tolerance on a worst-case basis,” he said. “[Colonial] they could afford to take all the way through trial, whereas they were essentially coerced into the earlier settlements as their maximum exposure exceeded their resources.”
Colonial was the 25th biggest bank by assets when it went bust, ranking as the sixth biggest collapse in history. Washington Mutual tops the list, with $307bn.
PwC had revenues of $37.7bn in the year to June, putting it a shade behind Deloitte, with $38.8bn in the year to May.