On the 26th of August this year in a Miami courtroom after 8 years of preliminaries, Price Waterhouse Coopers (PwC) was halfway through a six-week trial defending a US$5.5 Billion lawsuit brought by the trustee of US lender Taylor, Bean & Whitaker.
On that day in August, defendant PwC settled a $5.5 billion lawsuit brought against it. At issue: the global auditor’s alleged failure to catch a massive fraud in Florida that led to the sixth-largest bank failure in U.S. history.
The accusation against PwC was that year after year it gave Colonial Bank a clean audit result, notwithstanding that it demonstrably failed audit protocols and consequently failed to detect, amongst other things that Colonial Bank (now taken over by Taylor, Bean and Whitaker) had perpetrated a massive fraud.
Continuing the US legacy of worthless mortgages, Colonial Bank was the biggest lender to the mortgage firm Taylor, Bean & Whitaker. The collapse of Colonial, which had $25 billion in assets and $20 billion in deposits, was the biggest bank failure of 2009. The Federal Deposit Insurance Corp. (FDIC), the government agency in charge of managing Colonial Bank’s receivership estimates Colonial’s collapse will cost its insurance fund $5 billion, making it one of the nation’s most expensive bank failures.
In the suit, Taylor Bean trustees claimed that Colonial Bank bought $1 billion of fake mortgage assets concocted on paper by the Ocala mortgage firm with help from Colonial executives. To be precise, the Mortgage Warehouse Loan Division of Colonial provided short-term, secured financing to mortgage originators. The division’s largest customer was Taylor Bean, whose executives colluded with a Colonial employee to shuffle money to cover up overdrafts and shortfalls.
As the shortfalls mounted, executives sold worthless mortgage loan assets to the bank for more than $1 billion in the scam. The assets were based on loans that didn’t exist. Taylor Bean recycled the fake loans and trades and fed the bank false documents to cover its tracks with help from co-conspirators at Colonial Bank, according to the suit.
Yet PwC declared Colonial Bank was in good shape from 2002 until 2008, that is until the bank failed with more than 1,000 workers losing their jobs. The mortgage firm’s flamboyant head, Lee Farkas a consummate conman with a penchant for sports cars and corporate jets is still in the early stages of a 30-year jail term for fraud in a medium-security prison in the US.
Although details of the settlement have not been made public, it is highly likely that PwC glimpsed the ghost of the now defunct auditor Arthur Anderson formerly one of the world’s “Big Five” accounting firms, and who in the wake of Enron’s collapse, tried to shred Enron audit documents as part of an effort to hide billions in Enron’s losses, and its own complicity.
Apprehending that spectre, PwC most probably settled on a much smaller sum with the plaintiffs, rather than run the risk of obliteration (in 2002, Arthur Andersen surrendered its licenses to practice as certified public accountants after being found guilty of criminal charges).
In PwC’s current case, the FBI raided Taylor Bean’s ornate headquarters in Ocala in 2009 shortly after the mortgage firm had agreed to take control of the vastly larger but struggling Colonial Bank. The US$5.5 Billion suit that followed was the largest ever brought against an auditing firm.
In defence, PwC auditors testified that they had “no responsibility to detect fraud” when auditing Colonial Bank, which collapsed thanks to a massive $5.5 billion fraud by its executives.
Wes Kelly, a former senior auditor at PwC who worked on the Colonial Bank audits, said in a taped deposition shown to a jury in Miami that the auditing standards do not require the detection of fraud. The standards require the consideration of fraud, but not the finding or detecting of fraud, he said.
“We did consider the risk of fraud to the financial statements,” said Kelly, who is now employed by the U.S. Securities and Exchange Commission. “We considered fraud in the risk assessments. But we did not design audit procedures to detect fraud because it’s not a requirement under the audit procedures.”
PwC still faces two lawsuits heading to trial early next year from a Colonial Bank trustee and the FDIC. The accounting firm is facing $1 billion lawsuit filed by the The FDIC who says PwC’s audits should have uncovered the massive holes in Colonial’s balance sheet. That lawsuit, filed in a US Federal court in Alabama, is pending.
PwC is also facing a $1 billion lawsuit over claims of bad accounting advice it gave to failed commodities broker MF Global Holdings. PwC agreed to pay $65 million to settle a separate lawsuit last year over accusing it of failing to properly audit MF Global’s internal controls before its collapse. PwC has denied wrongdoing with respect to the Colonial and MF Global litigation.
Bizarrely perhaps, PwC’s predecessor auditor Deloitte & Touche LLP also settled massive lawsuits by Taylor, Bean & Whitaker Mortgage Corp.’s bankruptcy trustee and Deutsche Bank AG over $7.6 billion in losses associated with the collapse of the mortgage lender before PWC took over as auditor.
Bankruptcy trustee Neil Luria and Taylor Bean’s Ocala Funding unit sued Deloitte in September 2011 over claims the accounting firm failed to detect a fraud that led to losses at the defunct lender. Deutsche Bank, which filed its complaint in December 2011, invested in asset-backed notes issued by Ocala based on Deloitte’s audits of Taylor Bean’s financial statements from 2005 through July 2009.
Interestingly perhaps, the CNBC TV business crime series American Greed devoted an episode to this complex sorry financial mess in 2012.
In the wake of these appalling cases, and the willingness of massive auditing firms to proclaim innocence, the International Ethics Standards Board for Accountants released a new standard in the middle of July this year that redefines the roles of auditors, CFOs and other accounting professionals when they witness or suspect illegal acts at their own organizations or within a client’s organization.
The IESBA Code of Ethics applies to all professional accountants worldwide. IESBA is an independent
standard-setting board supported by the International Federation of Accountants, or IFAC, whose member bodies in the U.S. include the American Institute of CPAs and the Institute of Management Accountants.
The standard is known as NOCLAR, short for noncompliance with laws and regulations. It aims to guide
accountants on how to act in the public interest when they encounter or become aware of suspected illegal acts such as accounting fraud. When laws and regulations appear to have been broken, the new standard explains when and how accountants should report wrongdoing to the authorities, without breaching their ethical duty of confidentiality.
IESBA sees the new standard as an opportunity for the global accounting profession to enhance its reputation as a safeguard for trustworthy business and a healthy global financial system.