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PwC found negligent over Colonial Bank failure

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In the first ruling in many years to find an auditor liable over fraud, PwC was found negligent in a lawsuit brought by the US Federal Deposit Insurance Corp (FDIC) for violating auditing rules and failing to “take steps that could have detected a $2 billion fraud” that contributed to Colonial Bank’s failure in 2009.

Judge Barbara Rothstein found that the Big Four firm’s failure to catch a years-long fraud involving made-up mortgages at Colonial Bank amounted to professional negligence and will now consider in a separate trial whether damages should be imposed on PwC, and how much.

She rapped PwC for failing to follow up on “illogical dates” and check whether an entire class of loans — nearly 20% of its mortgage lending warehouse — existed. She also cited testimony from a PwC partner in an earlier, related case that “our audit procedures were not designed to detect fraud”.

Rothstein did dismiss other charges against the firm brought by the FDIC and Colonial’s bankruptcy trustee.

After Colonial’s collapse the FDIC spent $2.8bn when it stepped in to protect depositors.

The Financial Times reports that the case has sent shockwaves through a profession that has long sought to limit its responsibility for detecting malfeasance. According to the report official standards require auditors to provide “reasonable assurance” that financial statements are free of fraud but add that there is an “unavoidable risk” that some will go undetected.

Lawyers who defend the industry are outraged by the ruling, calling it an “aggressive interpretation”, “extremely disturbing”, and a “one-off decision that will be reversed on appeal”. They are particularly upset that the case ever went to trial. In most auditing failure cases, companies are barred from suing their auditors for failing to detect fraud if — as happened at Colonial — their employees actively participated in the malfeasance. But in this case, the bank went bust and the FDIC is now trying to recover money for taxpayers.

Attorney Michael Dell argues that the Colonial decision would fundamentally change the nature of auditing: “Audit firms would effectively be insurers for the wrongdoing of their clients.” PwC was paid $1m a year to audit Colonial but is now potentially on the hook for several hundred million dollars. The firm noted that the judge ruled for the firm on several counts and said it plans to appeal.

If the ruling stands, some lawyers believe investors will find it easier to hold auditors accountable in future corporate fraud cases. Industry defenders warn that expecting auditors to do more fraud checks would change audit dynamics, driving up costs and delaying companies from issuing their results.

https://www.ft.com/content/c2cc45d6-f1f6-11e7-b220-857e26d1aca4