PricewaterhouseCoopers LLP was negligent in connection with one of the biggest bank failures of the financial crisis, a federal judge has ruled, opening up the Big Four accounting firm to the potential of hundreds of millions of dollars in damages.
PwC violated auditing rules and didn’t take steps that could have detected a $ 2 billion fraud scheme that contributed to the 2009 failure of Alabama’s Colonial Bank, the judge ruled. The ruling Thursday came in a lawsuit brought against PwC by the Federal Deposit Insurance Corp.
U.S. District Judge Barbara Jacobs Rothstein will now consider separately whether damages should be imposed on PwC, and how much. She dismissed other FDIC allegations against PwC, as well as allegations of negligence that Colonial’s bankruptcy trustee brought against the accounting firm.
A PwC spokeswoman said the firm “looks forward to the damages phase where the FDIC will bear the burden of proof on what remains of their inflated damages claim.” She said the firm was “pleased” that the judge rejected the other claims.
A spokesman for the FDIC declined to comment on the ruling.
The lawsuit concerns a fraud scheme centering on Taylor Bean & Whitaker Mortgage Corp., once one of the nation’s biggest mortgage companies. Taylor Bean was a major customer of Colonial’s. and authorities have said Taylor Bean overdrew its Colonial account for years to cover its own cash shortfalls. The mortgage firm covered that up by, among other things, selling Colonial thousands of mortgages it had already sold to other investors, according to authorities.
After the fraud was discovered, Taylor Bean filed for bankruptcy in August 2009, and Colonial failed soon after, costing the FDIC’s deposit insurance fund billions of dollars. At least eight people, including Taylor Bean Chairman Lee Farkas and two Colonial employees, were convicted or pleaded guilty to participating in the scheme.
PwC was the outside auditor for Colonial’s bank holding company, and gave Colonial clean audits that blessed its financial statements for years. The FDIC and the Colonial trustee had alleged PwC was negligent in not detecting the fraud scheme, and they sued the firm in 2012 and 2011, respectively.
Judge Rothstein agreed, saying PwC failed to design its audits to detect fraud, violating auditing standards. She also said PwC could have uncovered the fraud simply by inspecting some of the underlying documents for the mortgages at issue, but it didn’t.
But Colonial can’t recover damages because its hands aren’t clean, the judge said—its own employees were involved in the fraud, and the bank itself was negligent and its employees interfered with PwC’s audits, she said.
A related lawsuit against PwC by Taylor Bean’s bankruptcy trustee was settled for undisclosed terms in 2016.
In addition, PwC could still face a separate jury trial in Alabama over similar allegations from the FDIC and Colonial that concern part of the time PwC served as Colonial’s auditor. The allegations about PwC’s conduct during that time have been split off from the rest of the case for technical reasons.
Write to Michael Rapoport at Michael.Rapoport@wsj.com