A First of its Kind: FDIC v. Independent Auditor

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A recent decision in a closely watched accounting malpractice matter – the first of its kind initiated by the FDIC – may suggest cause for concern for accountants.  As receiver for a failed bank, the FDIC may sue professionals who played a role in the failure of the institution. In the wake of recent bank failures, the FDIC has targeted officers and directors, attorneys, and brokers. Until recently, however, the FDIC had not pursued an audit firm.  That all changed on November 1, 2012 when the FDIC, as receiver for the failed Colonial Bank, initiated a $1 billion malpractice claim against the bank’s auditors PricewaterhouseCoopers and Crowe Horwath.  This lawsuit, and a recent decision denying the defendants’ motion to dismiss, raise critical questions. 

First, why now?  It has been debated why the FDIC for years sued various classes of professionals but not accountants. In February 2011, accounting blogger Francine McKenna wrote: “Given the widespread failures of small and regional banks in the financial crisis, why hadn’t the Federal Deposit Insurance Corporation brought any lawsuits against the audit firms that signed off on reports that turned out to be materially misleading?”  Although there was no clear answer, professionals predicted at the time that such suits were on the way. 

That prediction proved correct, of course, when the FDIC targeted Colonial Bank’s auditors in late-2012.  But, this raises the next question: was there anything in particular regarding Colonial Bank that led the FDIC to make this its test case?  In particular, scholars considered the application of the in pari delicto defense a potential hurdle for the FDIC.  The undisputed fraud, and the involvement of Colonial Bank’s executives in that fraud, serve as a double-edged sword for the FDIC: on the one hand, the auditors arguably should have detected the massive scheme but, on the other hand, “the guilt of the executives may give auditors the in pari delicto defense.”  As such, when it was filed, the case was not considered a “slam dunk” for the FDIC. 

When asked whether the particular facts of Colonial Bank and/or the venue would make it a good choice for the FDIC’s first accounting malpractice case, Professional Liability Matters contributor Jonathan Ziss of Goldberg Segalla said

“We don’t see anything in Alabama law that would give the government cause for great confidence. The in pari delicto defense has been recognized, as has the adverse interest exception. The case law isn’t especially mature, though, so perhaps the FDIC likes its chances with the Colonial fact pattern.” 

The last sentence proved to be spot-on.  As expected, the auditor defendants raised the in pari delicto defense and alleged that the knowledge of the conspiring bank’s employees is imputed to the bank, and hence the FDIC, and therefore the FDIC may not pursue the auditors for professional negligence. According to the court’s September 16, 2013 decision, however, any evaluation of the alleged role of the bank in perpetuating and covering-up the fraud would require a fact-intensive analysis that could not be considered during a motion to dismiss.  As a result, the case lives on to see another day.  We will closely follow these proceedings to see how the defense of in pari delicto plays out.  Moreover, the accounting community will take particular note of the classes of professionals targeted by the FDIC in 2014 and beyond.