Wolf Richter wolfstreet.com, www.amazon.com/author/wolfrichter
When it gets too complicated for senior auditors, send in a “college-aged intern.”
For PricewaterhouseCoopers, having for years rubber-stamped as outside auditor the financial statements of Colonial Bank in Alabama is getting expensive.
Colonial, the 25th largest bank in the US at the time, collapsed unceremoniously in 2009, brought down in part by a $2.3 billion fraud scheme it had going on with its biggest customer, Taylor Bean & Whitaker Mortgage, the 12th largest mortgage lender in the US, which had collapsed shortly before the bank.
The FDIC, which took over Colonial and made its insured depositors whole, was not amused. In November 2012, it sued PwC as the outside auditor of Colonial, accusing it of negligently auditing the bank from 2003 to 2005 and in 2008.
Today, federal district judge Barbara Jacobs Rothstein ruled that PwC, which in December was found negligent in detecting the fraud scheme at the bank, must pay the FDIC $625.3 million in damages, the full amount the FDIC had requested – and one of the largest awards for accounting malpractice.
Others involved in the scheme:
- In February, Deloitte & Touche, which had been Taylor Bean’s outside auditor, had settled allegations by the Justice Department for $149.5 million.
- In April, Crowe Horwath, which had been Colonial’s internal auditor, had settled allegations by the FDIC for $60 million.
- In 2016, PwC had settled with Taylor Bean’s bankruptcy trustee, but terms were not disclosed.
- Taylor Bean’s former Chairman Lee Farkas is serving a 30-year stint in the hoosegow after his 2011 conviction on 14 fraud and conspiracy charges.
- Several other people, including employees of Colonial, pleaded guilty or were convicted for their roles in the scheme.
Today’s ruling was about the amount of the award. In December, Judge Rothstein had already ruled that PwC had negligently failed to design and perform the audits, based on PwC’s own admissions, to detect the $2.3-billion fraud scheme between Colonial and Taylor Bean. It was the first time that a federal district judge ruled that an audit firm was liable for failing to detect a fraud under the Sarbanes-Oxley act.
In the December ruling, Judge Rothstein had found, according to Reuters:
The auditor relied on the chief architect of the fraud, Taylor Bean chair Lee Farkas, to verify key information about the collateral underlying a Colonial credit facility for Taylor Bean. PwC also signed off on Colonial’s audit without ever understanding the third and most complex iteration of the fraud, which involved a credit facility based on phantom mortgage securitizations.
After an auditor who was supposed to make sense of the transactions gave up, saying they were “above his pay grade,” PwC assigned a college-aged intern to evaluate the nearly $600 million asset.
Judge Rothstein was distinctly harsh about PwC’s failings. Basing Colonial’s certification on Farkas’ account of Taylor Bean’s collateral was “quintessentially the same as asking the fox to report on the condition of the hen house,” she wrote. And charging an intern to decipher a loan facility beyond the expertise of a senior auditor was a “truly astonishing” departure from PwC’s mandate, the judge wrote.
And there’s more…
Taylor Bean was one of Colonial’s most important customers, Judge Rothstein said, and the bank was at first eager to help the mortgage lender survive overdrafts. Later, as the fraud ballooned, Colonial execs frantically tried to recoup Colonial’s money from Taylor Bean. According to the judge’s decision, over the course of several years, to keep the scheme secret, Colonial execs lied to PwC auditors, circumvented internal controls by “recycling” mortgage data and even created wire transfers to trick PwC into believing Taylor Bean collateral mortgages had been paid off.
Today’s ruling awards the FDIC the full damages it had sought. PwC had earlier asked the judge to keep the damage award down to $306.7 million. Today, PwC said that it intends “to pursue an appeal of this matter at the earliest opportunity.”
And the bitter irony?
PwC is the same audit firm that confidence-inspiringly and diligently performs the annual audits of the financial statements of each of the 12 regional Federal Reserve Banks – such as the New York Fed and the San Francisco Fed – along with the combined financial statements of the Federal Reserve System. So when things get complex – and there surely are very complex and immense transactions at the Fed – and senior auditors can’t figure out what they’re looking at and can’t make heads or tails of it, they’re sending in a “college-aged intern” to paper over it?
PwC is also the firm that audited the financial statements of construction and outsourcing giant Carillion, which collapsed in January. PwC is part of the audit oligarchy that is now down to just four mega-firms, and they audit nearly all of the S&P 500 companies while also providing a host of consulting and tax services.