Lessons to be learnt from Colonial Bank
PWC have been in the spotlight recently in relation to Colonial Bank's $2.3bn fraud. PWC acted as independent auditor for Colonial BancGroup ("CBG"), the parent company of Alabama based Colonial Bank which you may recall collapsed in 2009 due to a fraudulent mortgage scheme with lender Taylor, Bean & Whitaker.
A professional negligence claim was brought against PWC by the receiver, the Federal Deposit Insurance Corporation ("FDIC"), for its failure to detect the fraud. A US federal Judge concluded that the auditors at PWC were negligent, that their work fell short of the required standard and that they missed red flags (fake mortgages with illogical dates) which should have alerted them to the fraud. The Judge dismissed the other four claims including FDIC's breach of contract claim, due to Colonial's employees' complicity in the scheme and their extensive actions to hide the fraud from PWC. She also dismissed CBG's negligence claim against PWC under (i) the doctrine of in pari delicto which precludes a wrongdoer from sharing in the proceeds of its own misdeeds and (ii) the "audit inference rule" which states that an audit client cannot recover if its own negligent or wrongful acts contribute to the auditors failures.
This decision is inconsistent with those made by other courts in the US on similar issues. As such PWC asked for a stay to appeal the liability decision but the request was denied. The ruling has left PWC at risk of a significant damages claim amounting to hundreds of millions of dollars. PWC is challenging the damages claim and has described the quantum as "inflated". It is for FDIC to prove the sums claimed.
Whilst this claim was dealt with in the US the professional negligence lessons to be learnt from it apply equally in most jurisdictions. One of the main criticisms of PWC was that it had assigned a very junior employee, described as a "college-aged intern", to evaluate what was nearly a $600 million asset. The Judge noted that charging an intern to decipher a loan facility of this magnitude was a "truly astonishing" departure from PWC's mandate. We have previously dealt with professional negligence claims for clients arising out of similar circumstances. The lessons for professional advisors here are that employees with an appropriate level of qualification and experience should be assigned to the task in hand with clear channels of communication/supervision in place.
The second lesson is that the client is not always right! It is the role of the auditor to question the conduct of employees and consider why things are being done in a certain way. Diligence is required to uncover underhand activity, particularly considering the length that complicit employees will go to in an attempt to cover their tracks. Advisors should always err on the side of caution when dealing with employees of a client and raise any concerns they may have.
We can assist in relation to bringing claims against professional advisors and advise on defending proceedings which may have been threatened against you. Please contact our Professional Negligence team for further information.