A federal court has denied the motion of the accountants of the failed Colonial Bank’s holding company to dismiss the claims the FDIC, in its capacity as the failed bank’s receiver, had filed against them. As discussed here, the FDIC’s November 2012 lawsuit was the first the agency had filed against a failed bank’s accounting firm as part of the current failed bank litigation wave. The FDIC alleged that the accountants should have but failed to detect the scheme of bank employees to make and then hide fraudulent loans to failed mortgage lender Taylor Bean & Whitaker.


Middle District of Alabama Judge W. Keith Watkins’s September 10, 2013 opinion, which can be found here, discusses important questions concerning what law governs the question  whether the misconduct and knowledge of former bank employees can be imputed to the FDIC as receiver. Judge Watkins determined, in reliance on the U.S. Supreme Court’s 1994 opinion in O’Melveny & Myers v. FDIC, that state law governs the question, but declined to rule on the question whether under Alabama the bank employees’ misconduct and knowledge could be imputed to the FDIC as receiver in this case.


When Colonial Bank failed in August 2009, it was the sixth largest U.S. bank failure of all time (as discussed here). In is complaint against the accountants, the FDIC alleges Colonial’s failure was triggered by the massive, multi-year fraud against the bank by the bank’s largest mortgage banking customer, Taylor Bean & Whitaker.


As I detailed in a prior post, here, In April 2011, Lee Farkas, Taylor Bean’s ex-Chairman, was convicted of wire fraud and securities fraud. Prior to Farkas’s conviction, two Colonial Bank employees pled guilty in connection with the Taylor Bean scheme. As reflected here, on March 2, 2011, Catherine Kissick, a former senior vice president of Colonial Bank and head of its Mortgage Warehouse Lending Division, pleaded guilty to conspiracy to commit bank, wire and securities fraud for participating in the Taylor Bean scheme. As reflected here, on March 16, 2011, Teresa Kelly, the bank’s Operations Supervisor and Collateral Analyst, pled guilty on similar charges.


In the criminal cases against the bank employees, the government alleged that the two bank employees caused the bank to purchase from Taylor Bean $400 million in mortgage assets that had no value. The employees also allegedly engaged in fraudulent actions to cover up overdrafts of Taylor Bean at the bank. The employees are also alleged to have had the bank engage in the fictitious trades with Taylor Bean that had no value. As Judge Walker said in his September 10 opinion in the FDIC’s suit against the accountants, “Like cat-skinning, bank fraud lends itself to multiple approaches.”


In its complaint against PwC, the bank’s holding company’s outside auditor, and Crowe Horvath, with performed internal audit for the bank’s holding company, the FDIC alleges that while Taylor Bean was carrying out its “increasingly brazen” fraud, PwC “repeatedly issued unqualified opinions” for Colonial’s financial statements, and Crowe “consistently overlooked serious internal control issues” – and, more the point, both failed to detect the fraud. The complaint alleges that if the firms had detected the fraud earlier, it would have prevented losses or additional losses that the bank suffered at the hands of Taylor Bean. The complaint asserts claims against the firms for professional negligence, breach of contract, and negligent misrepresentation. The complaint alleges that in the absence of the firm’s wrongful acts, the Taylor Bean fraud would have been discovered by 2007 or early 2008, and “losses currently estimated to exceed $1 billion could have been avoided.”


The accountants moved to dismiss, arguing that the misconduct and knowledge of the individual criminal defendants could be imputed to the FDIC, because as receiver it stepped into the bank’s shoes. The accountants also argued that because their services were performed for the holding company and not the bank, the FDIC as the failed bank’s receiver lacked standing to assert negligence and breach of contract claims against them.


In their motions, the accountants argued that federal law governed the question of whether the individuals’ knowledge and misconduct can be imputed to the FDIC, and that under federal law, the knowledge and misconduct could be imputed to the FDIC and therefore that the FDIC was estopped from asserting the failed bank’s claims.


Judge Watkins ruled, in reliance on the O’Melveny decision, that state law governed the imputation question. Judge Watkins noted that “when it considered virtually the same question presented by this case – whether the knowledge and conduct of a bank’s insiders could be imputed from the bank to the FDIC acting as receiver – the Supreme Court concluded the [sic] FIRREA did not offer an answer and that state law therefore governed.”


However, because Judge Walker found that there are factual questions whether or not the individual criminal defendants were acting within the scope of their authority when the participated in the scheme to defraud, he could not grant the dismissal motion based on the imputation of the individuals’ knowledge and misconduct.


Judge Walker also found that there is a factual question whether or not the bank had standing to assert the negligence claims the bank’s holding company’s accountants. Judge Walker also found that there is a factual question whether or not the holding company’s intended to make the bank a third party beneficiary of the accounting services agreement between the holding company and the accountants sufficient to allow the FDIC as the failed bank’s receiver to be able to assert breach of contract claims.


Readers of this blog may recall that in August 2012, certain former Colonial Bank directors and officers agreed to settle the securities class action lawsuit that had been filed against them in connection with allegations surrounding the bank’s collapse. The $10.5 million settlement was to be funded entirely by D&O insurance. The securities suit settlement is discussed here. Significantly, the settlement did not include the bank’s offering underwriters or its outside auditors.


Among the individual defendants party to the securities suit settlement was Colonial’s colorful and controversial former Chairman and CEO, Bobby Lowder. In addition to Colonial, Lowder has long been associated with Auburn University and its storied football program. I discussed Lowder’s Colonial Bank and Auburn connections in a prior post, which can be found here.


Coincidentally, Judge Watkins (according to Wikipedia) attended Auburn as an undergraduate; however, in an educational move that undoubtedly creates complicated loyalties during the college football season, he attended the University of Alabama for law school. Regardless of his loyalties as between Auburn and Alabama, he undoubtedly will be rooting for Alabama against Texas A&M this Saturday.


As I also noted in a prior post (here), in July 2012, the FDIC as receiver for Colonial Bank, as well as the bankrupt bank holding company on its own behalf, filed an action against the bank’s bond insurer. Among other things, the complaint alleges that the losses caused by the misconduct “constitute recoverable losses under the Bonds up to the full aggregate limits of liability of the Bonds.” The complaint states that the bond insurer “has neither accepted nor denied the Plaintiffs’ claims under the Bonds.” The complaint alleges that the insurer “has failed to investigate the claims and losses in a reasonable and appropriate manner.” In September 2012, the parties jointly moved the court to revise the schedule in the case to permit them to engage in settlement discussion.