In the latest twist in a long-running legal saga, on March 15, 2019, the FDIC announced that it had reached a $335 million settlement of the negligence action the agency had brought against PwC in connection with the accounting firm’s audit work for the defunct Colonial Bank. The curious thing about this settlement is that it represents only a little more half of the amount that a federal district court judge awarded the FDIC as damages in a July 2018 order in the case. The FDIC’s terse March 15, 2019 press release announcing the settlement can be found here.

 

Background

When Colonial Bank failed in August 2009, it was the sixth largest U.S. bank failure of all time (as discussed here). In a series of actions filed in its capacity as the failed bank’s receiver, the FDIC alleged that the FDIC alleged Colonial’s failure was triggered by a massive, multi-year fraud against the bank by the bank’s largest mortgage banking customer, Taylor Bean & Whitaker. A number of former executives from the bank were convicted of or pled guilty to a variety of criminal charges. 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.

 

In November 2012, the FDIC in its capacity as Colonial Bank’s receiver filed a negligence action against PwC, the bank’s outside audit firm, and against Crowe Horvath, which had served as the bank’s internal auditor before the bank’s failure. In its lawsuit against the accounting firms, the FDIC alleged 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 FDIC alleged 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 accounting firms moved to dismiss the FDIC’s action. As discussed here, in September 2013, Middle District of Alabama Judge W. Keith Watkins denied the defendants’ motions to dismiss.

 

In April 2018, Crowe Horwath settled the FDIC’s claims against the firm for $60 million.

 

The Bench Trials

The trial court judge in the FDIC’s action against PwC bifurcated the liability and damages portions of the case. Between September 18 and October 13, 2017, the liability phase went forward in a bench trial before Middle District of Alabama Judge Barbara Jacobs Rothstein. On December 28, 2017, Judge Rothstein entered an order sustaining the FDIC’s negligence claims. Among other things, Judge Rothstein said PwC “did not design its [Colonial Bank] audits to detect fraud and PwC’s failure to do so constitutes a violation of the auditing standards.”

 

The damages portion of the case went forward as a bench trial before Judge Rothstein from March 19 through March 23, 2018. In the damages phase, the FDIC argued that PwC should be held liable for damages of over $625 million. PwC argued that the damages should be limited to $306 million. In a July 2, 2018 order (here), Judge Rothstein ruled that the FDIC is entitled to damages from PwC of $625,309,085.

 

According to accounting maven Francine McKenna in an article on MarketWatch (here), the judgment against PwC in the Colonial Bank case was “the largest ever against an audit firm in the United States.”

 

The Settlement

On March 15, 2019, the FDIC announced that the agency and PwC had reached an agreement to settle the case for $335 million. The parties also filed a stipulation of dismissal with the court on March 15, 2019. Neither the press release nor the court documents provide any explanation for the settlement. As of the date of this post, the FDIC has not yet added the PwC settlement agreement on the website page on which it posts professional liability settlement agreements.

 

In an unusual move, Martin J. Gruenberg, a member of the FDIC Board of Directors and the former FDIC chair during the Obama administration, filed a statement dissenting from the settlement. Gruenberg stated “Given PwC’s professional negligence, which contributed directly to the failure of Colonial Bank and large losses to the Deposit Insurance Fund, I voted against authorizing the settlement without a written admission of liability by PwC.”

 

Discussion

A March 15, 2019 Law 360 article about the settlement stated that “with PwC still able to appeal, the FDIC has instead opted to settle the award.” The inference is that rather than run the risk of having its trial court victories overturned on appeal, the FDIC opted to settle the case.

 

The possibility that the FDIC opted to settle rather than run the risk of an appeal certainly has plausibility. However, the magnitude of the discount that the settlement represents relative to the amount of the trial court award is striking. Indeed, the amount of the settlement is only slightly more than the amount that PwC had urged as damages during the damages phase bench trial before Judge Rothstein.

 

It may be that the FDIC rightfully was concerned about the possibilities on appeal. During the course of this long-running case, the trial court was required to rule on a number of critical legal questions, many of them presenting novel issues. The FDIC may well have been concerned that the appeals court might overturn one or more of these rulings – which might not only adversely affect the FDIC’s claims in this action, but perhaps in future actions the FDIC might want to bring as well. (Among other things, the FDIC may not have wanted further judicial consideration of Judge Rothstein’s conclusion that PwC had a duty to design its audit to detect fraud and that its failure to do so constituted negligence.)

 

I can only assume that the decision to compromise its trial victory caused a certain amount of agitation at the FDIC. After all, the agency has made a very public practice of publicizing the magnitude of its professional liability recoveries. The agency’s victory in the trial court in its case against PwC relating to Colonial Bank represented a significant portion of the agency’s professional liability recoveries in claims pursued in the wake of the recent global financial crisis and bank failure wave.

 

As I commented above, the public dissent to the settlement by former FDIC Chair and current FDIC board member Martin Gruenberg is noteworthy. However, Gruenberg’s dissent did not relate to the amount of the settlement, but rather to the absence of a written admission of liability by PwC.

 

Cases settle for all kinds of reasons, and we may never know the reason for the FDIC’s agreement to compromise the sizeable damages it was awarded by the trial court in this case. To be sure, the amount for which this case settled represents a very substantial recovery, one that clearly justifies the FDIC’s actions in pursuing these claims.

 

In the end, this case will now become just one more part of the failed bank litigation lore, providing an interesting reference point should there be another wave of failed banks sometime in the future.