Auditors Missed $1.8 Billion in Funny Money, Failed Colonial Bank Says in Alabama

BIRMINGHAM, Ala. (CN) - Negligence and accounting malpractice by Pricewaterhouse Coopers and Crowe Horwath allowed Taylor Bean & Whitaker to sucker Colonial Bancgroup for $1.8 billion in securities backed by nonexistent mortgages, the bank and its bankruptcy trustee say. Colonial Bank's failure in 2009 was the 6th largest in U.S. history.

Colonial Bancgroup and bankruptcy trustee Kevin O'Halloran sued PricewaterhouseCoopers and Crowe Horwath for malpractice, breach of contract and negligence, in Montgomery County Court.

The bankrupt bank claims the seeds of its downfall were planted in 2002, and lasted until Colonial Bank collapsed in August 2009.

"The fraud involved, among other things, the sale by Taylor Bean to Colonial Bank of 99 percent participation interests in allegedly qualifying pools of mortgages which were required to be subject to existing, enforceable, takeout commitments from the takeout buyers," the complaint states. "This purchase facility was only available to Taylor Bean and referred to as the 'AOT' facility, meaning 'assignments of trade.' The magnitude of these purchases was significant. BancGroup's year-end consolidated financial statements for 2007 and 2008 stated the balance of this AOT facility, referred to as 'Securities Purchased Under Agreements to Resell,' to be in excess of $1.5 billion each year.

"In reality, there were no qualifying pools of mortgages, only manufactured data based on preexisting mortgages that had long ago been sold in the marketplace to investors. There were no collateral packages delivered to Colonial Bank as custodian that matched or supported this fraudulent data on the fictitious mortgage pools. There were no takeout commitments from takeout buyers. There were no real takeout buyers. The AOT facility was an empty vessel, and what had been purchased was a sham. The facts, details, and extent of this bank, wire and securities fraud would lead to the criminal conviction of Lee Farkas, the president of Taylor Bean, in April of 2011, and the guilty pleas of other employees of Taylor Bean and certain individuals within the MWLD [Colonial Bancgroup's Mortgage Warehouse Lending Division]. The extent of the Taylor Bean fraud exceeds $1.8 billion."

Throughout these seven years, Colonial employed PriceWaterhouseCoopers (PwC) as its outside independent auditor, the bank says. And it employed Crowe Horwath and its predecessor, Crowe Chizek & Co., as its internal auditor. But Colonial says: "No effort was made by PwC and Crowe to understand or audit the AOT facility at all, despite its materiality to BancGroup's consolidated financial statement."

The complaint continues: "Both PwC's independent audits and Crowe's internal audits of BancGroup's financial statements demonstrate a remarkable lack of due care and a failure by defendants to gain an understanding of BancGroup's business and the risks associated with it. PwC's and Crowe's complete failure to audit the MWLD's AOT facility or to perform a meaningful audit of the Taylor Bean relationship with the MLWD [sic] constitutes gross negligence, and PwC's and Crowe's representations and reports to BancGroup's Audit Committee were reckless and grossly inaccurate with regard to BancGroup's true financial condition and defendants' compliance with professional standards.

"Had PwC and Crowe properly discharged their professional duties, the ongoing fraud and the hole in BancGroup's balance sheet in excess of $1.8 billion would have been detected by no later than fiscal year-end 2007, and BancGroup's Board of Directors could have taken corrective measures, including (but not limited to) drastically altering the business or even placing BancGroup into bankruptcy at that point, thereby avoiding the deepening of BancGroup's insolvency and the concomitant consumption of BancGroup's existing assets. Unaware of such fraud, BancGroup continued to downstream to Colonial Bank more than $500,000,000 from the second quarter of 2008 through the second quarter of 2009 and incurred substantial additional debt in connection therewith.

"By the time the fraud was exposed in 2009, more than $1.8 billion had been siphoned out of Colonial Bank and BancGroup was left with hundreds of millions of dollars in worthless or non-existent assets on its balance sheet. By that point, however, BancGroup's collapse was assured. Unable at that point to take any corrective steps or to obtain any federal assistance, and left with no ability to raise funds by other means, BancGroup had no choice but to file for bankruptcy protection. BancGroup's capital investment in Colonial Bank in excess of $1.2 billion dollars was rendered worthless. BancGroup's damages, which continue to be assessed and determined, easily exceed $500,000,000."

Colonial Bank had 347 retail branches in Florida, Alabama, Georgia, Texas and Nevada.

The plaintiffs seek actual and exemplary damages, and disgorgement of the defendants' profits.

They are represented by Andrew P. Campbell with Leitman, Siegal, Payne & Campbell of Birmingham.

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