Colonial Bank Auditors Lose Bid for Documents

(CN) - Auditors who failed to discover that $1.8 billion of Colonial Bangroup's assets were backed by nonexistent mortgages, cannot subpoena more documents from bank regulators, a federal judge ruled.

Alabama-based Colonial BancGroup was a holding company that failed in 2009 due to its heavy investment in worthless mortgages.

According to court documents, now-defunct mortgage lender Taylor, Bean & Whitaker sold Colonial about $1.8 billion in bogus mortgages with the aid of an executive of the holding company.

In 2011, Taylor, Bean & Whitaker's majority owner Lee Farkas was convicted of securities fraud and sentenced to 30 years in prison. At least five other of the lender's executives were also sentenced to prison.

Both Colonial and Taylor, Bean & Whitaker sued Colonial's auditors, Pricewaterhouse Coopers (PwC) and Crowe Horwath LLP, for failing to discover the fraudulent nature of the mortgages.

"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," Colonial's receiver said in a complaint filed on behalf of the defunct company in Montgomery County Court.

Defendants served a subpoena on the Office of the Comptroller of the Currency in late 2014 seeking documents related to its supervision of Colonial, internal and external audit work performed by defendants, and for identification of OCC employees who examined Colonial.

They also served subpoenas on four banking regulator officials seeking their testimony on Colonial's mortgage meltdown.

The Comptroller of the Currency asked the court to quash a number of these requests, arguing that the documents sought are not relevant because defendant cannot shield itself from liability "based on pre-receivership conduct of the OCC."

Defendants claim they do not seek the documents to shield themselves from liability, but to show that the fraud was not easy to catch, and their accountants were not negligent for failing to do so.

U.S. District Judge Gladys Kessler agreed that the documents are relevant, but said the Comptroller of the Currency has already offered to provide numerous documents to defendants, which are sufficient to meet the defendants' needs.

"The documents defendants seek in addition to those already offered by the OCC are likely to be 'unreasonably cumulative or duplicative,' and, taking into account 'the importance of the proposed discovery in resolving the issues,' the burden and expense of the proposed discovery outweighs its likely benefit," Kessler said.

The court also quashed the subpoenas for the testimony of officials with the Comptroller of the Currency because the defendants did not first submit administrative requests to the OCC prior to serving the subpoenas as required by agency regulations.

Kessler said there were not exceptional circumstances in this case to relieve defendants of compiling the administrative rules, Crowe's contention that such a request would be futile notwithstanding.

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