TASK
5-25 (OBJECTIVES 5-1, 5-2, 5-6) Taylor Bean & Whitaker Mortgage Corp. (Taylor Bean) was a
Florida mortgage lender. Once one of the nation’s largest privately held mortgage compa-
nies, the company collapsed in 2009 after a multibillion dollar mortgage fraud unraveled.
Required
Required
In-class
Discussion
LEGAL LIABILITY
The downfall of Taylor Bean also triggered the collapse of Colonial Bank in one of the largest bank failures in U.S. history. The SEC charged Lee Farkas, the former chairman of Taylor Bean, and several other officers of the company with conspiring to sell more than
$1.5 billion worth of fabricated or impaired mortgage securities to Colonial Bank. The fraudulent scheme occurred from March 2002 until August 2009, when Taylor Bean filed for bankruptcy. The SEC charged Theresa Kelly, a former operations supervisor at Colonial Bank’s mortgage warehouse lending division, with being an active participant in the fraud
scheme.
The bankruptcy trustee for Taylor Bean sued PricewaterhouseCoopers (PwC), which had served as Colonial Bank’s auditor, for $5.5 billion in damages, claiming that PwC was negligent in not detecting the fraud. Although PwC was Colonial Bank’s auditor, Colonial
Bank and Taylor Bean had a close relationship. Most lawsuits related to the 2008 global financial crisis ended in settlements, and Taylor Bean’s auditor, Deloitte LLP, settled in 2013 for an undisclosed amount. The 2016 civil trial involving PwC was supposed to last six weeks. However, after three weeks, PwC settled with the bankruptcy trustee in a confidential settlement for an undisclosed amount.
a. Most of the auditor litigation related to the 2008 financial crisis resulted in settlements. Why do you think most audit firms settled rather than going to trial?
b. The case involving PwC and Taylor Bean was one of the few cases that actually went to trial. Why do you think PwC initially decided to go to trial? Why do you think the firm settled halfway through the trial?
c. The trustee that sued PwC alleged that they were negligent in failing to uncover the fraud. To what extent should auditors be held responsible for failing to detect fraud?
Does it matter that PwC was Colonial Bank’s auditor, and not the auditor for Taylor Bean?
Sources: 1. Patrick Fitzgerald, “PricewaterhouseCoopers Settles $5.5 Billion Crisis Era Lawsuit” The Wall Street Journal (August 26, 2016) (www.wsj.com); 2. U.S. Securities and Exchange Commission Litigation Release No. 22002 (June 16, 2011) (www.sec.gov).
5-26 (OBJECTIVE 5-6) Gordon & Groton, CPAs, were the auditors of Bank & Company, a
brokerage firm and member of a national stock exchange. Gordon & Groton audited and
reported on the financial statements of Bank, which were filed with the Securities and
Exchange Commission.
Several of Bank’s customers were swindled by a fraudulent scheme perpetrated by
Bank’s president, who owned 90 percent of the voting stock of the company. The swindled
customers were invited to invest in a special investment syndicate. The syndicate did not
exist; Bank’s president stole the funds and provided fictitious investment statements to
the investors. Bank’s president committed the fraud by directing that all correspondence
from customers be received directly by him. Gordon & Groton were unaware of this policy
regarding customer correspondence, and did not participate in the fraudulent scheme or
know of its existence.
The customers are suing Gordon & Groton, under the antifraud provisions of Section
10b and Rule 10b-5 of the Securities Exchange Act of 1934, for aiding and abetting the
fraudulent scheme of the president. The customers’ suit for fraud is predicated exclusively
on the nonfeasance of the auditors in failing to conduct a proper audit, thereby failing to
discover the fraudulent scheme.
Answer the following questions, including your reasoning in reaching your conclusion:
a. Do you believe the auditors were negligent in conducting the audit?
b. What is the probable outcome of the lawsuit?
5-27 (OBJECTIVE 5-6) The SEC Enforcement Division investigates possible violations of se-
curities laws; recommends SEC action when appropriate, either in a federal court or be-
fore an administrative law judge; and negotiates settlements. Litigation Releases, which are
Required
Required
Research
*Based on AICPA question paper, American Institute of Certified Public Accountants.
145
THE AUDITING PROFESSION
descriptions of SEC civil and selected criminal suits in the federal courts, are posted on the
SEC website (www.sec.gov/litigation/litreleases.shtml). Find Litigation Release No. 23765,
dated March 3, 2017.
a. What is the nature of the complaint underlying LR No. 23765?
b. How was the fraud underlying the complaint detected?
c. The litigation release does not discuss the role of the auditor. Given the nature of the
fraud, do you believe the auditor will be found liable if sued under the 1934 Securities
Act?
