We have seen this before: A successful public company is victimized by employee fraud; once uncovered, the fraud leads to the company’s failure, with creditors, shareholders and, sometimes, taxpayers left empty-handed; the blame-game swirls; and, in the end, enterprising lawyers sue the company’s auditors, contending they “woulda, coulda, shoulda” found and put a stop to the fraud. In fact, we’ve seen it so often — especially as a result of the vast shake-out in the mortgage industry since 2006 — that many may assume the pursuit of auditors in such circumstances is a natural next step. The auditors, after all, are often huge firms with deep pockets and a duty to be both independent from the company and careful to the extreme in going about their task. But scapegoating the auditors is not the right move.
The job of a public accounting firm is to provide reasonable — not absolute — assurance that a company’s financial statements are not materially misstated. Auditors do not and cannot guarantee a company’s solvency or its success. For one thing, auditors are not in a position to uncover most frauds. Even a properly designed and executed audit may not detect fraud, especially one sophisticated enough to have been successful. For another thing, it is bad policy to make auditors insurers. Under the careful balancing of interests struck by our complex regulatory and legal system, auditors have a specific job to do and extensive professional standards to guide them as they do it. Seeking to make public accounting firms responsible for employee fraud is almost never in anyone’s best interests.
This is particularly so in the case between the FDIC, Colonial BancGroup and PricewaterhouseCoopers (see “PwC ruled negligent in Colonial Bank auditing case”). In that case, Colonial Bank, a once-proud Alabama institution, was felled by a massive and long-term fraud. Colonial employees colluded with a customer, the now-defunct subprime mortgage company Taylor Bean & Whitaker, over many years to drain hundreds of millions of dollars from the bank. Despite the extensive oversight to which Colonial, like all banks, was subject, no one caught the fraud. It is all too easy to now say that the warning signs were clear. If that were the case, why didn’t others at the bank catch on, why didn’t federal and state regulators catch on, why didn’t even the FBI catch on until a whistleblower explained where to look for the details, deep in the data? It turns out the employees, unsurprisingly, had taken great pains to hide their misconduct.
In a ruling on December 28, the court rightfully found PricewaterhouseCoopers not liable to Colonial BancGroup because employees at the bank interfered with the audit. However, the court found PricewaterhouseCoopers partially liable to the FDIC, which is acting as receiver to the bank. If PricewaterhouseCoopers is not liable to Colonial BancGroup, the ruling should also apply to the FDIC’s claim, because the FDIC stands in the shoes of the bank. Instead, the court carved out an exception, preventing PricewaterhouseCoopers from asserting its full defense. There is simply no good reason for the FDIC to be allowed to foist their losses on the innocent partners and employees at PricewaterhouseCoopers.
Auditors are not blessed with clairvoyance. No matter how well-designed an executed an audit plan, and no matter how tenacious and downright perspicacious a firm’s personnel may be, an auditor cannot be expected to root out evil. An audit is not a forensic investigation; if it were, its cost would increase exponentially, and that burden would be borne by the entire market.
Lawsuits like that in Alabama against PricewaterhouseCoopers are misguided — no one but the fraudsters (who are rightfully in prison) is truly responsible for the fraud. These lawsuits are simply a tremendous waste of resources. They drag on for years, involve armies of lawyers, and clog the courts. What’s more, they come at a cost to all of us: Although any settlement or damages award falls on the particular accounting firm in the short term, it is ultimately paid by the investing and consuming public in the form of higher prices or lower share values. After all, most of us either have diversified retirement funds holding shares in public companies, are consumers of goods and services, or are taxpayers. Many of us fit into all three categories.
The court’s recent decision with respect to the FDIC is wrong and should be reversed on appeal. That would go a long way towards corralling overeager lawyers playing the post-mortem blame game. It would affirm the careful balance struck by our legislators, regulators and capital markets. And it would save us all money.