Accounting Theory 1

Contents
Executive summary:...............................................................................................................2
Introduction:...........................................................................................................................2
Key events and facts:..............................................................................................................2
Culpability of the parties involved:.........................................................................................4
Issues in Auditing:...................................................................................................................4
Root cause and mistakes:.......................................................................................................6
Conclusion:.............................................................................................................................7
References..............................................................................................................................8
Accounting Theory 2

Executive summary:

In this work, we will discuss about the particular case where an audtor has been found
negligent to perform their duties effectively with required skill & care. Here, we have chosen
the case of PwC vs colonial bank where the stated bank got bankrupt due to fraud made by
particular people of the management from long period and not examined by the mentioned
well known auditor of the company. The main purpose of this assignment has to briefly
discuss the facts of the case so taken for the study, causes & mistakes that resultant led to
fraud as well irregularities in the stated case on part of auditor. After full analysis of the case
on the basis of facts, it has been concluded that it is required for the regulatory to have step in
so as to decide repercussions to the auditors in order to ensure proper perforce of duties by
auditors with required skill & knowledge. The same is also necessary from the point of
auditee who ha to bear the result of negligence on part of auditor that led to loss of business
some time insolvency.

Introduction:

The chosen case is of PwC vs colonial bank. It is one of the leading cases where the auditor
has been compensating at high amount for negligence on part of their duty. As we know that
as per the rule, it is responsibility of the selected auditor to provide their reasonable assurance
in regard to the financial statement of the company that the roper books of account has been
maintained and the financial position is free of any type material misstatement due to fraud
or any type of error. This case directly relates to recognise the auditr’s liability when the
duties are not performed with due diligence and skill& care. Practically in my opinion,
auditor cannot be said to be primary responsible in detection of fraud due to limitation in
performing the job by them such as sampling method which led them to provide reasonable
assurance about the data so anaylsed. Also it is really very hard to detect the fraud or error if
the same is collusive in nature and has been performed by the management peoples
who are shard capable to hide the same. It can also be said that it is essential to recognize the
duty of care where the proximity and the foreseeability seems to be exist between the
defendent and plaintiff. The concept of proximity would concentrate more on the types of the
relationship that exists between the plaintiff and the defendant and seeks to suffice the
closeness and the direction as being fair and just about the imposition of duty if care in terms
of law.
Accounting Theory 3

Key events and facts:

From the year 2002to the eyar2009, the CBG, holding company with its subsidiary
Colonial Bank found to be victimized with a massive fraud that resultant led to
insolvency. It was later on founded that the two employee of Colonial bank namely
Terssa Kelly and Catherine had made conspiracy with the employees of Taylor Bean&
Whitaker (TBW). Fraud in the state’s case was came into force by TBW selling to CBG
interest so as to qualify for the pools of mortgage which in reality does not exist. At the
time when the same got disclosed or fraud was detected, resultant FDUC got closed and
sold colonial bank. Also resultant the CBG was bankrupt and the fraudulent person
was convicted for the fraud so done though penalties & imprisonment. As per the CBG,
they said both the accounting firms “Crowe” internal auditors and price water house
cooper (independent auditors) are liable or defencing in the stated case. The bank allege
the accounting firms with a statement that theyboth failed to detect the fraudulent
activities which being found continues from 7 years and resultant cause financial injury
to the colonial bank. The colonial bank file claim against both the accounting firms for
professional negligence and breach of contract and resultant demand for the
compensation of $630 billion from PWC.

Taylor Bean & Whitaker and Colonial Bank collapsed in 2009, after federal
regulators, not the auditors, found a $3 billion fraud involving fake mortgage
assets. In 2012, the trustee of the Taylor Bean & Whitaker Bankruptcy
Plan sued both TBW’s auditor, Deloitte LLP, and Colonial’s auditor, PwC,
for negligence, seeking $7 billion in damages from Deloitte and $5.5 billion
in damages from PwC.  

In 2013, just weeks before starting a trial, Deloitte agreed to settle; the
parties mutually agreed not to disclose the amount. On August 16, 2016,
three weeks into a jury trial for the TBW Trustee’s claims, PwC stopped the
proceedings by agreeing to settle. Again, the amount was not disclosed.
Accounting Theory 4

This time the public will find out how much PwC has to pay for allegedly not
detecting the fraud at Colonial Bank that led to its failure. That’s
because federal law prohibits the FDIC from entering into a confidential
settlement.
Rothstein held a three-day hearing on the Colonial Bank damages in March
and is expected to render a decision in the next month on how much the
FDIC, as receiver of failed Colonial Bank, can collect from PwC.

The $319 million difference in the two damage experts’ estimates is the
result of a difference in opinion between the two parties in whether several
hundred millions of dollars of “junk” loans dumped into Colonial Bank’s
warehouse lending facility were also part of the fraud between the bank
and TBW.

According to a court filing made by PwC after the damages hearing, there
was no “junk” loan fraud, given that every warehouse lines lender
experienced significant losses from loans it could not sell or securitize
because of insufficient or missing documentation and other violations of
representations and warranties made by mortgage originators during the
financial crisis.

The FDIC said in its court filing after the damages hearing that every other
one of TBW’s warehouse lender except Colonial Bank “put back,” that is
returned for full refund, the faulty loans it could not sell or securitize. Only
Colonial Bank allowed TBW’s loans to age on its books and lose value over
time, therefore increasing the eventual loss to the bank and now the FDIC.

The FDIC presented evidence at the hearing that the two Colonial
executives who decided to keep the loans on the books were the ones who
later pleaded guilty for their part in the fraud. If they had sent the bad loans
back to TBW, the fraud would have been stopped earlier, the FDIC said.
The FDIC alleged that PwC did not detect this part of the fraud in addition
to missing the other parts of the fraud the accounting firm does agree the
FDIC should be now compensated for

Even PwC’s offer of $306 million would be the largest-ever

accounting malpractice final verdict amount
Accounting Theory 5

What are the facts of this lawsuit? Who is the plaintiff and who is the defendant?The
plaintiffs, Taylor Bean & Whitaker Mortgage Corp. sued the defendant,
PriceWaterhouseCoopers claiming billions of damages for its negligence of detecting a
massive fraud scheme. The fraud being undetected led to Taylor Bean’s downfall and
eventually triggered the collapse of Colonial Bank in 2009. 2What is
PricewaterhouseCoopers? Who was its client? What work was it doing for the client in this
case? What is the firm's responseto being sued?PriceWaterhouseCoopers is one of the Big 4
accounting firms. PWC served as an external auditor for Colonial BancGroup Inc. and thus,
provided auditing services. In PWC’s defense, they argued that it is not the auditor’s job to
find fraud. Moreso, they claimed that ‘even a properly designed and executed audit may not
detect fraud, especially in instances where there is collusion, fabrication of documents, and
the override of controls’

What are the rules regarding an auditor's responsibility to detect fraud? In what situations
could the auditor be liable?The rules require an auditor to provide reasonable assurance that
the financial statements are free of material misstatements whether caused by error or fraud.
Standards are defined in GAAS on how auditors should perform an audit. Possible scenarios
where an auditor may be liablewould be cases where an auditor is negligent in performing
his/her duties in performing an audit. 4Why aren't auditors responsible to detect fraud in
many cases? Should they be? Why or why not?In my opinion, Auditors are not primarily
responsible in detection of fraud due to limitations present in performing the job. Auditors do
the sampling technique when performing an audit and therefore can only provide reasonable
assurance. Fraud has increasingly been difficult to detect especially when it is collusive in
nature and committed by the top management who are capable of hiding it. 5Why did the
plaintiff choose to sue PwC in this case? Should this be one of those situations in which
auditors are responsibleto detect fraud?The plaintiffs chose to sue PWC because they believe
that the auditing firm had been negligent in detecting a massive fraud scheme that brought
Taylor Bean and Whitaker Mortgage’s downfall. In this case, if the court proves that PWC
failed to audit billions of dollars of transactions, failed to certify assets and proved to have
relied on unsigned contracts, then PWC should be liable. 6Why isn't the plaintiff recovering
all of the damages from the parties who perpetrated the frauds? Was PwC one of the
perpetrators?The plaintiffs believed that PWC failed to perform its job due to negligence and
therefore led to suing PWC to recover damages from them as well. The perpetrators were
sentenced to prison for the fraud they committed. PWC was not one of the perpetrators in this
case.

Culpability of the parties involved:

ricewaterhouseCoopers LLP was negligent in connection with one of the biggest bank
failures of the financial crisis, a federal judge has ruled, opening up the Big Four
accounting firm to the potential of hundreds of millions of dollars in damages.
Accounting Theory 6

PwC violated auditing rules and didn’t take steps that could have detected a $2 billion
fraud scheme that contributed to the 2009 failure of Alabama’s Colonial Bank, the
judge ruled. The ruling Thursday came in a lawsuit brought against PwC by the
Federal Deposit Insurance Corp.
...

 A former senior vice president and head of Colonial Bank’s Mortgage Warehouse
Lending Division was sentenced today to eight years in prison for her role in a more
than $2.9 billion fraud scheme that contributed to the failures of Colonial Bank and
Taylor, Bean & Whitaker (TBW). Colonial Bank was one of the 25 largest banks in the
United States and TBW was one of the largest privately-held mortgage lending
companies in the United States in 2009.

https://www.justice.gov/opa/pr/former-colonial-bank-
senior-vice-president-sentenced-8-years-prison-fraud-
scheme

https://www.forbes.com/sites/francinemckenna/2012/11/10
/a-tale-of-two-lawsuits-pricewaterhousecoopers-and-
colonial-bank/#42524a0579c0

The trial judge in the above stated case was of an opinion that the audit firm led a special
degree of duty and skill to the company to ensure the benefit of the shareholders. The audit
firm should have taken a reasonable degree of care to restrict the steps that were taken by its
principals towards the manipulation of the profits. The audit firm should have restricted the
access to the capital of the company to the markets and should have forced it to go for a
formal insolvency and this should have been much before when the company has filed for
insolvency. The trial judge of the case went on to state that the audit firm failed to meet its
standard of care when it failed to discover and report the irregularities during the month of
August of the year 1997. The audit firm still signed off the company’s financial statements
which were all falsified. It was due to this that the trial judge of the case awarded damages
Accounting Theory 7

with of $85 million. The court it Appeal for Ontario upheld the amount awarded by the trial
judge and dismissed his appeal and went to cross appeal as against his decision.

The Supreme court of Canada went on to allow the appeal that was filed by the audit firm in
part. The court overturned the findings of the trial judge and held that it had owed a duty of
care and skill for the company. The audit firm still gave a press release and the comfort letter.
But there was a split of opinion on the fact whether the audit firm owed a certain degree of
skill and degree when it came to the preparation of the statutory audit. This was with most of
the holding to which the audit firm owed and breached its duty of skill and care towards the
company.

Issues in Auditing:

As was held by SSC in Hercules that in case, an action has been brought as against the
auditor for the losses that the company has suffered, then the same can be brought by the
company itself or by the derived action. In the stated case, the case was noted and was
initiated by the bond holders of the company that were not able to due the audit firm. But
even then, the same was brought as against the audit firm by the special receiver who was
appointed by the company. The case was brought forward on the behalf of the company. This
enabled the company to receive a larger amount of the award that was awarded by the trial
judge. The win of the company has proved that this indirect route is successful which will
benefit the creditors even more than it would benefit the shareholders. This is a loop hole in
the litigation when it comes to the audit liability. While Hercules was of an opinion that the
effect of this indeterminate liability should have been determined on the basis or the duty of
care of the auditor.

But the company under review believed this was not of much concern for it and the fact that
the auditor did not have much concern about the liability based on the policies that were
being used.

The SSC was also of an opinion that the Negligent audit that was done by the company in one
year could not be applied to the other year which would affect the limited potential liability if
Accounting Theory 8

the company. The holding of the SSC would hold in the proximate relationship that would
preclude the context if the statutory audit which was then considered to be a major
development in the stated case. Such is the jurisprudence that was developing and there was
one ruling for the same. This was already ruled in the case judgement of Ontario even when
the SSC had handed over its judgment.

 There were so many uncertainties to the tune of the decision that would affect the dynamic
and the process of an audit in detail. The capital markets institute of the Roman School of
Management at the university of Toronto which had hosted a panel during the month of
January of the year 2018 so to assess in the different implications if the various decisions
when it comes to the responsibility of an auditor, governance and the public companies of
Canada. Since the higher exposure of the risk for these firms, there is an increased amount of
insurance premium for these firms. This has resulted in a debate for the way in which this risk
should be allocated or apportioned. This would most probably result in charging a higher
amount of the audit fees form the clients. The fact of the British Commonwealth is a matter
of a great mix for the various members. The commercial court of England and the Wales had
stated the fact the decision that was taken in the case of the given company would not be
considered for the purposes of identifying the scope of the duty of the auditor under the
English law. Nor such is the decision that would be considered under the different
circumstances in which the legal causation would have been established. The majority had
already decided that the approach which was used in the stated case would not be followed
under the English law as the dame is today. Nor would this show any correlation between the
negligence of the auditors and any loss that has claimed in by the client company. There will
have to be some confidence on the reliance which exists most of the trial judges relied upon.

Root cause and mistakes:

The following were the root causes and the mistakes:

 Any sort of the breach if the accounting standards or the auditing standards did not
cause any sort of damage to the Live mint company
 The audit procedures that were followed during the audit of the year 1996 though
were never in conformation with the GAAS but it is also true that the dame caused no
harm to the company under review.
Accounting Theory 9

 The issues that arose during the year of 1997 were of such a nature that these should
have been reported to the audit committee of the company. The same should have
been done even when the audit firm went on to issue and release the press release and
confirm the comfort letter which related with the financing efforts of the company.
These issues should have been reported to the security regulators of the company and,
the mistake which the audit firm did was the fact that the audit firm did not refuse the
expressing of the audit opinion on the financial statements of the company. The audit
firm failed to do this and committed this mistake.
 The doctrine of the identification of the corporate and that of ex turpi causa non orator
action was never available to the audit firm for its defence.
 In line with the English jurisdiction, the negligence of the audit firm was the main
cause of the damages in question
 The contributory negligence was never available for reducing the amount of the
damages in question
 The deepening amount of insolvency was not available for the purposes of reducing
the amount of the damages as well.

Conclusion:

The relevant framework for the purposes of analysing the duty of care of the defendant in
relation with the tort of negligence misrepresentation. Another framework by the name of
Anns/Cooper seeks the fact of the prima facie of the duty of care which exists between the
stated parties. And if this is the case, then the residual policy which negates the fact if which
limits the scope of the duty or the resulting amount of the damages will have to be considered
(Tlaonline.ca. (2019). At the very first stage, the duty of care will have to be recognised
wherein the proximity and the reasonable foreseeability would exist between the plaintiff and
the defendant. The conclusion drawn from this is the fact that the regulatory authorities need
to step in and decide some repercussions and penalties for the audit firms so that they carry
on their duty with utmost skill and care. The relevant decisions need to be taken and
appropriate measures will have to be adopted so that the risk of loss of investor confidence is
minimised. This would go on to seek for the relationship of proximity of the injury. The
concept of proximity would concentrate more on the types of the relationship that exists
between the plaintiff and the defendant and seeks to suffice the closeness and the direction as
Accounting Theory 10

being fair and just about the imposition of duty if care in terms of law. There are some pre-
existing or the analogous categories that results in a proximity. In cases there is no proximity,
then a new category will have to be recognised based on the close and the direct relationship.
In the cases wherein a defendant like the audit firm in the stated case goes on to provide a
representation or a service, then the audit firm should have taken and exercised a certain
degree of skill and care which was the main responsibility of the defendant.
Because the audit firm owed sole r a certain degree of skill or care to the company under
review, the law would go on to ask for the injury which has been suffered by the plaintiff. An
example of this is the company undertaken for review. The reasonable foreseeability of the
injury which requires the fact that the injury which has been caused to the plaintiff would not
have been caused had the audit firm exercised some degree of skill and care. And, the fact
that the audit firm did not consider the faith of the investors that realised on its comfort letter
is something which is disappointing.

At the very second stage, the court would consider the considerations or the residual policy
which is very much outside the relationship which exists between the parties that would go
on to negate the duty of recognition and the duty of care. The chosen case reflects the effect
of the recognition of the duty of care which exists between the various parties that are
involved along with the legal system, the society. There are many other factors that need
some consideration. The examples include the law which provides a remedy, whether there is
an existence of some duty of care which goes on to create some spectre of an unlimited
liability to an unlimited class. Also, an example includes the reasons as to why a certain
degree of due care and skill not be recognised.

In the nutshell, the auditing ethics and the cases wherein an auditor is at fault will have to be
revised and necessary penalties and prosecution will have to be levied so that the auditors are
careful about what they are doing, the way in which they are performing their duties and
whether they are expressing the true and a fair opinion on the financial statements of the
client or not.
Accounting Theory 11

References

Gupta, A. (2019). Deloitte & Touche v Livent Inc.: A New Duty of Care for Auditors |
TheCourt.ca.. [online] TheCourt.ca. Available at: http://www.thecourt.ca/deloitte-
touche-v-livent-inc-a-new-duty-of-care-for-auditors/ [Accessed 7 May 2019].

Lexology.com. (2019). The increasing scope of auditors' negligence: Livent Inc. v. Deloitte

& Touche LLP | Lexology. [online] Available at:
https://www.lexology.com/library/detail.aspx?g=835e9498-6501-4d56-9d66-
471269ea41bf [Accessed 7 May 2019].

Ontariocourts.ca. (2019). Livent Inc. v. Deloitte & Touche, 2016 ONCA 395. [online]
Available at: http://www.ontariocourts.ca/decisions/2016/2016ONCA0395.htm
[Accessed 7 May 2019].

Scc-csc.lexum.com. (2019). Deloitte & Touche v. Livent Inc. (Receiver of) - SCC Cases
(Lexum). [online] Available at: https://scc-csc.lexum.com/scc-csc/scc-
csc/en/item/16920/index.do [Accessed 7 May 2019].

Smallbusiness.chron.com. (2019). How Different Inventory Methods Can Affect Net Income.

[online] Available at: https://smallbusiness.chron.com/different-inventory-methods-can-
affect-net-income-34570.html [Accessed 7 May 2019].

Tlaonline.ca. (2019). [online] Available at:

http://tlaonline.ca/document/121/Livent_SCC_decision-Gowling_.pdf [Accessed 7 May
2019].

Tlaonline.ca. (2019). [online] Available at:

http://tlaonline.ca/document/121/Livent_SCC_decision-Gowling_.pdf [Accessed 7 May
2019].