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(Updates with details on Deloitte’s oversight in 14th paragraph.)
Sept. 26 (Bloomberg) -- Deloitte & Touche LLP, one of the so-called Big Four accounting firms, was sued for failing to detect a fraud that allegedly led to more than $7 billion in losses at defunct mortgage lender Taylor, Bean & Whitaker Mortgage Corp.
Deloitte, which audited Taylor Bean’s financial statements from 2002 to August 2009, ignored red flags in the company’s books, allowing the lender’s former chairman, Lee Farkas, to orchestrate a fraud that toppled the company, according to the complaints filed today in state court in Miami. Taylor Bean’s bankruptcy trustee, Neil Luria, and its Ocala Funding unit are seeking more than $7.6 billion in damages.
“Deloitte’s negligence, and willful blind eye, was the fuel without which the looters’ fraud would have sputtered out long before it resulted in the multibillion-dollar debt under which TBW collapsed,” according to Luria’s complaint.
The claims are “utterly without merit,” Jonathan Gandal, a spokesman for New York-based Deloitte, said in an e-mail. Taylor Bean and Ocala were wholly owned private companies through which “convicted felon Lee Farkas and his co- conspirators committed their crimes,” Gandal said.
“The bizarre notion that his engines of theft are entitled to complain of injury from their own crimes and to sue the outside auditors they lied to defies common sense, not to mention the law,” Gandal said in the e-mail.
Taylor Bean, once the 12th-largest U.S. mortgage lender, collapsed in 2009 after federal regulators began probing a fraud that involved fake mortgage assets, targeted the federal bank bailout program and contributed to the failure of Montgomery, Alabama-based Colonial Bank.
Farkas was sentenced in June to 30 years in prison for his role in the fraud that duped some of the largest U.S. financial institutions. Six conspirators, including former Chief Executive Paul Allen, pleaded guilty and were sentenced to prison terms ranging from three months to eight years.
Deloitte failed to understand the lender’s business, particularly its financing through Ocala, the trustee and Ocala said in their lawsuits.
Taylor Bean relied on a variety of credit lines and financing to process about $30 billion in mortgages a year, the plaintiffs said. The lender initially relied on banking partner Colonial Bank and later its subsidiary Ocala, according to court papers.
To fund the fraud, Farkas and others caused Taylor Bean to sell Colonial millions of dollars in phantom mortgages. The company sold the same mortgage two or three times to Colonial, Ocala and the Federal Home Loan Mortgage Corp., according to court papers.
Deloitte certified Taylor Bean’s books for seven years, Steven W. Thomas, an attorney for Ocala and Luria said today in a phone interview. The auditor can’t simply chalk up its conduct to ignorance, Thomas said.
“If they do then they’re admitting at least negligence because part of their job was to understand the business,” Thomas said.
Ocala issued asset-backed notes based on Deloitte’s clean audited financial statements from 2005 through July 20, 2009.
The unit, which wasn’t a part of Taylor Bean’s bankruptcy, has about $1.75 billion in outstanding notes, according to court papers. About $1.6 billion in notes were sold to BNP Paribas Mortgage Corp. and Deutsche Bank AG. A bankruptcy judge allowed the unit to pursue a $1.6 billion claim against Taylor Bean, according to court papers.
Deloitte allegedly missed glaring red flags in its audits, including Taylor Bean’s recording of transactions in a mortgage loan participation facility at Colonial as sales rather than loans, thereby inflating its accounts receivables, according to court papers. The accounting firm also certified one audit even after questions arose minutes before it signed off, Ocala said in its complaint.
In an e-mail sent during a 2008 audit, a Deloitte partner questioned the treatment of $6 billion in gross debits and credits, Ocala said. When questioned, Taylor Bean officials claimed it had something to do with “off balance sheet” facilities, Ocala alleged. With minutes to go until a midnight deadline, Deloitte certified the consolidated financial statements even as questions remained as to how the $6 billion should be treated, the funding company said.
“Deloitte missed this fraud because it simply accepted management’s conflicting, incomplete and often last-minute explanations of highly questionable transactions, even though those explanations made no sense,” according to the Ocala complaint.
Deloitte quit in 2009 after company officials refused to provide explanations during its audit, both complaints claim. Federal authorities raided Taylor Bean’s headquarters on Aug. 4 of that year and the company suspended operations the next day, firing about 2,000 employees.
Lawmakers and regulators are calling for increased scrutiny of the role of Wall Street’s auditors in the 2008 financial crisis. The Public Company Accounting Oversight Board, a nonprofit watchdog for auditors of U.S.-listed firms, said last month it’s considering whether to force public companies to routinely replace the firms that audit their financial disclosures.
The board’s announcement follows a Senate Banking subcommittee hearing in April on the role of the accounting firms in the financial crisis and controls that may be needed for the industry.
The four largest accounting firms are Ernst & Young LLP, PricewaterhouseCoopers LLP, KPMG LLP and Deloitte & Touche.
The cases are Luria, Plan Trustee of the Taylor, Bean & Whitaker Trust v. Deloitte & Touche LLP; Ocala Funding LLC, v. Deloitte & Touche LLP, Circuit Court of the 11th Judicial Circuit, Miami-Dade County, Florida.
--With assistance from Tom Schoenberg, Phil Mattingly and Jesse Hamilton in Washington. Editors: Fred Strasser, Andrew Dunn
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