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FDIC seeks $21M in damages from failed bank's auditor for alleged malpractice

The FDIC demanded the recovery of at least $21 million in damages from Crowe Horwath LLP for claims that the accounting firm committed "malpractice" through its alleged failure to identify a supposed scheme by the CEO of a failed Illinois bank to manipulate financial statements.

The complaint, which the FDIC filed June 9 in the U.S. District Court for the Northern District of Illinois, follows an investigation launched months after the June 2014 failure of Moline, Ill.-based Valley Bank by the agency, acting in its capacity as receiver. The FDIC initiated a legal proceeding in November 2015 against Crowe Horwath to enforce an administrative subpoena after it allegedly found "ample reason" to suspect that the firm "may be liable based on its negligent audits" for fiscal years 2010 and 2011 of Valley Bank and its holding company, Davenport, Iowa-based River Valley Bancorp Inc.

The FDIC alleged that Crowe Horwath's "willful and wanton deviation from basic auditing standards" in connection with the two audits allowed Larry Henson, Valley Bank's then-president and CEO, to continue to originate and fund "millions of dollars in loans" from March 2011 through June 2013 in violation of a 2009 cease-and-desist order.

Among the FDIC's accusations are that the firm issued an unqualified audit opinion on the 2010 financial statements despite allegedly "knowing that Valley had significant deficiencies in its internal controls," as well as no formal process for identifying loans that should have been classified as troubled debt restructurings and that it supposedly engaged in bank-financed sales of nonperforming mortgage-backed securities to related parties. Those transactions, the FDIC claimed, allowed the bank to "mask problems in its balance sheet."

The following year, the FDIC alleged, Crowe Horwath "knew, but failed to disclose, that Henson was misstating Valley's financial statements" through a supposed failure to record loan losses and the manipulation of Valley Bank's allowance for loan and lease losses. E-mail exchanges among the in-charge auditor, the audit engagement partner and the audit manager allegedly included a discussion of concerns about the allowance calculation, but the FDIC claimed that Crowe Horwath "blindly accepted the Bank's contrived numbers and improperly issued an unqualified audit opinion without sufficient appropriate audit evidence to support that opinion."

The agency claimed that Henson's scheme would have been discovered in 2011 had the accounting firm "done anything other than issue unqualified audit opinions." Instead, the FDIC alleged, the improper scheme continued, triggering significant deterioration in Valley Bank's financial condition.

The FDIC and Henson entered a stipulation in November 2016 under which the former executive consented to an order of prohibition from further participation in the affairs of any financial institution without admitting or denying any violations, unsafe or unsound banking practices, and/or breaches of fiduciary duty.

Crowe Horwath said in its response to the November 2015 FDIC petition that it had produced the audit files requested by the agency as well as "numerous" other documents, but it objected to complying with certain other requests such as the production of personnel files, arguing that doing so prior to the agency's identification of any employees that may have engaged in negligence would be premature. A federal judge granted the portion of the FDIC's petition pertaining to Crowe Horwath's production of information concerning the firm's available insurance coverage, but denied the request pertaining to personnel files.

The June 9 complaint accuses the firm of accounting malpractice, gross negligence and negligent misrepresentation and it seeks an unspecified amount of punitive damages as well as actual damages.

A Crowe Horwath spokeswoman declined to comment.

The FDIC is currently engaged in litigation with Crowe Horwath in connection with another failed bank. A bench trial is scheduled for later in 2017 regarding the claims of the agency, acting as the receiver for failed Montgomery, Ala.-based Colonial Bank, that the firm should have discovered a fraud through which a bank executive conspired with failed mortgage banking firm Taylor Bean & Whitaker Mortgage Corp. to "illegally siphon" more than $1.8 billion out of the bank.

Crowe Horwath and the FDIC entered a $2 million settlement in July 2015 related to the failure of Naples, Fla.-based Orion Bank. The firm made no admission of liability in the settlement.

The FDIC has also entered settlements with other accounting firms that performed work on behalf of failed banks, including Deloitte & Touche LLP in connection with the failure of Washington Mutual Bank and BKD LLP in connection with the failure of Batesville, Ark.-based First Southern Bank. It is empowered to sue professionals who allegedly caused losses to failed depository institutions, including former officers and directors, legal counsel, appraisers, brokers, securities underwriters, and accountants.