Four years after First National Bank of Keystone collapsed in the costliest bank failure of the past decade, a federal court will soon consider whether the West Virginia bank's accountants should bear some of the blame.
The Federal Deposit Insurance Corp.'s lawsuit against Grant Thornton LLP, perhaps the agency's highest-profile case to come to trial in years, could signal a stronger pursuit of nonbankers the FDIC considers responsible for bank failures.
And lawyers and accountants who work for banks will be watching the case to see if it offers any lessons for other failure-related suits the FDIC is pursuing.
"A lot of people have their eyes on this one," said John C. Murphy, a partner with the law firm of Cleary, Gottlieb, Steen & Hamilton and a former FDIC general counsel.
Bankers will also be watching the case closely, because it could affect the cost of audits and the nature of their relationship with accountants.
Grant Thornton, which audits many banks, argued in a court filing that accounting costs would skyrocket if it were held responsible for problems at Keystone that existed before the firm issued its audit report. The higher rates would cover the increased liability accountants would face as a result of such a decision, Grant Thornton said.
That theory makes some sense to at least one accounting industry executive. "Coverage is going down. Premiums are going up at just an astounding rate for all CPA firms. Any kind of court case like this, people will be watching. Depending on the outcome, there could be a financial impact," said the executive, who spoke on the condition of anonymity.
Grant Thornton would like to avoid further attention. One of its European affiliates was the auditor for Parmalat Finanziaria SpA when the Italian dairy giant began to unravel, and the Securities and Exchange Commission last month accused the firm and a partner in its Detroit office of aiding a securities-fraud scheme.
Acting in its role as the receiver for Keystone, the FDIC claims the fraud that brought Keystone down should have been caught when Grant Thornton began auditing the former $1.1 billion-asset bank's books in 1998. The agency seeks a penalty of between $25 million and $187 million plus punitive damages.
In an April 1999 audit report, Grant Thornton said Keystone's financial reports for the two previous years were in line with accounting standards. Regulators discovered the fraud in August 1999 and shut Keystone the next month.
The FDIC argues that if Grant Thornton had completed its audit properly, it would have certainly come across the fraud that eventually cost the Bank Insurance Fund nearly $651.2 million, making Keystone's collapse the fund's 14th-costliest failure of all time. The FDIC also says Grant Thornton failed to follow certain accounting procedures it agreed to undertake when it signed on to audit Keystone.
During the period that Grant Thornton was auditing Keystone, the bank claimed ownership of more than $500 million of loans it had actually sold, leaving it insolvent.
The trial, whose start has been pushed back several times, is slated to begin March 1. When Grant Thornton and the FDIC face off next month before Judge David Faber of the U.S. District Court for the Southern District of West Virginia in Charleston, the accounting firm is expected to raise several challenges to the agency's case.
Grant Thornton says it was duped by the same fraudulent activities that delayed the regulators' discovery of the bad investments that ruined Keystone.
"The assumption in cases against accountants has historically been, 'If it's this bad, they had to know.' That's the fundamental principle that the accountants are challenging. 'If the regulators didn't know, why should we?' " Mr. Murphy said.
Grant Thornton also says the law prevents accounting firms from being held responsible for any harm done to clients before an audit report is issued - in this case, freeing Grant Thornton from responsibility for losses Keystone incurred before the April 1999 report.
A spokesman for Grant Thornton did not return calls for comment by press time.
Former FDIC lawyers said it will often investigate the role a failed bank's attorneys and accountants played in a collapse, but lawsuits against such outside professionals are not filed unless the FDIC believes it has a strong case. However, the lawyers also said the pursuit of Grant Thornton and the accountants involved in two other recent bank failures could signal an increased willingness by the FDIC to find fault outside a bank's directors, executives, and employees.
In a $2 billion suit, the FDIC said Ernst & Young approved the faulty accounting that led to the 2001 failure of Superior Bank FSB of Hinsdale, Ill. A federal judge dismissed the suit last year, but the FDIC is appealing.
The agency also investigated the role Deloitte & Touche LLP played in the 2002 collapse of Hamilton Bank NA of Miami, though a lawsuit is less likely in that case.
Several observers said they were surprised the FDIC's case had not been settled more than two and a half years after the FDIC first brought its allegations against Grant Thornton. The two parties are slated to meet with Judge Faber in an unusual Saturday pretrial conference Feb. 21.
"I'm sure there were efforts here to settle it. If, in fact, the demands were so great, it may be that the government decided it wasn't worth it to settle, or the FDIC may have decided that they have such a good case that they want everything," said Ronald Glancz, the chairman of the financial services practice at Venable LLC. "That doesn't mean the case won't settle - many times cases are settled on the courthouse steps."
