DALLAS -- A federal judge Monday dismissed a $560 million lawsuit filed against Ernst & Young by the Federal Deposit Insurance Corp., saying the national accounting firm was not liable in the failure of a big Texas thrift it had audited.

The decision could set a precedent for the numerous lawsuits brought by the federal government against auditors of banks and thrifts that later failed.

The FDIC argued that an Ernst & Young predecessor, Arthur Young & Co., was negligent in its audits of Dallas-based Western Savings Association, whose 1986 failure will cost taxpayers an estimated $1 billion.

Had accountants uncovered risky practices, the agency contended, Western would have curtailed abuses and lessened the depth of its eventual insolvency.

Judge Supports Argument

But U.S. District Judge H. Barefoot Sanders Jr. sided with Ernst & Young, which argued that Western's former owner, Jarrett E. Woods Jr., already knew about questionable practices inside the thrift.

It was unprovable that Mr. Woods would have reformed Western's practices if the auditor had discovered them, Ernst & Young argued, and the executive, as sole owner, had vast power to conceal abuses. Given that power, it was unreasonable to expect private auditors to succeed where federal regulators had failed to uncover abuses, Ernst & Young argued.

FDIC spokesman Alan Whitney said the agency was considering an appeal of Judge Sanders' ruling.

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