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Aborted Audit Excruciates Auditors

PwC settles with PinnFund investors for $39.5 million

October 18, 2006

WASHINGTON correspondent for MortgageDaily.com

Auditors have settled for nearly $40 million a lawsuit charging them with failing to notify investors of an audit that was aborted upon the discovery of financial fraud. The settlement caps the sensational history of a mortgage banker that used hundreds of millions of dollars intended to fund mortgage loans for his own lavish lifestyle -- buying himself a yacht, giving his adult-film actress girlfriend a mansion, and driving his company into a massive bankruptcy.

PricewaterhouseCoopers agreed to settle with investors of PinnFund USA for $39.5 million, according to court documents.

The accounting powerhouse was accused of not revealing irregularities it found during an aborted audit of two limited partnerships set up to invest in loans issued by PinnFund, which effectively aided the funds' general partner in defrauding them.

"PricewaterhouseCoopers LLP was between a rock and a not-quite-so-hard place, and unfortunately chose the rock," plaintiff's attorney J. Farley Neuman said in a statement posted on his law firm's Web site. "It discovered strong evidence of fraud and was faced with the dilemma of either disclosing that evidence to limited partners, thereby risking a lawsuit by the partnership and/or its general partners, or withdrawing from the audit and remaining quiet, thereby risking a lawsuit by the innocent limited partners. It chose the latter, which in my opinion was a mistake from both a legal and an ethical perspective."

The San Francisco, Calif.-based attorney added, "It did nothing to prevent a massive fraud from continuing and exposed itself to liability to the victims of that fraud."

The investors sued in 2002, accusing the auditing firm of abetting a fraudulent scheme carried out by James Hillman, at the time the general partner of two partnerships, Grafton Partners LP and Allied Capital Partners, in which they had invested as limited partners. Both partnerships invested in loans issued by PinnFund, USA, Inc.

PwC auditors reportedly noticed irregularities indicating possible fraud in 1999 and told Hillman that it could not issue audit reports on Grafton and Allied until the questions were resolved. Hillman then terminated the audit. PwC neither issued an audit report on Grafton and Allied nor reported its suspicion of fraud to anyone other than Hillman.

PinnFund's owner was later discovered misappropriating the money invested in the fund, and Hillman, who directed the limited partnerships' investments into PinnFund, was implicated in the scheme, court filings indicate. As a result, the Securities and Exchange Commission shut down PinnFund. Grafton's and Allied's limited partners then sued PwC, alleging aiding and abetting fraud and conspiracy to defraud, among other theories.

The investors claimed that PwC should have revealed what it knew.

The trial court granted PwC's motion for summary judgment, ruling that PwC had no duty to communicate with investors. But the appellate court reversed on the issue of aiding and abetting fraud.

"Because of ambiguities in the professional standards for accountants Generally Accepted Accounting Principles and Generally Accepted Auditing Standards, many accountants believe that they may withdraw from an audit on discovery of facts indicating fraud or other illegal acts. This case strongly suggests otherwise," Neuman said.

The settlement has been approved by a federal bankruptcy court and a California state court. The money will go into a fund established under a global settlement agreement reached in federal court in 2002 and be distributed to the plaintiffs, according to WebCPA.com.

PinnFund raised more than $330 million from at least 166 investors in a Ponzi scheme that funded the exotic lifestyle of its chief executive, Michael Fanghella, amid losses at the company. The financial scam was among the biggest ever in Southern California.

Fanghella, who allegedly spent more than $100 million on parties, call girls, alcohol, drugs, and gifts for adult-film actress girlfriend, Kelly Cook -- also known as "Kelly Jaye" and "Kelly Spagnola" -- for whom he bought a $5 million home, plead guilty in 2002. He was sentenced to 10 years in federal prison.

A PwC spokesman told MortgageDaily.com, "Having denied the original allegations, we are happy to have put this matter behind us."


Former PinnFund CEO Sobs at Sentencing
PinnFund U.S.A.'s former chief executive officer reportedly sobbed as he was sentenced for one of the biggest fraud cases in southern California history.

Two More Plead Guilty In PinnFund Scam
Two additional defendants have plead guilty in one of the largest fraud cases in Southern California history.

Guilty As Charged
Former PinnFund USA, Inc. CEO Michael Fanghella has pled guilty to Justice Department charges, according to a recent announcement from the U.S. Attorney in San Diego, California. Fanghella and others allegedly conspired to devise and perpetuate one of the largest fraud schemes in Southern California history.

Fanghella Faces Trial In May
Former PinnFund USA, Inc. chief Michael J. Fanghella is scheduled for criminal trial in May, according to U.S. Attorney spokeswoman Deborah Hartman. Fanghella is accused in a civil case by the Securities and Exchange Commission of misappropriating nearly $110 million -- which was raised for the purpose of funding subprime mortgages -- to pay for extravagant personal living expenses, including at least $10 million spent on his former adult film actress girlfriend.

PinnFund Fugitive Surrenders
Former PinnFund CEO Michael Fanghella surrendered to the U.S. Marshals Service in San Diego Wednesday morning, according to the San Diego Daily Transcript. Mr. Fanghella is accused by Securities and Exchange Commission (SEC) attorneys of the largest securities fraud in recent Southern California history.

Former PinnFund CEO Planned To Escape To Caribbean On $1 million Yacht
In what has recently become a tabloid-like mortgage industry story, the San Diego Daily Transcript (Transcript) reported that former PinnFund CEO Michael Fanghella purchased a $1 million, 75 foot yacht in September 2000 with the intention of making a one-way trip to the Caribbean. His estranged wife, Patrice Fanghella, hired a private investigator who discovered that the yacht was preparing for the trip.

Lisa D. Burden is a legal analyst for MortgageDaily.com and holds a law degree from the University of Maryland. She is currently a freelance journalist who previously wrote for Institutional Investor publications and the Baltimore Daily Record.

e-mail Lisa at: [email protected]

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