|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."
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