NEW YORK, Sept 10 (Reuters) - Accounting firms PricewaterhouseCoopers and Crowe Horwath must face a lawsuit accusing them of professional malpractice and breach of contract for not catching a fraud that led to the 2009 collapse of Colonial Bank, a federal judge has ruled.
Filed in 2011 by the bank's parent Colonial BancGroup Inc and its trustee, the lawsuit accused the accounting firms of making "reckless and grossly inaccurate" reports to the bank's board, allowing Colonial to conceal a seven-year fraud that drained it of $1.8 billion.
In an opinion on Tuesday, U.S. District Judge Keith Watkins rejected the auditors' motion to dismiss the complaints, saying the bank made "plausible" claims that PwC and Crowe breached their contract with Colonial.
PwC was the public auditor for Montgomery, Alabama-based Colonial before its collapse, while Crowe provided internal audit services.
Caroline Nolan, a spokeswoman for PwC, said it audited Colonial "in full accordance with professional standards" and is confident it will prevail on the merits of the case, which will now go forward in district court.
Jan Lippman, a spokeswoman for Crowe, said the audit firm was hired to help Colonial with internal services but did not serve as the bank's internal auditor. She said the claims are without merit.
Rufus Dorsey, a lawyer for Colonial, said he was pleased with the decision.
The fraud, one of the biggest stemming from the last decade's mortgage crisis, went undetected until a raid by federal authorities on Aug. 3, 2009. One of the largest U.S. regional banks, Colonial was seized by regulators and filed for bankruptcy protection later that month.
PwC and Crowe are facing a similar lawsuit by the Federal Deposit Insurance Corporation, receiver for the bank. The 2012 FDIC lawsuit said that PwC and Crowe missed "huge holes" in Colonial's balance sheet caused by the diversion of money to now bankrupt Taylor Bean & Whitaker Mortgage Corp.
Lee Farkas, former chairman of Taylor Bean, was sentenced to 30 years in prison in 2011 for his role in the fraud. Several other officers of Taylor Bean and Colonial pleaded guilty for their roles in the scheme.
In Tuesday's opinion, Watkins rejected Crowe's argument that it had no professional duty to Colonial because it was not the bank's internal auditor but merely a provider of services, calling that a "reed thin" distinction.
He also rejected PwC's argument that the negligence claim against it must be dismissed because Colonial's own negligence played a role in its fate, saying that is a question of fact for a jury to decide.
The case is: The Colonial BancGroup Inc et al v PricewaterhouseCoopers et al, U.S. District Court, Alabama Middle District, No 11-cv-00746 (Reporting by Dena Aubin; Editing by Kevin Drawbaugh and Tom Brown)