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FEDERAL DEPOSIT INSURANCE CORP. v. ERNST & YOUNG

April 15, 2003

FEDERAL DEPOSIT INSURANCE CORPORATION, IN ITS CORPORATE CAPACITY, PLAINTIFF,
v.
ERNST & YOUNG, LLP, DEFENDANT.



The opinion of the court was delivered by: Robert W. Gettleman, United States District Judge

MEMORANDUM OPINION AND ORDER

Plaintiff Federal Deposit Insurance Corporation (the "FDIC"), in its corporate capacity, initiated the instant suit against defendant accounting firm Ernst and Young ("E&Y"), alleging fraud, gross negligence and accounting malpractice arising from defendant's audit of a failed federal savings bank. E&Y moved to dismiss the complaint, or in the alternative, stay the action pending arbitration. After consideration of extensive briefing and oral argument, the court grants E&Y's motion to dismiss.

FACTS

E&Y was the independent auditor of Superior Bank FSB ("Superior"), a federal savings bank regulated primarily by the Office of Thrift Supervision ("OTS"). In 1993, Superior launched a subprime lending business, making a substantial number of home mortgage and automobile loans to borrowers whose credit ratings were impaired due to an insufficient credit history, late payments, and/or previous bankruptcy.

In a process known as "securitization," Superior grouped its loans and sold interests in them to investors in the form of securities known as AAA-rated asset-backed securities. Superior retained a residual interest in the assets used to collateralize the securities it sold to investors. That residual interest was available as a credit enhancement to pay principal and interest on the bonds Superior had issued in the event the collateral for those bonds proved insufficient. Once the bonds were fully paid, any value that remained as a result of the residual interests retained by Superior would belong to Superior.

In its complaint, the FDIC alleges that Superior overvalued the residual interests on its financial statements by failing to properly discount the residual interests to reflect the fact that Superior had no present ability to use those assets for its own benefit. According to the FDIC, from 1995 through 2001, E&Y, as Superior's auditor,

repeatedly asserted false statements and representations of material facts, including, among other things, that the methodology in valuing the securitization transaction assets was correct, that E&Y's audits were performed in accordance with [generally accepted accounting standards], that Superior's financial statements were correct and in conformity with [generally accepted accounting principles], and that Superior's financial statements presented fairly, in all material respects, the consolidated financial positions of Superior.
The FDIC maintains that E&Y's overvaluation of Superior's assets made Superior appear extremely profitable, when in fact it was losing substantial amounts of money. The FDIC alleges that E&Y was motivated to conceal this overvaluation to facilitate the profitable sale of its consulting arm to Cap Gemini.

On July 25, 2001, Superior was declared insolvent and the FDIC was appointed receiver. The FDIC paid all of the insured deposits, allegedly totaling more than $500 million. In December 2001, the FDIC and OTS entered into a settlement agreement in which they released the owners of Superior from any potential claims in exchange for a promise to pay $460 million to the FDIC. This agreement expressly contemplated that the FDIC would bring claims against E&Y arising out of Superior's failure, and that the FDIC, as receiver and conservator of Superior, would pay 25% of any net proceeds recovered by any "Agency Party" from the "E&Y claims" to Superior's owners. The agreement defines "Agency Party" to include the FDIC acting in any capacity and OTS, and "E&Y claims" is defined as any claim "arising out of or in connection with Superior." The FDIC signed the agreement in its corporate capacity, as receiver and conservator for Superior, and as manager for the Federal Savings and Loan Insurance Corporation ("FSLIC").

The FDIC, in its corporate capacity, then brought the instant suit for compensatory and punitive damages against E&Y, alleging fraud, gross negligence, and accounting malpractice. In its responsive pleading, E&Y argues that plaintiff failed to state a claim under Illinois law for negligence or gross negligence, and failed to plead fraud with particularity as required under Fed. R. Civ. P. 9(b). More significantly, as a threshold matter, E&Y argues that the FDIC does not have standing to maintain this suit in its corporate capacity and that, if the FDIC does have such standing, it is bound by a mandatory arbitration provision contained in E&Y's audit engagement letter with Superior. Specifically, that provision*fn1 states:

Any controversy or claim arising out of or relating to the services covered by this letter or hereafter provided by us to the Bank (including any such matter involving any parents, subsidiary, affiliate, successor in interest, or agent of the Bank or of Ernst & Young LLP) shall be submitted first to voluntary mediation, and if mediation is not successful, then to binding arbitration, in accordance with the dispute resolution procedures set forth in the attachment to [this engagement letter].*fn2
The FDIC responds that it has stated a claim under Illinois law for both negligence and gross negligence, and that its fraud allegations comply with Fed.R.Civ.P. 9(b). With respect to E&Y's standing arguments, the FDIC maintains that Congress explicitly granted it the authority to sue in its corporate capacity for losses that it sustains, and that the FDIC is not bound by the arbitration clause. With this background in mind, the court turns to the merits of the instant motion.

DISCUSSION

The FDIC, which was established to insure the deposits of all banks and savings associations, operates in multiple capacities, often simultaneously. In its corporate capacity, the FDIC maintains and administers the Bank Insurance Fund and Savings Association Fund. 12 U.S.C. § 1821(a)(4). In the event of liquidation of, or other closing or winding up of the affairs of an insured depository institution, the FDIC in its corporate capacity is the entity that makes payments on insured deposits from the appropriate fund. 12 U.S.C. § 1821 (f). After making insured depositors whole, the FDIC in its corporate capacity then steps into the shoes of the depositors and is automatically subrogated to "all rights of the depositor against [the failed institution]." 12 U.S.C. § 1821(g)(1).

As a "body corporate," the FDIC's powers include, but are not limited to, adopting and using a corporate seal, making contracts, appointing officers and employees, acting as receiver, and prescribing by-laws. 12 U.S.C. § 1819. The FDIC also has the power to "sue and be sued, and complain and defend, by and through its own attorneys, in any court of law or equity, State or Federal." Id.

When an institution becomes insolvent, the FDIC is often appointed receiver and assumes responsibility for managing and protecting the failed bank's assets on behalf of its creditors and shareholders. See 12 U.S.C. § 1821(c)(5). As receiver, the FDIC succeeds to "all rights, titles, powers, and privileges of the insured depository institution, and of any stockholder, member, accountholder, depositor, officer, or director of such institution with respect to the institution and the assets of the institution." 12 U.S.C. § 1821(d)(2)(A). After appointment, the FDIC in its receivership capacity has two options: liquidation of assets or a purchase and assumption transaction. See, e.g., FDIC v. Bierman, 2 F.3d 1424, 1438 (7th Cir. 1993) ("When the FDIC in its capacity as receiver is appointed, it steps into the shoes of the bank and then either liquidates the assets and pays off the depositors or engages in a ...


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