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Federal Deposit Insurance Corp. v. Crowe Horwath LLP

United States District Court, N.D. Illinois, Eastern Division

March 27, 2018

FEDERAL DEPOSIT INSURANCE CORPORATION, as Receiver for Valley Bank, Plaintiff,


          Honorable Edmond E. Chang United States District Judge.

         Plaintiff Federal Deposit Insurance Corporation (FDIC-R), as receiver for Valley Bank (Valley), filed this lawsuit against Crowe Horwath LLP, alleging accounting malpractice, gross negligence, and negligent misrepresentation.[1] R. 1, Compl.[2] The claims arise out of Valley's loss of around $21 million, allegedly caused by Crowe's malpractice in auditing the consolidated financial statements of Valley's holding company, River Valley Bancorp, Inc. (RVBI) in 2010 and 2011. Id. ¶ 1. Crowe moves to strike, Fed.R.Civ.P. 12(f), the FDIC-R's jury demand and request for punitive damages, arguing that neither the jury demand nor punitive damages are available. R. 17, Def.'s Motion to Dismiss. Crowe also moves to dismiss Counts Two (negligence) and Three (negligent misrepresentation) of the complaint under Federal Rule of Civil Procedure 12(b)(6). Id. For the reasons discussed below, the motion to strike is denied and the motion to dismiss is granted in part and denied in part.

         I. Background

         In deciding a motion to dismiss, the Court must “accept all well-pleaded facts as true and draw reasonable inferences in the plaintiffs' favor.” Roberts v. City of Chi., 817 F.3d 561, 564 (7th Cir. 2016). For the years 2010 and 2011, Crowe was the independent auditor of Valley Bank, a full-service bank that engaged in commercial and consumer lending. Compl. ¶¶ 14, 21-22. Valley was a subsidiary of RVBI, a holding company that also held two other banks around the country. Id. ¶ 15. Valley's Chairman and CEO, Larry C. Henson, pursued aggressive growth strategies. Id. ¶ 16. In April and May 2009, Valley's regulators warned the Board that the bank's financial condition had sharply deteriorated due to the too-aggressive growth strategies. Id. ¶ 17. In September 2009, Valley entered into a Cease and Desist Order (Consent Order) with the FDIC, which required Valley to, among other things, maintain specific capital ratios. Id. ¶ 18. The Consent Order remained in effect throughout Crowe's audits. Id. Henson did not comply with the Consent Order, but rather engaged in a scheme to hide Valley's true financial condition. Id. ¶ 19.

         In October 2010, Crowe entered into an engagement letter with RVBI, under which Crowe was to conduct audits of RVBI and its subsidiaries, including Valley, for the year-ended December 31, 2010. Compl. ¶ 21. Crowe executed the 2010 audit and issued a Report of Independent Auditors in March 2011. Id. In June 2011, Crowe entered into another engagement letter with RVBI, this time to conduct audits of RVBI and its subsidiaries, including Valley, for a two-year period. Id. ¶ 22. Crowe executed the 2011 audit, which included a restatement of Valley's 2010 financial statements, and issued a Report of Independent Auditors in May 2012. Id. Crowe started the audit of Valley's 2012 financial statements, but never finished it, because Crowe was terminated after a dispute with Valley over the bank's Allowance for Loan and Lease Losses (ALLL) methodology. Id. ¶¶ 23, 65. The 2010 and 2011 reports certified that the financial statements fairly presented Valley's financial position for those years in conformity with Generally Accepted Accounting Principles (GAAP). Id. ¶¶ 21-22.

         As Valley's external auditor, the FDIC-R alleges, Crowe had a duty to determine whether Valley's financial statements fairly presented the bank's financial position. Compl. ¶ 25. Crowe also had a duty to obtain a reasonable assurance that the financial statements were free from material misstatement due to error or fraud. Id. Federal regulations required Valley to be audited by an independent Certified Public Accountant, and Crowe knew that Valley and its regulators would rely on the audit opinions and comparative financial statements that Crowe issued. Id. ¶¶ 26-27. The FDIC-R alleges that Crowe knew Valley had inadequate internal controls, ignored known fraud risks in its performance of the 2010 and 2011 audits-even when the risks were realized and identified-and issued unqualified opinions despite knowing about Valley's manipulation of its financial statements. Id. ¶¶ 2-3, 5-6, 53. As a result, from 2011 to 2013, Henson was able to continue to originate and fund $21 million in loans that violated the 2009 Consent Order. Id. ¶¶ 3, 61, 67. Ultimately, Henson's scheme continued until regulators discovered it and forced Henson to resign in June 2013. Id. ¶¶ 3, 24. According to the FDIC-R, if Crowe had performed its audits in accordance with professional standards, then it would not have issued opinions without qualifiers, and Henson's scheme to mask Valley's deteriorating financial condition would have been discovered as much as two years earlier, which would have prevented further harm to the bank. Id. ¶¶ 5-7, 67.

         After the Illinois Department of Financial and Professional Regulation closed Valley in June 2014, it appointed the FDIC-R as receiver for Valley. Compl. ¶¶ 8, 14. The FDIC-R brings this suit against Crowe, alleging accounting malpractice, gross negligence, and negligent misrepresentation. Id. at 21-25. Crowe moves to strike the FDIC-R's jury demand and request for punitive damages, and to dismiss the FDIC-R's gross negligence and negligent misrepresentation claims. Def.'s Mot. to Dismiss. at 1.

         II. Standards of Review

         A. Rule 12(f)

         Crowe moves to strike the FDIC-R's jury demand and request for punitive damages under Rule 12(f). R. 18, Def.'s Mot. to Dismiss Br. at 4-7. Under Rule 12(f), a district court “may strike from a pleading an insufficient defense or any redundant, immaterial, impertinent, or scandalous matter.” Fed.R.Civ.P. 12(f); see also Delta Consulting Grp., Inc. v. R. Randle Const., Inc., 554 F.3d 1133, 1141 (7th Cir. 2009). Motions to strike are usually disfavored.[3] See Heller Fin., Inc. v. Midwhey Powder Co., 883 F.2d 1286, 1294 (7th Cir. 1989). Motions to strike are appropriate, however, if they expedite litigation, and sometimes striking a jury demand might do that. See, e.g., Talbot v. Robert Matthews Distrib. Co., 961 F.2d 654, 664 (7th Cir. 1992) (allegations may be stricken if the matter bears no possible relation to controversy); see also DeliverMed Holdings, LLC v. Medicate Pharm. Inc., 2012 WL 345380, at *2 (S.D. Ill. Feb. 1, 2012) (noting that the “pending motion to strike, if meritorious, may expedite the case by removing unwarranted jury demands.”). Requests for relief may also be stricken when they seek relief that is not recoverable as a matter of law. Delta Consulting Grp., Inc., 554 F.3d at 1142. “The party moving to strike has the burden of showing that the challenged allegations are so unrelated to plaintiff's claim as to be devoid of merit, unworthy of consideration, and unduly prejudicial.” Pavlik v. FDIC, 2010 WL 3937621, at *1 (N.D. Ill. Oct. 5, 2010) (cleaned up).[4]

         B. Rule 12(b)(6)

         Crowe also moves to dismiss the FDIC-R's claims for negligence and negligent misrepresentation under Rule 12(b)(6). Def.'s Mot. to Dismiss Br. at 8-10. Under Federal Rule of Civil Procedure 8(a)(2), a complaint generally need only include “a short and plain statement of the claim showing that the pleader is entitled to relief.” Fed.R.Civ.P. 8(a)(2). This short and plain statement must “give the defendant fair notice of what the … claim is and the grounds upon which it rests.” Bell Atl. Corp. v. Twombly, 550 U.S. 544, 555 (2007) (alteration in original) (cleaned up). The Seventh Circuit has explained that this rule “reflects a liberal notice pleading regime, which is intended to ‘focus litigation on the merits of a claim' rather than on technicalities that might keep plaintiffs out of court.” Brooks v. Ross, 578 F.3d 574, 580 (7th Cir. 2009) (quoting Swierkiewicz v. Sorema N.A., 534 U.S. 506, 514 (2002)).

         “A motion under Rule 12(b)(6) challenges the sufficiency of the complaint to state a claim upon which relief may be granted.” Hallinan v. Fraternal Order of Police of Chi. Lodge No. 7, 570 F.3d 811, 820 (7th Cir. 2009). “[A] complaint must contain sufficient factual matter, accepted as true, to ‘state a claim to relief that is plausible on its face.'” Ashcroft v. Iqbal, 556 U.S. 662, 678 (2009) (quoting Twombly, 550 U.S. at 570). These allegations “must be enough to raise a right to relief above the speculative level.” Twombly, 550 U.S. at 555. The allegations that are entitled to the assumption of truth are those that are factual, rather than mere legal conclusions. Iqbal, 556 U.S. at 678-79.

         III. Analysis

         A. Motion to Strike

         Crowe argues that the FDIC-R's jury demand and request for punitive damages must be stricken because Valley-and the FDIC-R standing in its shoes as receiver-is a party or third-party beneficiary to the 2010 and 2011 engagement letters and thus is bound by the provisions that waive a jury demand and bar ...

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