# Petition for Writ of Certiorari — Ellis v. Grant Thornton LLP (No. 08-542)

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## Record

- **Collection:** Supreme Court brief
- **Document type:** Petition for Writ of Certiorari
- **Published:** January 1, 2009

## Text

VUPTCHIG UUUIL, U.o.

\\ ve. Q) 99-542 Oct 20 2008

In the OFFICE OF THE CLERK
Supreme Court of the United States

GARY ELLIS,

Petitioner,
Vv.

GRANT THORNTON LLP,
Respondent.

On Petition for Writ of Certiorari
to the U.S. Court of Appeals
for the Fourth Circuit

PETITION FOR WRIT OF CERTIORARI

Benjamin L. Bailey
Counsel of Record

Eric B. Snyder

Rodney A. Smith

BAILEY & GLASSER LLP
209 Capitol Street
Charleston, WV 25301
(304) 345-6555

(304) 342-1110 Facsimile

October 20, 2008 Counse/ for Petitioner

—— =

GibsonMoore Appellate Services, LLC
421 East Franklin Street ¢ Suite 230 ¢ Richmond, VA 23219
814-249-7770 #¢ www.gibsonmoore.net

Questions Presented

I. Did the Fourth Circuit violate Federal
Rule of Civil Procedure 52(a) by making factual
findings that conflicted with the District Court’s
detailed findings made after a bench trial without
finding clear error?

If. Did the Fourth Circuit ignore this
Court’s precedent and depart from the usual course
of judicial proceedings by failing to remand even
though it predicted state law differently than the
District Court and did not have the full record?

ll

Parties to the Proceeding

The caption of the case contains the names of
all the parties. FDIC was a party in the consolidated
trial but was severed after trial for appellate
purposes.

1

Table of Contents

Page
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Reasons for Granting the Petition .....................6..0006 7 :

1. The Fourth Circuit overruled

factual findings without finding clear error,

in violation of Federal Rule of Civil
REE RE ee a eS NS AR ee 7

A. Rule 52(a) requires appellate
courts to find clear error before overruling
i sda caliaindadelenionseene 7

B. The Fourth Circuit stated the
clearly erroneous standard, but applied a
de novo standard of review when it made
factual findings that conflicted with
findings made by the District Court................ 8

iV

C. Making matters worse, the Fourth
Circuit conducted its de novo review with
ek fe een 10

2. The Panel fundamentally erred by
failing to remand to the District Court............... 12

A. The Fourth Circuit applied a
different legal standard that required
NS BE I a sis ncnescccsccevevactascavenssesi 13

B. This Court has required remand in
closely analogous cases where a new
standard was applied and there was more

than one possible resolution ............. clobcanmaial 15
REE ACRE MIE DSR RE Ae NORE EN OR Ne OT 17
Appendix:

Opinion, U.S. Court of Appeals
for the Fourth Circuit
ET NR i TEN A-l

Judgment, U.S. Court of Appeals
for the Fourth Circuit
NE i II os cvcciccccssesccssscsscesseseneeen A-27

Order Denying Rehearing
ee A-28

Judgment Order of
The Honorable David A. Faber
LE . ) Se A-29

Findings of Facts and
Conclusions of Law
I I FOIE oo occcccvccccccccccovccccsccenccss A-30

Letter to District Court from
Court of Appeals
Re: Transcript
I SEIT «isu crndiccccetncdgeeccnesnbepseonsinel A-161

Table of Authorities

Page(s)
Cases

Anderson v. City of Bessemer City,
470 U.S. 564 (1985)

Bank of Bluetield v. Crawford,
386 S.E.2d 310 (W. Va. 1989) passim

Bose Corp. v. Consumers Union,
466 U.S. 485 (1984) .......................... Pa Se 8,11

Comm Tr of Internal Revenue v. Duberstein,
363 U.S. 278 (1960)

DeMarco v. United States,
415 U.S. 449, 450 (1974) ...............................2. 7,16

Ellis v. Grant Thornton,
530 F.3d 280 (4th Cir. 2008)

Icicle Seafoods, Inc. v. Worthington,
475 U.S. 709 (1986)

Logan Bank & Trust Co. v.
The Letter Shop, Inc.,
437 S.E.2d. 271 (W. Va. 1993)

North American Specialty Ins. Co. v. Lapalme,
258 F.3d 35 (1st Cir. 2001)

Pullman-Standard v. Swint,
456 U.S. 273 (1982)

State ex rel Elish v. Wilson,
434 S.E.2d. 411 (W. Va. 1993)

United States v. United States Gypsum Co.,
I i 5 eatin 8, 10

Statutes
28 U.S.C. § 1254(1)

SLE E OD 1,3

Rule

TIRE SEAS EE RR RO PCT! 6,9, 11
FED. R. Civ. P. 5 passim
FED. R. Civ. P.

Other

4h Cir. L.R. & IOP 30(b)

Restatement (Second) of Torts § 552

W. VA. CONST. ART. 8, § 4

Opinions Below

The judgment order of the District Court entering
judgment in favor of Gary Ellis and against Grant
Thornton is unpublished and printed at Pet. App. A-
29. The 132-page Findings of Fact and Conclusions
of Law in support of the Judgment Order is
unpublished and printed at Pet. App. A-30 to A-160.
The opinion and judgment order of the United States
Court of Appeals for the Fourth Circuit reversing the
District Court is published at 530 F.3d 280 (4th Cir.
2008) and reprinted at Pet. App. A-1 to A-27. The
Fourth Circuit order denying Mr. Ells’ petition for
rehearing or rehearing en banc is unpublished and
printed at Pet. App. A-28.

Jurisdiction

Gary Ellis, Petitioner, seeks review of a published
opinion and order reversing the District Court
judgment in favor of Mr. Ellis that was entered by
the Fourth Circuit on June 25, 2008. Pet. App. A-1 -
A-27. The Fourth Circuit denied the Petitioner’s
petition for rehearing and rehearing en banc on July
22, 2008. Pet. App. A-28. The statutory provision
conferring jurisdiction to review the judgment is 28
U.S.C. § 125401). The District Court had diversity
jurisdiction pursuant to 28 U.S.C. § 1332.

Statutes Involved

No statutes are involved in this Petition for a
Writ of Certiorari.

Statement of the Case

Petitioner and plaintiff below, Gary Ellis, seeks
review of a published opinion of the United States
Court of Appeals for the Fourth Circuit which
overturned the factual findings of the District Court
without finding clear error, announced a new and
more restrictive test for his theory of liability, made
its own factual findings on an incomplete record,
applied the new factual findings to the new test, and
then reversed the district court’s nearly $2.5 million
judgment in favor of Mr. Ellis without even
considering remand. The District Court reached its
verdict, set out in a 132-page memorandum opinion
and order, after a three-and-a-half-week bench trial.
In usurping the fact-finding role of the district court,
the Fourth Circuit set precedent, in a published
opinion, expressing outright antagonism toward
what appeared, until now, to be two fundamental
and well-settled elements of federal law. First,
Federal Rule of Civil Procedure 52(a) prohibits an
appeals court from substituting its view of the facts
for that of the district court without finding clear
error.) Second, and related, a court of appeals that
lays down additional elements of proof for a cause of
action must always remand unless the entire record
permits only one resolution. See Pullman-Standard
v. Swint, 456 U.S. 273 (1982); Icicle Seafoods, Inc. v.
Worthington, 475 U.S. 709 (1986).

' Federal Rule of Civil Procedure 52(a)(6) specifically
provides: “Findings of fact, whether based on oral or other
evidence, must not be set aside unless clearly erroneous, and
the reviewing court must give due regard to the trial court's
opportunity to judge the witnesses’ credibility.”

The Fourth Circuit’s refusal to follow Rule 52(a)’s
requirements presents this Court with a simple yet
important question: whether a court of appeals may
reverse a district court’s findings of fact made after a
lengthy bench trial without finding clear error. The
Fourth Circuit’s willingness to retry the facts of Mr.
Ellis’ case on appeal, based on an incomplete record,
injects frightening unpredictability and uncertainty
into the bench trial process.

In addition, and just as important, the Fourth
Circuit ignored this Courts precedent by
establishing a new legal standard and failing to
remand even though the appellate record was
incomplete. Following the reasoning of the Fourth
Circuit, which is now law, any appeal panel may
simply add elements to a cause of action, find a
partial record “devoid of evidence” on the new
elements, and then enter judgment for the
defendant. And, making matters worse, the Fourth
Circuit has refused to police itself. Indeed, only the
district court judge sitting by designation on the
appeal panel voted to rehear this case when
presented with Mr. Ellis’ petition for rehearing or
rehearing en banc drawing the Fourth Circuit’s
attention to the Panel’s extreme departure from
established review standards and precedent. This
Court’s review and the exercise of its supervisory
powers are thus necessary to prevent courts of
appeal from following the Fourth Circuit’s lead away
from the black letter mandate of Rule 52(a).

1. Summary of facts

This is a diversity case, brought pursuant to 28
U.S.C. § 1332, in which Gary Ellis, Petitioner,
asserted causes of action for accountant negligence

and negligent misrepresentation against Grant
Thornton LLP, Respondent, based on its work
auditing and preparing quarterly financial reports
for the First National Bank of Keystone. The
negligence respecting Mr. Ellis occurred from March
24, 1999, through April 19, 1999. During that
period, Mr. Ellis, a prominent figure in West
Virginia’s banking industry, was invited by Keystone
to consider taking the job as president of the bank.
Pet. App. A-71 - A-72, 4§ 88-90. In deciding whether
to take the job, Mr. Ellis requested that he be
permitted to review Keystone’s financial and
regulatory situation. Pet. App. A-9. On March 24,
1999, Keystone’s Board voted to authorize a
confidentiality agreement, which—among other
things—permitted Stan Quay, Grant Thornton’s lead
partner on the Keystone engagement, to share with
Mr. Ellis Grant Thornton’s opinions regarding the
financial condition of the bank. Jd. On March 24,
25, 30 and April 19, 1999, in the presence of several
eyewitnesses at a bar and at meetings at the bank,
Mr. Quay reviewed the financial health and financial
statements of Keystone with Mr. Ellis and assured
him that all was well at Keystone and that Grant
Thornton would give Keystone a clean audit opinion.
Pet. App. A-9 - A-10. As the District Court found,
Mr. Ellis relied on Grant Thornton’s ora] and written
representations and accepted a _ position as
Keystone’s president. Pet. App A-10 - A-11; Pet.
App. A-73 - A-74, 44 93-96.

Four months later, an investigation revealed that
Keystone was hopelessly insolvent for want of half a
billion dollars of loan inventory, which was
repeatedly overlooked by Grant Thornton. Pet. App.
A-3, A-87. Grant Thornton does not dispute in its

appeal that its monumental oversight was negligent.
Pet. App. A-6, n.l. On September 1, 1999, the
regulators closed Keystone, and Mr. Ellis lost his
long and exemplary career in banking by being
associated with the failure of Keystone. Pet. App. A-
3, A-87,A-94 - A-95, A-109.

2. Procedural history

Keystone’s collapse generated waves of criminal
investigations and lawsuits. On November 8, 1999,
Mr. Ellis was sued in a securities class action arising
out of Keystone’s failure. Pet. App. A-11. Mr. Ellis
asserted cross-claims for negligence and negligent
misrepresentation against Grant Thornton. /d.

Mr. Ellis’ claims against Grant Thornton went to
trial in the summer of 2004, along with claims
brought by the FDIC against Grant Thornton. Pet.
App. A-ll. Judge Faber, the Chief Judge of the
Southern District of West Virginia, presided over the
more-than-three-week bench trial and ruled in favor
of Mr. Ellis on March 14, 2007. Pet. App. A-29. In
his 132-page Findings of Fact and Conclusions of
Law, Judge Faber cited and relied upon the single
syllabus point of the West Virginia Supreme Court's
decision in Bank of Bluefield v. Crawford, 386 S.E.2d
310 (W. Va. 1989), for the standard for accountant
lability. Pet. App. A-106. The Syllabus in Bank of
Bluefield articulated the following straightforward
test: “In the absence of privity of contract, an
accountant 1s liable for the negligent preparation of
a financial report only to those he knows will be
receiving and relying on the report.” Syl. Pt. 1, Bank
of Bluefield, 386 S.E.2d at 310. The District Court
properly concluded that the syilabus was the law in
West Virginia and never cited to, or applied, any

part of the Restatement (Second) of Torts (the

“Restatement”) or the law from any other state. Pet.
App. A-30 - A-160.

Despite the concise and sufficient statement of
state law in Bank of Bluefield, the Fourth Circuit
panel (the “Pane!”), in an opinion authored by Senior
Circuit Judge Hamilton, found that it had to predict
West Virginia law and, as a result, adopted an
entirely new test for accountant liability. Pet. App.
A-1 - A-26. The Panel promulgated for West
Virginia a six-factor test for accountant liability set
forth by the First Circuit predicting that
Massachusetts would adopt the Restatement
(Second) of Torts. Jd; see also North American
Specialty Ins. Co. v. Lapalme, 258 F.3d 35 (1st Cir.
2001). The new test was much more demanding
than the test applied by the District Court and, as a
result, required additional fact finding.

After adopting this new and more rigorous test,
the Panel broke with this Court’s precedent, as well
as Fourth Circuit precedent, by failing to remand for
further factual development even though the Panel
did not have the entire record from the lengthy trial.
Instead of remanding, or even discussing the
possibility of remand, the Panel undertook a de novo
review of the incomplete record before it and made
factual findings. In so doing, the Panel ignored
District Court findings that conflicted with the
Panel’s new findings, and failed to find that the
District Court’s findings were in clear error, which
disregarded Federal Rule of Civil Procedure 52’s
express requirements. The Panel’s procedural error
resulted in the dismissal of Mr. Ellis’ claims, which

the District Court had found meritorious after the
lengthy trial.

Mr. Ellis petitioned the Fourth Circuit for
rehearing or rehearing en banc. Pet. App. A-28.
Interestingly, the District Court judge who sat on
the Panel voted to grant panel rehearing, but no
Fourth Circuit judge requested a poll on the petition
for rehearing en banc. Id.

Reasons for Granting the Petition

The Fourth Circuit’s disregard of appellate
review standards and this Court’s jurisprudence
resulted in an appellate review process that lacked
fundamental fairness and ignored basic appellate
review standards. Mr. Ellis petitions this Court to
reverse the Fourth Circuit’s decision and to require
remand to the District Court for further proceedings.

1. The Fourth Circuit overruled factual
findings without finding clear error, in violation
of Federal Rule of Civil Procedure 52(a).

A. Rule 52(a) requires appellate courts to
find clear error before overruling factual
findings.

Federal Rule of Civil Procedure 52(a) requires
appellate courts to uphold district courts’ factual
findings unless those findings are “clearly
erroneous.” As recognized by this Court, Rule 52(a)’s
deferential standard is based on the premise that
“factfinding is the basic responsibility of district
courts, rather than appellate courts... .” DeMarco
v. United States, 415 U.S. 449, 450 (1974). Such
deference is given because of the trial court’s unique
position to determine witnesses’ demeanor,

credibility, and inferences from documentary
evidence. See Bose Corp. v. Consumers Union, 466
U.S. 485, 500 (1984).

This Court has found that a trial court’s factual
findings are clearly erroneous, even where there is
some evidence to support them, only when “the
reviewing court on the entire evidence 1s left with
the definite and firm conviction that a mistake has
been committed.” United States v. United States
Gypsum Co., 233 U.S. 364, 395 (1948). However, an
appellate court may not reverse a district court’s
factual findings simply because the reviewing court
would have reached a different conclusion in the first
instance. See Anderson v. City of Bessemer City,
470 U.S. 564, 573 (1985). When findings are based
on oral evidence rather than factual evidence, the
“clearly erroneous” presumption becomes even more
difficult for appellate courts to reach because they do
not have the benefit of observing witnesses’
demeanor. See Bose Corp., 466 U.S. at 500.
“Similarly, the standard does not change as the trial
becomes longer and more complex, but the likelihood
that the appellate court will rely on the presumption
tends to increase when trial judges have lived with

the controversy for weeks or months instead of just a
few hours.” Jd.

B. The Fourth Circuit stated the clearly
erroneous standard, but applied a de novo
standard of review when it made factual
findings that conflicted with findings made by
the District Court.

In this case, the Panel acknowledged that the
standard of review for the District Court’s factual
findings is clear error, but inexplicably made its own

findings that contradicted the District Court without
applying the Rule 52. standard or even
acknowledging that the Panel's findings contradicted
the District Court’s findings. Pet. App. A-1 - A-26.
After an extended trial and an opportunity to judge
the credibility of all witnesses, the District Court
found that “Keystone’s board of directors and Gary
Ellis reasonably relied on Grant Thornton’s report,”
and that “Ellis relied on the financial statements
Quay gave him, and Quay’s oral representations to
Ellis and others that Keystone was going to get a
clean audit opinion.” Pet. App. A-70, A-73. The
District Court also found that “Quay intended and
knew that Ellis would rely on his statements, and
Ellis did, in fact, rely on them” and that “Grant
Thornton knew that Gary Ellis, as a potential officer
and director of Keystone, would be relying on its
audit of Keystone.” Pet. App. 4-74, A-106.

Without holding that any of these findings of the
District Court were clear error, the Panel applied its
new test and made the following, contradictory
findings: “Unquestionably, given that the audit
report stated that it was not intended for use by
third parties, Ellis could not justifiably rely on the
audit report in signing his employment contract with
Keystone.” Pet. App. A-25. As to Grant Thornton's
knowledge, the Fanel found that “Quay’s statements
concerning the clean audit opinion were offered by
Quay to the board and the shareholders to apprise
the board and the OCC of Keystone’s financial
condition. They were not offered to induce
individuals to accept employment with Keystone.”
Id. The Pane} also held, contrary to the District
Court and the evidence, that Mr. Quay knew
precisely why he was talking to potential president

10

Mr. Ellis about Keystone’s financial condition, that
“Grant Thornton was not aware that any potential
employee of Keystone was going to base their
decision to seek employment with Keystone on the
outcome of the audit. Rather ... Grant Thornton was
aware that its audit opinion may be relied upon by
shareholders, investors, and perhaps potential
employees such as Ellis.” Pet. App. A-22. Finally,
and perhaps most egregiously, the Panel made the
following finding without the benefit of observing
any witness’ demeanor during trial: “A person as
sophisticated and experienced in the banking
business as Ellis is, he knew he could not justifiably
rely on Quay’s statements when the report itself
stated otherwise.” Pet. App. A-25.

The Panel’s factual findings clearly contradict the
District Court’s explicit findings. Yet, the Panel
made these findings without any discussion of how
these findings contradicted the District Court’s
findings. The Panel’s failure to apply the “clearly
erroneous” standard ignored Rule 52(a)’s express
requirements and impermissibly resulted in a de
novo review of the record before the Panel.

C. Making matters worse, the Fourth
Circuit conducted its de novo review with only
part of the record.

The Fourth Circuit compounded its review
standard error by making its conflicting findings
without the benefit of the full trial record. This
Court has steadfastly held that only after a review of
the “entire evidence” an appellate court can find
clear error. See, e.g., United States v. United States
Gypsum Co., 333 U.S. 364, 395 (1948) (“A finding is
‘clearly erroneous’ when although there is evidence

11

to support it, the reviewing court on the entire
evidence is left with the definite and firm conviction
that a mistake has been committed”) (emphasis
added); Comm’r of Internal Revenue v. Duberstein,
363 U.S. 278, 291 (1960) (same); Bose Corp. v.
Consumers Union of United States, Inc., 466 U.S.
485 (1984) (stating that this Court’s Rule 52
jurisprudence “expressly contemplate[s] a review of
the entire record”).

In this case, the Fourth Circuit only had the Joint
Appendix provided by the parties and not the entire
transcript from the lengthy trial. See Fourth Circuit
L.R. & Internal Operating Proc. 30 (requiring that
the Joint Appendix only contain “the parts of the
record which are vital to the understanding of the
basic issues on appeal”)?; Pet. App. A-162. The Joint
Appendix, which was assembled by the parties
before the Fourth Circuit predicted its new, more
rigorous six-part standard for accountant liability, in
no way reflects “the entire record,” or even all of the
portions of the record relevant to the additional
factual findings made by the Fourth Circuit. Despite
only having a portion of the record, the Fourth
Circuit erroneously concluded that “the record
simply is devoid of evidence suggesting that Ellis
proved the fourth, fifth, and sixth elements” of its
new six-part test. Pet. App. A-18. Because it only
had a portion of the trial record, .owever, the Fourth
Circuit had no basis to conclude that the record
“simply is devoid” of such evidence. Nor could it

2 Fourth Circuit Local Rule and Operating Procedure Rule
30(b) further provides: “The use of a selectively abridged
record allows the judges to refer easily to relevant parts of the
record and saves the parties the considerable expense of
reproducing the entire record.”

12

reasonably have been left with the “definite and firm
conviction” that the District Court had erred in its
findings.

If the Panel concluded that the District Court’s
factual findings, made after observing more than
three weeks of trial testimony, were unsupported by
the record and therefore “clearly erroneous,” then
the Panel should have addressed that issue.
Instead, the Panel elected to ignore the findings of
the District Court and conduct its own de novo
review of the incomplete record before it. In
reviewing the case in this manner, the Panel
violated Rule 52(a)’s requirements and this Court’s
precedent, which reversed the outcome of the case.

2. The Panel fundamentally erred by failing
to remand to the District Court.

In addition to the strictures imposed by Rule
52(a), this Court has further limited the scope of
permissible appellate fact finding where the
appellate court applies a different legal standard
than the district court and that standard requires
additional fact finding or calls into question fact
finding made under an incorrect legal standard. See
Pullman-Standard v. Swint, 456 U.S. 273 (1982);
Icicle Seafoods, Inc. v. Worthington, 475 U.S. 709
(1986). In such circumstances, the appellate court
must remand to allow the district court to engage in
additional fact finding unless there is only one
possible resolution of the factual issue. Swint, 415
U.S. at 292. In this case, the Panel ignored this
limitation on appellate review by adopting a more
rigorous legal standard and engaging in fact finding
even though the factual issues could be resolved in
more than one way.

13

A. The Fourth Circuit applied a different
legal standard that required additional fact
finding.

The Fourth Circuit Panel applied a much more
demanding standard than the District Court, which
resulted in the need for additional fact finding. As
noted, the District Court adopted the single syllabus
point from Bank of Bluefield v. Crawford, which
provides: “In the absence of privity of contract, an
accountant is liable for the negligent preparation of
a financial report only to those he knows will be
receiving and relying on the report.” 386 S.E.2d 310
(W. Va. 1989). In West Virginia, syllabus points are
written by the Supreme Court of Appeals and are,
constitutionally, the law of the state. W. Va. Const.
art. 8, § 4. The Bank of Bluefield court surveyed the
law and favorably considered the Restatement
(Second) of Torts but did not adopt it wholesale in
the Syllabus, as it has in other cases.

On the other hand, the Fourth Circuit narrowly
construed the holding of Bank of Blueficld and
predicted the adoption of, and then applied, a six-
factor test established by the First Circuit predicting
that Massachusetts would adopt Restatement
(Second) of Torts § 552. Pet. App. A-18. Under the
new six-factor standard, a finding of liability
requires the injured party to establish: (1)
inaccurate information; (2) negligently supplied; (3)
in the course of an accountant’s professional
endeavors; (4) to a third person or limited group of

3 Compare Syllabus, Bank of Bluefield, 386 S.E.2d 310 (W.
Va. 1989), with Syl. Pt. 3, State ex re] Elish v. Wilson, 434
S.E.2d. 411 (W. Va. 1993), and Syl. Pt. 3, Logan Bank & Trust
Co. v. The Letter Shop, Inc., 437 S.E.2d. 271 (W. Va. 1993).

14

third persons for whose benefit and guidance the
accountant actually intends or knows will receive the
information; (5) for a transaction (or for a
substantially similar transaction) that the
accountant actually intends to influence or knows
that the recipient so intends; (6) with the result that
the third party justifiably relies on such information
to his detriment. Jd.

As applied by the Panel, the new test differs from
the Bank of Bluefield test in at least three material
respects. First, as part of the fourth element, the
Panel concluded that Mr. Ellis was required to show
that Grant Thornton knew that Mr. Ellis was one
member of a “limited group of persons for whose
benefit the audit report was prepared” when Grant
Thornton decided to give Keystone a clean audit
opinion. Pet. App. A-18 - A-22. This temporal
requirement is not stated anywhere in Bank of
Bluefield, much less in the Syllabus relied upon by
the District Court.

Second, with regard to the fifth element, the
Panel concluded that this element could only be met
if the original “transaction” contemplated reliance on
the audit opinion by third parties, and that Mr. Ellis’
decision regarding accepting the Presidency of
Keystone was not such a transaction. Pet. App. A-22
- A-25. As with the fourth element, this rigid
interpretation of the fifth element introduces a
temporal requirement that was not considered in
Bank of Bluefield. In other words, the Bank of
Bluefield court never considered or held that an
accountant could be shielded from liability in
circumstances where the accountant affirmatively
made negligent assurances to a_ third-party

15

regarding the accountant’s opinions after the
accountant was originally engaged, as occurred here.
Yet the Panel’s conclusion completely exonerated
Grant Thornton, and Mr. Quay, from. the
consequences of their admittedly negligent oral
representations—made to Mr. Ellis’ face—that the
bank would receive a clean audit, and their
subsequent final written audit opinion which did the
same.

Third, as applied by the Fourth Circuit, the sixth
element of the new test requires that reliance must
be justified. Pet. App. A-25. Again, the Bank of
Bluefield Syllabus does not include this requirement.
Instead, Bank of Bluefield only requires that the
accountant know that a third party “will be receiving
and relying on the report.” Syl. Pt. 1, Bank of
Bluefield, 386 S.E.2d at 310. The district court
specifically found, as required by Bank of Bluefield,
that Quay and Grant Thornton knew Mr. Ellis would
be receiving and relying on their representations,
and that such reliance was “reasonable.” As a result
of the Panel’s new legal requirements, additional
factual findings were apparently required regarding
“justification,” but neither the parties nor the district
court have had an opportunity to address this
requirement.

B. This Court has required remand in
closely analogous cases where a new standard
was applied and there was more than one
possible resolution.

This Court addressed the issue of remand under
similar circumstances in /fPullman-Standard Vv.
Swint, 456 U.S. 273 (1982), and found that remand
was required. In Swint, the Fifth Circuit corrected

16

legal standards applied by a district court and made
factual findings related to the corrected legal
standards, some of which conflicted with the factual
findings made by the district court. Jd. at 279-285.

Upon review, this Court held: “When an
appellate court discerns that a district court has
failed to make a finding because of an erroneous
view of the law, the usual rule is that there should
be a remand for further proceedings to permit the
trial court to make the missing findings.” /d. at 291.
The Court further held, “Where findings are infirm
because of an erroneous view of the law, a remand is
the proper course unless the record permits only one
resolution of the factual issue.” Swint, 415 U.S. at
292. In reversing the Fifth Circuit’s decision and
requiring remand, this Court reasoned that
“factfinding is the basic responsibil‘ty of district
courts, rather than appellate courts, and .. . the
Court of Appeals should not have resolved in the
first instance this factual dispute which had not
been considered by the District Court.” Jd. at 291-
292 (quoting DeMarco v. United States, 415 U.S. 449
(1974)).

This Court again addressed closely analogous
circumstances in TIcicle Seafoods, Ince. V.
Worthington, 475 U.S. 709 (1986), and held that
remand was required. In Icicle Seafoods, the Ninth
Circuit, like the Panel here, stated that the standard
of review for factual issues was clear error, but then
engaged in a de novo review of the record before it
and failed to discuss or analyze the district court's
factual findings. Jd. at 713-14. Also analogous to
this case, the Court of Appeals in Jcicle Seafoods
applied a new legal standard and made

17

determinative factual findings instead of remanding
to the district court. Jd. at 714. This Court found
that the Court of Appeals was mistaken to engage in
such fact finding, reversed the Court of Appeal’s
opinion, and required remand. In so doing, this
Court stated: “If the Court of Appeals believed that
the District Court had failed to make findings of fact
essential to a proper resolution of the legal question,
it should have remanded to the District Court to
make those findings.” /d. at 714.

In this case, the Panel ignored the holdings of
both Swint and Jcicle Foods by failing to remand
even though there clearly was more than one
possible resolution to the factual issues addressed by
the Panel. Importantly, the Panel could not possibly
have known whether the District Court’s factual
conclusions were flawed because the Panel did not
have the entire record. Pet. App. A-161 - A-162.
Moreover, it is axiomatic that there was more than
one possible resolution of the factual issues because
the Trial Court and the Panel reached different
conclusions on several determinative factual issues.
As explained, the District Court—after observing
weeks of trial testimony and having access to all
relevant documents—made factual findings that
were inconsistent with findings made by the Panel.
Based on these inconsistent findings alone, the
Panel should have applied the holdings of Swint and
Icicle Foods and remanded for further fact finding.

Conclusion

The Panel’s decision to engage in de novo fact
finding instead of remanding—despite predicting a
new legal standard and not having the entire
record—constitutes a dramatic failure to abide by

18

fundamental rules of appellate review. This error
deprived Mr. Ellis of a predictable and fair review
process and usurped the fact-finding authority
vested in the District Court. The result, if allowed to
stand, establishes new precedent that will deter
litigants from considering bench trials as more
efficient alternatives to jury trials and_ will
undermine confidence in the appellate process. For
these reasons, this Court should exercise its
supervisory powers and grant this Petition for a Writ

of Certiorari.
Age
ae

Benjamin L. Bailey*

Eric B. Snyder

Rodney A. Smith**
BAILEY & GLASSER LLP
209 Capitol Street
Charleston, WV 25301
(304) 345-6555

(304) 342-1110 Facsimile

*Counsel of Record
** Admission Pending

October 20, 2008 Counsel for Petitioner

A-1

PUBLISHED
UNITED STATES COURT OF APPEALS
FOR THE FOURTH CIRCUIT

GARY ELLIS,

Plaintiff-Appellee,
Vv. 07-1352
GRANT THORNTON LLP,

Defendant-Appellant.

Appeal from the United States District Court for the
Southern District of West Virginia, at Bluefield.
David A. Faber, Chief District Judge.
(1:04-cv-00043)

Argued: March 19, 2008
Decided: June 25, 2008
[Entered: June 25, 2008]

Before DUNCAN, Circuit Judge, HAMILTON,
Senior Circuit Judge, and William L. OSTEEN, Jr.,
United States District Judge for the Middle District
of North Carolina, sitting by designation. Reversed
by published opinion. Senior Judge Hamilton wrote
the opinion, in which Judge Duncan and Judge
Osteen joined.

A-2

COUNSEL

ARGUED: Stanley Julius Parzen, MAYER BROWN,
L.L.P., Chicago, Illinois, for Appellant. Benjamin Lee
Bailey, BAILEY & GLASSER, L.L.P., Charleston,
West Virginia, for Appellee. ON BRIEF: John H.
Tinney, Kimberley R. Fields, THE TINNEY LAW
FIRM, P.L.L.C., Charleston, West Virginia; Bradley
J. Andreozzi, AYER BROWN, L.L.P., Chicago,
Illinois; Mark W. Ryan, Andrew J. Morris, MAYER
BROWN, L.L.P., Washington, D.C., for Appellant.
Eric B. Snyder, BAILEY & GLASSER, L.L.P.,
Charleston, West Virginia, for Appellee.

OPINION

HAMILTON, Senior Circuit Judge: The principal
issue presented in this appeal is whether Grant
Thornton LLP (Grant Thornton), an accounting firm
retained by First National Bank of Keystone
(Keystone), in response to an investigation by the
Office of the Comptroller of the Currency (OCC) into
Keystone’s banking activities, owed a duty of care
under the West Virginia law of negligent
misrepresentation to Gary Ellis, who allegedly relied
on oral statements made by Stan Quay (Quay), a
Grant Thornton partner, and a Grant Thornton
audit report of Keystone’s 1998 financial statements
in deciding to accept the job as president of
Keystone. We hold that Grant Thornton owed Ellis
no such duty under West Virginia law. Accordingly,
we reverse the judgment of the district court, which
found in favor of Ellis on his negligent
misrepresentation claim against Grant Thornton.

I

In late June 1999, the OCC began to intensify its
ongoing investigation into Keystone’s banking
activities. The OCC’s investigation revealed that
Keystone’s books overstated the value of the loans
Keystone owned by over $515 million. Based on
these overstatements, Keystone was declared
insolvent and was closed on September 1, 1999. This
case is yet another case that com’ s before this court
in the wake of Keystone’s collapse. See Gariety v.
Vorono, No. 06-2248, 2008 WL 110906 (4th Cir.
January 8, 2008) (unpublished) (civil action filed by
individuals who purchased Keystone stock between
September 28, 1998 and September 1, 1999); FDIC
v. Bakkebo, 506 F.3d 286 (4th Cir. 2007) (civil action
brought by FDIC); Gariety v. Grant Thornton, LLP.
368 F.3d 356 (4th Cir. 2004) (securities class action
by persons who purchased stock prior to Keystone’s
failure); United States v. Cherry, 330 F.3d 658 (4th
Cir. 2003) (criminal appeal); United States v.
Church, 11 Fed. App’x. 264 (4th Cir. 2001)
(unpublished) (same). This case concerns Ellis, who
took the job as president of Keystone in April 1999.
According to Ellis, he took the position only because
he relied on negligent misrepresentations made by
Quay and made by Grant Thornton in the audit
report.

A

Prior to 1992, Keystone was a small community
bank providing banking services to clients located
primarily in McDowell County, West Virginia.

Before its collapse, Keystone was a national] banking
association within the Federal Reserve System, the
deposits of which were insured by the FDIC.

In 1992, Keystone began to engage in an
investment strategy that involved the securitization
of high risk mortgage loans. Between 1992 and 1998,
Keystone originated nineteen securitizations. In
general, Keystone would acquire Federal Housing
Authority or high loan to value real estate mortgage
loans from around the United States, pool a group of
these loans, and sell interests in the pool through
underwriters to investors. The pooled loans were
serviced by third-party loan servicers, including
companies like Advanta and Compu-Link. Keystone
retained residual interests (residuals) in each loan
securitization. The residuals were subordinated
securities that would receive payments only after all
expenses were paid and all investors in each
securitization pool were paid. Thus, Keystone stood
to profit from a securitization only after everyone
else was paid in full. The residuals were assigned a
value that was carried on the books of Keystone as
an asset. Over time, the residual valuations came to
represent a significant portion of Keystone’s book
value.

From 1993 until 1998, when the last loan
securitization was completed, the size and frequency
of these transactions expanded from about $33
million to approximately $565 million for the last
one in September 1998. All told, Keystone acquired
and securitized over 120,000 loans with a total value
in excess of $2.6 billion.

The loan securitization business appeared to be
quite profitable. On paper, Keystone’s assets grew
from $107 million in 1992 to over $1.1 billion in
1999. In reality, however, the securitization program
proved highly unprofitable. Due to the risky nature
of many of the underlying mortgage loans, the failure
rate was excessive. As a result, the residual interests
retained by Keystone proved highly speculative and,
in actuality, they did not perform well.

Keystone’s valuation of the residuals was greater
than their market value. J. Knox McConnell,
Keystone’s largest shareholder until his death, Terry
Church (Church), another Keystone director, and
others concealed the failure of the securitizations by
falsifying Keystone’s books. Bogus entries and
documents hid the true financial condition of
Keystone from the bank’s directors, shareholders,
depositors, and federal regulators.

Keystone’s irregular bank records drew the
attention of the OCC, which began an investigation
into Keystone’s banking activities. This investigation
revealed major errors in Keystone’s accounting
records that financially jeopardized Keystone. In
May 1998, the OCC required Keystone to enter into
an agreement obligating Keystone to take specific
steps to improve its regulatory posture and financial
condition. This agreement required Keystone to,
among other things, retain a nationally recognized
independent accounting firm "to perform an audit of
the Bank’s mortgage banking operations and
determine the appropriateness of the Bank's
accounting for purchased loans and all

securitizations." (J.A. 3043). In August 1998,
Keystone retained Grant Thornton as its outside
auditor.

Under the agreement between Grant Thornton
and Keystone, Grant Thornton was to, among other
things, perform for Keystone, in accordance with
Generally Accepted Auditing Standards (GAAS), an
audit of Keystone’s consolidated financial statements
as of December 31, 1998. Quay was the lead Grant
Thornton partner on the Keystone audit. Susan
Buenger (Buenger), a junior manager, performed
substantial work on the audit as well.

Grant Thornton performed the audit on
Keystone’s 1998 financial statements. Keystone’s
1998 financial statements reflected ownership of
more than $515 million in loans that it did not own.
Due to negligence on the part of both Quay and
Buenger, Grant Thornton’s audit did not uncover the
$515 million discrepancy.!! In fact, on March 24,
1999, Quay presented several members and
prospective members of Keystone’s board and
Keystone’s shareholders with draft copies of
Keystone’s 1998 financial statements and told them
that Keystone was going to get an unqualified or

! Grant Thornton does not challenge the district court’s
finding of negligence in this appeal, electing to assume, for the
sake of argument, that Quay and Buenger were negligent in
preparing the audit and making any statements concerning the
soundness of Keystone’s financial condition. Given Grant
Thornton’s position, we, too, will assume, without deciding,
that Quay and Buenger were negligent in preparing the audit
and making any statements concerning the soundness of
Keystone’s financial condition.

“clean” audit opinion on its 1998 financial
statements. (J.A. 2701).2 At the shareholders

2 Although accountants provide a variety of services to
clients, their primary function is auditing. Samuel S. Paschall,
Liability to Non-Clients: The Accountant's Role and
Responsibility, 53 Mo. L. Rev. 693, 698 (1988). In a typical
audit, the financial statements of an entity, usually a
corporation, are verified by examining the corporation's
accounting records and supporting evidence. Jd. After
examining such records and evidence, the accountant expresses
an opinion as to whether such statements fairly represent the
corporation’s actual financial position in accordance with the
Generally Accepted Accounting Principles (GAAP). Jd. at 698-
99. For practical reasons of cost and time, an accountant is
rarely able to examine every accounting transaction of a
corporation. Denise M. Orlinsky, Note, An Accountant's
Liability to Third Parties: Bily v. Arthur Young & Co., 43
DePaul L. Rev. 859, 862 (1994). Therefore, the performance of
an audit requires a high degree of professiona)] skill and
judgment, as the accountant can only test the output of the
corporation’s accounting systems. Jd. In performing an audit,
an accountant follows procedures outlined in the GAAS. Jd. The
end result of an audit is the audit report or opinion, which
evaluates the information obtained to determine whether the
corporation’s financial statements fairly represent the financial
position of the corporation in accordance with the GAAP. Jd. at
863-64. The audit opinion is usually expressed in a letter
addressed to the client and can be one of four types: an
unqualified audit opinion, a qualified audit opinion, an adverse
audit opinion, or a disclaimer audit opinion. /d. at 864. An
unqualified audit opinion is an expression of opinion by the
accountant without any exceptions, reservations, or
qualifications that the financial statements of the corporation
represent its financial position and the results of its operations.
Id. A qualified audit opinion, on the other hand, states that
improper accounting treatment has been applied to one or more
items and that, consequently, the financial statements are not
in compliance with the GAAP. 7d. at 865. An adverse audit
opinion is issued if any items have a material and pervasive

A-8

meeting the next day, Quay also distributed copies of
Keystone’s financial statements. At that time, Quay
reiterated that Keystone was going to get a clean
audit opinion on its 1998 financial statements.

On April 19, 1999, even though Keystone was, in
fact, insolvent as of the end of 1998, Grant Thornton
issued and delivered to Keystone’s board its audit
opinion stating that Keystone’s financial statements
were fairly stated in accordance with the GAAP and
reflecting a shareholder’s equity of $184 million. The
intent of the report was plainly stated on the first
page of the report: "This report is intended for the
information and use of the Board of Directors and
Management of The First National Bank of Keystone
and its regulatory agencies and should not be used
by third parties for any other purpose." (J.A. 2903).

The audited financial statements provided by
Quay to the board on April 19, 1999 were
substantially the same as the financial statements
Quay had provided board members and shareholders
in March 1999. Based on Grant Thornton’s audit
report, Keystone’s board continued to declare
dividends and operate the bank.

effect on the financial statement, thus destroying their fairness
of presentation. Jd. A disclaimer audit opinion is issued if the
accountant is unable to form an opinion because of serious
limitations on the scope of the examination of the audit. Jd. at
866. Typically, the corporation then uses this audit opinion for
its own business planning, and the audit opinion is used to
inform outside parties as to the financial health of the audited
company. Paschall, Liability to Non-Clients: The Accountant's
Role and Responsibility, 53 Mo. L. Rev. at 699.

A-9

B

In 1984, Gary Ellis was President of the Bank of
Dunbar. The Bank of Dunbar was later merged into
United National Bank (United) at which time Ellis
joined the management team at United, eventually
becoming its president. From the time of the merger
with the Bank of Dunbar until the time Ellis left
United, United more than doubled in size. In 1998,
United merged with George Mason Bankshares of
Virginia. In the spring of 1999, following the merger,
Ellis voluntarily began looking for employment
outside United. Ellis had dealt with Keystone in the
past, and, on March 19, 1999, Billie Cherry (Cherry),
chairman of Keystone’s board, called Ellis and
invited Ellis to attend Keystone’s annual
shareholders meeting on March 25, 1999. During the
call, Cherry suggested that Ellis should consider
becoming president of Keystone.

Ellis was not fired or told to leave United, had no
deadline for J icaving United, and could have
remained at United rather than leaving for the
Keystone position. Ellis attended Keystone’s board
meeting on March 24, 1999, at which the board
granted Ellis’ request to review, upon the signing of
a confidentiality agreement, the financial condition
of the bank. Although it is not clear from the record
whether a confidentiality agreement was signed, the
Keystone board permitted Ellis to discuss the
financial condition of the bank with Quay and other
Keystone insiders with the understanding that the
information be kept confidential. Consequently,
following the Keystone board meeting on March 24,

A-10

1999, Ellis met Quay and two other outside directors
at a bar at the Fincastle Country Club. Quay spoke
with Ellis and the two outside directors because
Keystone did not have a chief financial officer, thus
making Quay the only person capable of going over
the financial statements with the others. At the
country club, Quay told Ellis and the two outside
directors that Keystone was going to receive a "clean
[audit] opinion." (J.A. 401). Ellis also attended the
March 25, 1999 shareholders’ meeting at which
Quay informed the group that Grant Thornton was
going to give Keystone a clean audit opinion for
1998. On March 30, 1999, Ellis visited Keystone.
During this visit, Quay told Ellis once again that
Keystone would receive a clean audit opinion for
1998.

On April 2, 1999, Ellis met with his attorneys to
draft a proposed employment agreement with
Keystone. During the first two weeks of April 1999,
Ellis met with Church and others regarding
their expectations for him. It was decided that
Ellis would be responsible for the "“banking"
business at Keystone as opposed to the mortgage
loan securitizations. On April 19, 1999, at a
Keystone board meeting, Ellis reviewed Grant
Thornton’s final audit report on Keystone for
1998. The board voted to approve Ellis’ hiring
as president of Keystone. Ellis officially resigned
from United by letter dated April 20, 1999.
Ellis’ employment contract was signed on April 26,

A-1l

1999.3 According to Ellis, he relied on Grant
Thornton’s audit, which was consistent with Quay’s
earlier March 1999 statements that Grant Thornton
was going to issue a clean audit opinion for 1998, in
deciding to accept the job as president of Keystone.

C

After being named as a defendant in the Gariety
v. Grant Thornton, LLP securities class action, Ellis
filed a cross-claim against Grant Thornton for
negligent misrepresentation under West Virginia
law in which he sought to recover damages in the
form of lost earnings. The district court consolidated
Ellis’ negligent misrepresentation claim for trial
with the claims asserted by the FDIC in FDIC v.
Grant Thornton, LLP. 1:00-cv-0655, (S.D.W.Va.
January 15, 2004) (order). The case was tried in the
summer of 2004. In March 2007, the district court
ruled in favor of Ellis on his _ negligent
misrepresentation claim and found that he was
entitled to $2,419,233 in damages. The district court
found that, in accepting the job as president of
Keystone, "Ellis relied on the financial statements
Quay gave him," "Quay’s oral representations," and
the Grant Thornton audit report. (J.A. 2706). The
district court also found that "Quay intended and
knew that Ellis would rely on his statements." (J.A.
2707). In view of these findings of fact, the district
court concluded that Grant Thornton, as the auditor

3 Ellis signed a two-year contract at a base salary of
$375,000, plus benefits including the use of a corporate vehicle
and a country club membership. He also purchased $49,500 in
Keystone stock.

A-12

of Keystone, was liable to Ellis under the West
Virginia law of negligent misrepresentation, citing
First National Bank of Bluefield v. Crawford, 386
S.E.2d 310 (W. Va. 1989), because Grant Thornton
(through Quay’s oral statements and the audit °
report) made negligent misrepresentations
concerning the financial condition of Keystone
knowing that Ellis would receive and rely upon those
representations in making his decision to accept or
reject employment with Keystone. After ruling in
favor of Ellis, the district court deconsolidated Ellis’
negligent misrepresentation claim from the FDIC's
claims against Grant Thornton and _ entered
judgment in favor of Ellis in the amount of
$2,419,233. Grant Thornton noted a timely appeal.

II

On appeal from a bench trial, we may set aside
the district court’s findings of fact only if they are
clearly erroneous. Minyard Enter., Inc. _ v.
Southeastern Chem. & Solvent Co., 184 F.3d 373,
380 (4th Cir. 1999); Fed. R. Civ. P. 52(a). In
determining whether a finding of fact is clearly
erroneous, we must give due regard to the
opportunity of the district court to judge the
credibility of the witnesses. Fed. R. Civ. P. 52(a). A
finding of fact is clearly erroneous when, "although
there is evidence to support it, the reviewing court
on the entire evidence is left with the definite and
firm conviction that a mistake has been committed.”
United States v. United States Gypsum Co., 333 U.S.
364, 395 (1948). As a federal court sitting in
diversity, we have an obligation to apply the

A-13

jurisprudence of West Virginia’s highest court, the
Supreme Court of Appeals of West Virginia. Wells v.
Liddy, 186 F.3d 505, 527-28 (4th Cir. 1999). In a
situation where the state’s highest court has spoken
neither directly nor indirectly on the particular issue
before us, we are called upon to predict how that
court would rule if presented with the issue. /d. In
this case, we are called upon to predict whether,
under the facts of this case, Grant Thornton owed
Ellis a duty of care under the West Virginia law of
misrepresentation.

In Bank of Bluefield, the Supreme Court of
Appeals of West Virginia addressed the question of
whether the lack of privity of contract between an
accountant and a bank was a complete defense to the
bank’s suit against the accountant for professional
negligence in preparing a financial statement. 386
S.E.2d at 310-11. The court answered that question
in the negative. Jd. at 315. In Bank of Bluefield, the
bank alleged that the accountamt had been
professionally negligent in preparing a financial
statement for a construction cOmpany upon which
the bank had relied in determining whether to give
the construction company a loan. The parties
stipulated that: (1) the bank informed the
accountant that it would need the financial
statement prior to the October 5, 1984 closing of the
loan; (2) the financial statement was delivered to the
bank before the closing date; (3) the bank alleged
that it reasonably relied on the financial statement
in making the loan to the construction company; and
(4) there was no privity of contract between the bank
and the accountant. The state trial court in Bank of

A-14

Bluefield held that, in the absence of contractual
privity between the parties, the bank could not
recover from the accountant. Jd. at 311.

In resolving the issue before it, the court in Bank
of Bluefield discussed the four approaches to
resolving the question of under what circumstances
an accountant can be liable to third parties for a
negligent misrepresentation. Jd. at 311-13. The first
of these approaches was announced in Ultramares
Corp. v. Touche, 174 N.E. 441 (N.Y. 1931), which
held that negligence actions were only permitted by
parties in privity of contract or in a situation so close
as to approach that of privity. Jd. at 182-83. The
second approach was also developed by the New
York Court of Appeals, which slightly modified the
Ultramares Corp. approach in 1985. See Credit
Alliance Corp. v. Arthur Andersen & Co., 483 N.E.2d
110 (N.Y. 1985) (relaxing the strict Ul/tramares Corp.
privity doctrine by requiring a_ relationship
"sufficiently approaching privity").4 The third

4 Credit Alliance Corp. announced the following three-prong
test for determining whether an accountant can be held liable
for negligence to a third party who has detrimentally relied on
inaccurate financial statements: (1) the accountant must have
been aware that the financial reports were to be used for a
particular purpose or purposes; (2) in the furtherance of which
a known party or parties was intended to rely; and (3) there
must have been some conduct on the part of the accountant
linking him to that party or parties, which evinces the
accountant’s understanding of that party or parties’ reliance.
483 N.E.2d at 118. The Credit Alliance Corp. approach is often
referred to as the “near-privity" approach. First Nat? Bank of
Commerce v. Monco Agency, Inc., 911 F.2d 1053, 1058 (5th Cir.
1990).

A-15

approach is set forth in § 552 of the Restatement
(Second) of Torts. Under this approach, a person or a
limited class of persons who the auditor can foresee
as parties who will (and do) rely upon financial
statements are allowed to recover. Restatement
(Second) of Torts § 552(1)-(2). The fourth approach is
the reasonably foreseeable approach, which permits
all parties who are reasonably foreseeable recipients
of financial statements for business purposes to
recover as long as they rely on the statements for
those business purposes. See, e.g., H. Rosenblum,
Inc. v. Adler, 461 A.2d 138, 142-46 (N.J. 1983).5
After summarizing these four approaches, the court
in Bank of Bluefield adopted the Restatement § 552
approach for West Virginia, finding that the rule

5 Although it is sometimes difficult to discern the
differences between the four approaches, appropriate lines can
be drawn between the restrictive UlJtramares Corp., Credit
Alliance Corp., and Restatement approaches and the
nonrestrictive foreseeability approach. For example, although
the Restatement’s approach expands liability to a larger
potential class of third parties than do the U/tramares Corp.
and Credit Allianeve Corp. approaches, it does not extend
liability beyond an identified third party, 7 known third party,
or third parties who enter into the same type of transaction as
originally contemplated. In other words, under the U/tramares
Corp. and Credit Alliance Corp. approaches, "the precise
identity of the informational consumer [must] be foreseen by
the auditor," Monco Agency, Inc., 911 F.2d ai 1059, but, under
the Restatement approach, the precise “informational
consumer” need not be known, /d.; rather the Restatement
approach “contemplates identification of a narrow group, not
necessarily the specific membership within that group." Jd.
Moreover, unlike the foreseeability approach, the Restatement
approach does not extend to “every reasonably foreseeable
consumer of financial information.” /d. at 1060.

A-16

stated therein was "more appropriate because it
imposes a standard of care only to known users who
will actually be relying on the information provided
by the accountant." 386 S.E.2d at 313; see also id. at
310 Syllabus of the Court ("In the absence of privity
of contract, an accountant is liable for the negligent
preparation of a financial report only to those he
knows will be receiving and relying on the report.").®
In view of the court’s adoption of the Restatement
approach in Bank of Bluefield, the court answered
the certified question—was privity a defense—in the
negative. Jd. at 315. Consequently, other than the
adoption of the Restatement approach, the Bank of
Bluefield court gave no further meaningful guidance
concerning under what circumstances an accountant
can be liable to third parties for negligent
misrepresentations under § 552. Restatement
(Second) of Torts § 552 provides in relevant part:

(1) One who, in the course of his business,
profession or employment, or in any other
transaction in which he has a pecuniary
interest, supplies false information for the
guidance of others in their business
transactions, is subject to liability for

6 We note that the Bank of Bluefield court did not identify
what constitutes a "known" user, the definition of which is
important to separate the third parties entitled to recover
under the Restatement approach and not entitled to recover
under the Ul/tramares Corp. and Credit Alliance Corp.
approaches. Such a demarcation, however, was not essential to
the Bank of Bluefield court's rejection of these approaches, so
its failure to employ precise cabining language is
understandable.

A-17

pecuniary loss caused to them by their
justifiable reliance upon the information, if he
fails to exercise reasonable care or competence
in obtaining or communicating’ the
information.

(2) [T]he liability stated in Subsection (1) is

limited to loss suffered (a) by the person or .
one of a limited group of persons for whose

benefit and guidance he intends to supply the

information or knows that the recipient

intends to supply it; and

(b) through reliance upon it in a transaction
that he intends the information to influence or
knows that the recipient so intends or in a
substantially similar transaction.

Restatement (Second) of Torts § 552(1)-(2). The
Restatement approach is deliberately restrictive to
encourage the free flow of commercial information.
See id. § 552, cmt. ("By limiting the liability for
negligence of a supplier of information to be used in
commercial transactions to cases in which he
manifests an intent to supply the information for the
sort of use in which the plaintiffs loss occurs, the
law promotes the important social policy of
encouraging the flow of commercial information
upon which the operation of the economy rests."). It
also seeks to protect suppliers of commercial
information from liability in instances in which they
oblige themselves to provide information but the
terms of the obligation are unknown to them. See id.
(‘A user of commercial information cannot

A-18

reasonably expect its maker to have undertaken to
satisfy this obligation unless the terms of the
obligation were known to him.").

Although the West Virginia Supreme Court of
Appeals in Bank of Bluefield did not set forth what
must be proven by an injured third party proceeding
under § 552 against an accountant for the
accountant’s negligent misrepresentations, other
courts have set forth six elements that essentially
track the language of the Restatement. See, e.g., N.
Am. Specialty Ins. Co. v. Lapalme, 258 F.3d 35, 41-
42 (1st Cir. 2001) (setting forth six elements). Under
this authority, a finding of liability requires the
injured party to prove (1) inaccurate information, (2)
negligently supplied, (3) in the course of an
accountant’s professional endeavors, (4) to a third
person or limited group of third persons for whose
benefit and guidance the accountant actually intends
or knows will receive the information, (5) for a
transaction (or for a _ substantially similar
transaction) that the accountant actually intends to
influence or knows that the recipient so intends, (6)
with the result that the third party justifiably relies
on such misinformation to his detriment. Jd. The
third party has the burden of proving each of these
elements. Jd. at 42. Moreover, the accountant’s
“actual knowledge . . . should be ascertained at the
time the audit report or financial statement is
issued." Jd. at 39, 42.

In this case, the record simply is devoid of
evidence suggesting that Ellis proved the fourth,
fifth, and sixth elements. With regard to the fourth

A-19

element, it is clear that Ellis failed to show that
Grant Thornton knew (or intended) that potential
employees, like Ellis, were intended to receive the
audit report for their benefit and guidance. The
audit report was delivered to the board of directors
of Keystone. The audit report plainly states that the
audit report was not intended for use by third
parties. Rather, the audit report was prepared for
the benefit of Keystone and the OCC, which is
entirely consistent with the agreements between
Keystone and the OCC and between Keystone and
Grant Thornton. Thus, Ellis, or any other potential
employee, was not a member of any limited group of
persons for whose benefit the audit report was
prepared.

Perhaps recognizing the tenuousness of relying
on the audit report itself, especially since he signed
his employment contract a week after the audit
report was issued to the board, Ellis relies heavily on
Quay’s statements in March 1999 indicating that
Grant Thornton was going to give Keystone a clean
audit opinion.? Of course, reliance on Quay’s
statements improves the position of Ellis, as Quay’s
statements did not include a disclaimer. However,
the Restatement approach instructs that we should

7 Grant Thornton claims that oral statements can never
form the basis of liability under § 552 when such statements
are made before the release of the final audit opinion. We need
not decide this issue because, even assuming as we do for
purposes of this appeal that oral statements made before the
release of the final audit opinion can form the basis of auditcr
liability under § 552, Ellis cannot prevail.

A-20

assess cases in light of "[t]he ordinary practices and
attitudes of the business world." Restatement
(Second) of Torts § 552, cmt. j. Viewed in this light, it
is clear that Grant Thornton was Keystone’s auditor
and was hired to conduct an audit for the benefit of
Keystone and the OCC. Grant Thornton was not
hired to go over with each potential employee the
soundness of Keystone’s financial condition. Indeed,
throughout most of the course of the audit report’s
preparation, Ellis was an unknown, unidentified
potential employee of Keystone. Grant Thornton was
not aware of the existence of the potential
employment transaction between Ellis and Keystone
until after Grant Thornton reached its decision to
give Keystone a clean audit opinion. If the scope of
the audit involved potential employees, one would
expect at least some knowledge on the part of Grant
Thornton before they formed their audit opinion.

Moreover, Quay first informed the board of
directors on March 24, 1999 that Grant Thornton
was going to give Keystone a clean audit opinion.
Thus, the clean audit opinion information was
disclosed for the benefit of Keystone’s board and not
potential employees such as Ellis. Ellis’ attempt at
turning Quay’s clean audit opinion statements into
ones for his benefit, by virtue of his meetings with
Quay, ignores the business reality that Grant
Thornton was hired and performed the audit for the
benefit of Keystone and the OCC. It also ignores the
fact that any release of information to Ellis was done
at the behest of Keystone, not Grant Thornton.
There is no evidence in the record to support the
conclusion that Ellis was a member of any limited

A-21

group of persons for whose benefit Quay’s
statements were made.

Our conclusion concerning the fourth element is
buttressed by Illustration 10 in § 552. That
illustration provides:

A, an independent public accountant, is
retained by B Company to conduct an annual
audit of the customary scope for the
corporation and to furnish his opinion on the
corporation’s financial statements. A is not
informed of any intended use of the financial
statements; but A knows that the financial
statements, accompanied by an auditor's
opinion, are customarily used in a wide
variety of financial transactions by the
corporation and that they may be relied upon
by lenders, investors, shareholders, creditors,
purchasers and the like, in numerous possible
kinds of transactions. In fact B Company uses
the financial statements and accompanying
auditor's opinion to obtain a loan from X
Bank. use of A’s negligence, he issues an
unqudlifiedly favorable opinion won a
balance sheet that materially misstates the
financial position of B Company, and through
reliance upon it X Bank suffers pecuniary loss.
A is not liable to X bank.

Id. § 552, cmt. h, illus. 10. Illustration 10, we believe,
is materially indistinguishable from our case. Like
the accountant in the illustration, Grant Thornton
was not aware of an intended use of its audit opinion

A-22

beyond the customary business planning use of an
audit opinion by a corporation such as Keystone and
the use by the OCC for oversight, as it was hired "to
conduct an annual audit of the customary scope for
[Keystone] and to furnish [its] opinion on
[Keystone’s] financial statements." Jd. Indeed, Grant
Thornton was not aware that any potential employee
of Keystone was going to base their decision to seek
employment with Keystone on the outcome of the
audit. Rather, in performing its audit function,
Grant Thornton was aware that its audit opinion
and any statements made leading up to the issuance
of the audit opinion may be rehed upon by ;
shareholders, investors, and perhaps potential |
employees such as Ellis. However, more than a
tenuous awareness of this sort is required to impose

liability on Grant Thornton. To hold otherwise would
transform the Restatement approach into the
foreseeability approach, which the court in Bank of
Bluefield clearly rejected. Ellis was required to show

that Grant Thornton knew that its audit opinion

would be used by Keystone to assist potential
employees in making their decision concerning
whether to come to work for Keystone. The record

simply does not demonstrate that Ellis made such a
showing.

,
:

With regard to the fifth element's substantiality
requirement, we examine two questions. First, we
examine, from the accountant’s standpoint, what
risks he reasonably perceived he was undertaking
when he delivered the challenged report or financial
statement. Lapalme, 258 F.3d at 41. If the
accountant is unaware of a potential risk, then

A-23

liability cannot attach. Next, we make an objective
comparison between the transaction to which the
accountant had actual knowledge and _ the
transaction that in fact occurred. Jd. This
comparison cannot be hypertechnical, but, rather,
must be conducted in light of customary business
world practices and attitudes. Restatement (Second)
of Torts § 552, cmt. j. "The goal of this inquiry is to
determine whether the two transactions share
essentially the same character. If so, the actual
transaction is substantially similar to _ the
contemplated transaction (and, therefore, liability-
inducing)." Lapalme, 258 F.3d at 41. When Grant
Thornton issued its audit report, it was not
assuming the risk that third parties would rely on
the report. As noted above, the report itself states
that it is not to be used by third parties. To the
extent that Ellis relied on Quay’s statements, it
cannot be said that Grant Thornton was assuming
the risk of being liable for Ellis’ future lost earnings.
The audit opinion was formed by the time Quay met
with Ellis, and Quay was simply repeating
information that was earlier disclosed to the
Keystone board in his presence. With regard to the
objective comparison, the liability of the maker of a
negligent misrepresentation extends "to _ all
transactions of the type or kind that the maker
intends or has reason to expect." Restatement
(Second) of Torts § 552, cmt. j. For example,
"independent public accountants who negligently
make an audit of books of a corporation, which they
are told is to be used only for the purpose of
obtaining a particular line of banking credit, are not

A-24

subject to liability to a wholesale merchant whom
the corporation induces to supply it with goods on
credit by showing him the financial statements and
the accountant’s opinion." Jd. Moreover, an
accountant who negligently conducts an audit for A
corporation knowing that A corporation is going to
show the audit to B corporation as a basis for the
extension of credit from B corporation is not liable to
B corporation if B corporation buys a controlling
interest in A corporation in reliance upon the audit.
Id. § 552, cmt. j, illus. 14. Thus, when the character
of the transaction materially changes, there is no
liability. See Lapalme, 258 F.3d at 44 ("Even if the
change involves a new transaction, rather than
merely a modification of the earlier (known)
transaction, the accounting firm might still be held
liable if the identity of the third party is unchanged,
the type of transaction pretty much the same, and
the firm’s exposure relatively constant.").

Here, Grant Thornton was hired to conduct an
audit of Keystone. It was aware at the time it was
hired and during the auditing process that the audit
was being done for the benefit of Keystone and the
OCC. It was not aware during this process that its
audit was being performed for the benefit of
potential employees of Keystone. Indeed, there
simply is no evidence in the record that Grant
Thornton cared one way or the other who Keystone
hired or whether Ellis became president of Keystone.
In fact, Ellis was not even on the radar screen until
after Grant Thornton concluded that it was going to
issue Keystone a clean audit opinion. Moreover, any
release of information to Ellis was done at the behest

A-25

of Keystone, not Grant Thornton. This fact further
suggests that Grant Thornton never intended to
deviate from its standard auditing functions. In
short, to find the fifth element satisfied, we would
have to materially change the transaction from an
audit undertaken to benefit Keystone and the OCC
to one intended to benefit potential employees of
Keystone. Such a material change to the nature of
the transaction is prohibited under the Restatement
approach.

Ellis fares no better on the sixth element.
Unquestionably, given that the audit report stated
that it was not intended for use by third parties,
Ellis could not justifiably rely on the audit report in
signing his employment contract with Keystone.
With regard to Quay’s oral assurances, likewise,
Ellis could not justifiably rely on those statements.
First, Ellis was aware at the time he signed his
employment contract that the audit report was not
to be used by third parties. A person as sophisticated
and experienced in the banking business as Ellis is,
he knew he could not justifiably rely on Quay’s
statements when the report itself stated otherwise.
Moreover, as previously noted, Quay’s statements
concerning the clean audit opinion were offered by
Quay to the board and the shareholders to apprise
the board and the OCC of Keystone’s financial
condition. They were not offered to induce
individuals to accept employment with Keystone. As
such, it is difficult to discern how an individual as
sophisticated and experienced as Ellis would
justifiably rely on this information in accepting a job
at Keystone.

Ill

For the reasons stated herein, the judgment of
the district court is reversed.

REVERSED

A-27 :

"'
:

FILED: June 25, 2008
[Entered: June 25, 2008]

UNITED STATES COURT OF APPEALS
FOR THE FOURTH CIRCUIT

No. 07-1352
(1:04-cev-00043)

GARY ELLIS,
Plaintiff - Appellee

Vv.

GRANT THORNTON LLP,
Defendant - Appellant

JUDGMENT

In accordance with the decision of this Court, the
judgment of the District Court is reversed.

This judgment shall take effect upon the issuance
of this Court’s mandated in accordance with Red. R.
App. P. 41.

/s/ Patricia S. Connor, Clerk

A-28

FILED: July 22, 2008
(Entered: July 22, 2008]

UNITED STATES COURT OF APPEALS
FOR THE FOURTH CIRCUIT

No. 07-1352
(1:04-cv-00043)

GARY ELLIS,
Plaintiff - Appellee

Vv.

GRANT THORNTON LLP,
Defendant - Appellant

ORDER

The Court denies the petition for rehearing and
rehearing en banc. No poll was requested on the
petition for rehearing en banc.

Entered at the direction of Senior Judge
Hamilton, with the concurrence of Judge Duncan.
Judge Osteen voted to grant panel rehearing.

For the Court
/s/ Patricia S. Connor, Clerk

A-29

IN THE UNITED STATES DISTRICT COURT
FOR THE SOUTHERN DISTRICT OF
WEST VIRGINIA
BLUEFIELD

GARY ELLIS,
Plaintiff,

v. CIVIL ACTION NO. 1:04-0043

GRANT THORNTON, LLP,
Defendant.

[Entered: March 14, 2007]
JUDGMENT ORDER

For reasons expressed in the Findings of Fact and
Conclusions of Law filed this day in consolidated
Civil Actions Nos. 1:00-0655, 1:03-2129, and 1:04-
0043, the court hereby ENTERS JUDGMENT in
favor of Gary Ellis on his claim against Grant
Thornton in the amount of $2,419,233, with post-
judgment interest and costs.

The Clerk is directed to send a copy of this
Judgment Order to counsel of record.

IT IS SO ORDERED this 14th day of March, 2007.

ENTER:
ENTER:
/s/ David A. Faber
David A. Faber
Chief Judge

A-30

IN THE UNITED STATES DISTRICT COURT
FOR THE SOUTHERN DISTRICT OF
WEST VIRGINIA

GRANT THORNTON, LLP,
Plaintiff,
CIVIL ACTION NO. 1:00-0655
FEDERAL DEPOSIT INSURANCE
CORPORATION,
Defendant:
and
FEDERAL DEPOSIT INSURANCE
CORPORATION,
Plaintiff,
CIVIL ACTION NO. 1:03-2129
GRANT THORNTON, LLP,
Defendant;
and
GARY ELLIS,
Plaintiff,
Vv. CIVIL ACTION NO. 1:04-0043
GRANT THORNTON, LLP,
Defendant.

[Entered: March 14, 2007]

FINDINGS OF FACT AND
CONCLUSIONS OF LAW

DAVID A. FABER, Chief Judge.

A-31

INTRODUCTION

A bench trial was held on May 17, 2004, through
June 10, 2004. Closing arguments were held on
August 20, 2904. Set forth herein are the court's

findings of fact and conclusions of law pursuant to
Fed.R.Civ.P. 52.

Because this case was tried before the court as a
bench trial, the court's findings are presumed to be
based on admissible evidence. Fishing Fleet, Inc. v.
Trident Ins. Co., Ltd., 598 F.2d 925, 929 (5th Cir.
1979); see also Chicago Title Ins. Co. v. IMG Exeter
Associates Ltd. P’ship, 985 F.2d 553, 1993 WL 27392
at *4 (4th Cir. 1993) (unpublished); see also Harris
v. Rivera, 454 U.S. 339, 346, 102 S.Ct. 460, 70
L.Ed.2d 530 (1981) (“In bench trials, judges routinely
hear inadmissible evidence that they are presumed
to ignore when making decisions.”). Accordingly, the
court finds it unnecessary to rule on each separate
objection raised by the parties. The court has
considered those objections relating to the evidence
supporting the findings contained herein and, to the
extent such objections relate to the evidence which
the court cites in support of its findings, such
objections are hereby overruled.

VINDINGS OF FACT
I. Background

1. The First National Bank of Keystone
(“Keystone” or the “Bank”) located in Keystone,

McDowell County, West Virginia, was incorporated
in 1904 under the National Banking Act. GT Ex. 22.

A-32

Prior to 1992, Keystone was a small community
bank servicing primarily McDowell County and the
surrounding area. Keystone was a national banking
association within the Federal Reserve System, the
deposits of which were insured by the Federal
Deposit Insurance Corporation (“FDIC”). Keystone's
principal place of business was in West Virginia.
Prior to his death in 1997, J. Knox McConnell, the
Bank's president and its largest shareholder,
controlled Keystone. FDIC Ex. 431 at 2-3.

2. From at least 1992 through October 1997,
Keystone's board of directors consisted of two inside
directors, J. Knox McConnell and Billie Cherry, and
outside directors Michael Gibson, a local attoraey;
Andres Rago, a local doctor; Julian Budnick, a
retired furniture salesman; and Louis Pais, a retired
beer distributor. When McConnell died in October
1997, Terry Church replaced him on the board. At
the same time, Billie Cherry became president of the
Bank, and Melissa Quizenbeury, a_ long-time
employee, became a director. Gibson, May 20, 2004,
Tr. at 7, 10; FDIC Exs. 90, 124, 248 at 2; GT Exs.
208, 625. After McConnell's death, Church controlled
every material aspect of the Bank's operations.
Carney, May 19, 2004, Tr. at 69-71; Quay, June 4,
2004, Tr. at 13-14; FDIC Ex. 417 at 3. Church was
also the executrix of McConnell's estate, giving her

control of the largest single block of Keystone stock.
FDIC Ex. 248 at 2.

3. In December 1998, Julian Budnick resigned
from the board and was replaced by his son Victor
Budnick, an attorney. Budnick, May 18, 2004, Tr. at

A-33

86-88; Gibson, May 20, 2004, Tr. at 10. In March
1999, two new directors were elected: Bernard
Kaufman, a retired attorney and investor, and
Daniel Halsey, a local car dealer. Most of the outside
directors owned sizable blocks of Keystone stock, and
outside director Gibson actually bought more stock
during the last few months of the Bank's existence.
Gibson, May 20, 2004, Tr. at 58; FDIC Ex. 248 at 2,
FDIC Exs. 263, 880.

4. This civil action arises from the fraudulent
operation and eventual collapse of Keystone. The
fraud was conceived and perpetrated by senior bank
management and continued for years until detected.
In addition to McConnell, who died in October, 1997,
before the Bank was closed, the principal
perpetrators of the fraud, all Keystone insiders, were
Terry Church, Michael Graham and Billie Cherry.
FDIC Exs. 431, 432. Church, Graham and Cherry
have all been convicted of numerous felonies, their
convictions have been affirmed on appeal, and all
three were sentenced to lengthy terms of
incarceration.! FDIC Exs. 430, 433, 434, 435, 558,
560, and 579. For several years the wrongdoers
successfully concealed the fraud from the public,
from the Bank's examiners, from the Bank's board of
directors, and even from some of Keystone's own
senior management.

5. Central to the fraud was an investment
strategy that involved securitization of high risk

1 On December 29, 2006, Cherry died of a cerebral
hemorrhage while in federal custody.

A-34

mortgage loans. Beginning in 1992, Keystone
originated nineteen securitizations over a six-year
period. GT Ex. 514. Keystone would acquire Federal
Housing Authority (“FHA”) or high loan to value real
estate mortgage loans from around the United
States, pool a group of these loans, and sell interests
in the pool through underwriters to sophisticated
investors. GT Ex. 22. The pooled loans were serviced
by third-party loan servicers; principal among these
servicers were Advania and Compu-Link. GT Ex. 22.
Keystone retained residual interests (“residuals”) in
each loan securitization. GT Ex. 22. The residuals
were subordinated securities that would receive
payments only after all expenses were paid and all
investors in each securitization pool were paid. GT.
Ex. 22. In short, Keystone stood to profit from a
securitization only after everyone else was paid. The
residuals were assigned a value that was carried on
the books of the Bank as an asset. Over time, the
residual evaluations came to represent a significant
portion of the Bank's book value. GT Ex. 22.

6. From 1993 until 1998 when the last loan
securitization was completed, the size and frequency
of these transactions expanded from about $33
million to approximately $565 million for the last
one in September 1998. FDIC Ex. 431 at 3. All told,
Keystone acquired and securitized over 120,000
loans with a total value in excess of $2.6 billion.
FDIC Ex. 431 at 3. Keystone appeared to be an
exceptionally profitable bank, whose _ assets
purportedly grew from $107 million in 1992 to over
$1.1 billion in 1999. FDIC Ex. 431 at 3; GT Ex. 22.

A-35

7. In reality, the securitization program proved
highly unprofitable. Owing to the risky nature of
many of the underlying mortgage loans, the failure
rate was excessive. As a result, the residual interests
retained by the Bank proved highly speculative and,
in actuality, they did not perform very well. Malami,
May 26, 2004, Tr. at 77-134; Potter, May 26, 2004,
Tr. at 159-60; Potter, May 27, 2004, Tr. at 34-35.
Keystone's valuation of the residuals was greater
than their market value. Quay, June 4, 2004, Tr. at
29; FDIC Ex. 286. McConnell, Church, and others
concealed the failure of the securitizations by
falsifying the Bank's books. FDIC Ex. 431. Bogus
entries hid the true financial condition of the Bank
from the Bank's directors, shareholders, depositors
and regulators. FDIC Ex. 431. Among the bogus
documents were false remittance reports prepared
by Graham and given to examiners from the Office of
the Comptroller of the Currency (“OCC”). At the
same time, the wrongdoers embezzled large sums
from the Bank, covering their theft with other false
entries in the Bank's books. FDIC Ex. 431.

8. The embezzlement of funds and _ the
falsification of Keystone's financial records were both
integral parts of the fraudulent scheme. The scheme
participants booked false credits to interest income
to make it appear that Keystone was highly
profitable and booked false debits to loans to
fraudulently inflate assets and capital-which made
this a very common (“a garden variety”) form of
fraud. These fraudulent entries, and their reflection
in the Bank's financial statements, enabled
Keystone's corrupt management to continue to

A-36

embezzle funds and _ conceal their earlier
embezzlements. Carmichael, May 24, 2004, Tr. at
36-41; Carmichael, May 25, 2004, Tr. at 30-31;
Goldman, June 9, 2004, Tr. at 83-84.

9. One of the boldest acts of fraud designed to
conceal the Bank's true financial condition occurred
when approximately $515 million in loans were sold
by Keystone, but continued to be carried on the
Bank's books as assets. FDIC Ex. 431; GT Ex. 22.
Discovery of these fraudulent entries would have
revealed at once the fraud and the Bank's
insolvency, resulting in the Bank's immediate
seizure and closure by federal regulators. Johnson,
May 17, 2004, Tr. at 148; C. Wilson, May 17, 2004,
Tr. at 240.

IT. Hiring of Grant Thornton

10. Keystone had a long history of conflict with
federal bank examiners and regulators. GT Ex. 22.
In May, 1998, the OCC sought civil money penalties
against Keystone's management and board for
repeatedly filing inaccurate call reports. Casey, June
1, 2004, Tr. at 105; Gibson, May 20, 2004, Tr. at 12;
FDIC Ex. 64 at 5; FDIC Ex 182 at 31; FDIC Ex. 183
at 48. Call reports are detailed statements of a
bank's financial condition that must be filed with the
FDIC at the end of each quarter. Carney, May 19,
2004, Tr. at 103; FDIC Exs. 106, 171, 270, 323.

11. In examinations from 1995 to 1998, the OCC
repeatedly criticized Keystone's management and
records. GT Exs. 22, 243; FDIC Exs. 182, 183. The
OCC asked for additional civil monetary penalties

b
.
j
,
,
f

A-37

when it discovered over $100 million in errors in
Keystone's accounting records. Carney, May 19,
2004, Tr. at 62-63; Goldman, June 9, 2004, Tr. at
111. In its 1998 examination report, the OCC stated
that Keystone's management had demonstrated an
unwillingness or inability to follow appropriate
accounting guidelines and comply with applicable
laws and regulations. FDIC Ex. 183 at 3; GT Ex. 22.
In the same examination, the OCC stated that
Keystone had not filed an accurate call report the
last seven quarters, that the Bank was willfully
violating brokered deposit restrictions, and that data
was being manipulated to enhance Keystone's
capital position. FDIC Ex. 183 at 22, 41, 48. At one
point, the OCC, suspecting that McConnell and
Church were involved in an illegal kickback scheme
concerning appraisal fees, made a criminal referral.
FDIC Ex. 180; Quay, June 4, 2004, Tr. at 17-20; GT
Ex. 22. The OCC discovered that Graham had made
an “input error” of $31 million while entering data
on loan’ residual evaluations, and _ criticized
numerous other actions of Bank management
designed to enhance Keystone's capital position as
reflected by the Bank's records. FDIC Ex. 183 at 48.
Over time a hostile relationship developed between
Keystone officials and the regulators. GT Ex. 22.
Church and McConnell (prior to his death) were at
the center of this conflict. GT Ex. 22.

12. By the Spring of 1998, conflict between
Keystone and the regulators had reached a critical
juncture. In May of 1998, the OCC required
Keystone to enter into a Formal Agreement
obligating Keystone to take specific steps to improve

A-38

its regulatory posture and financial condition. FDIC
Ex. 64; Gibson, May 20, 2004, Tr. at 12. This
included retaining a nationally recognized
independent accounting firm. Gibson, May 20, 2004,
Tr. at 14; Buenger, June 2, 2004, Tr. at 179-81;
FDIC Exs. 64, 228. Discussions followed between
Bank officials and defendant Grant Thornton LLP
(“Grant Thornton”) concerning the possible
employment of Grant Thornton as the Bank's
outside auditor. Grant Thornton knew that the Bank
had significant accounting problems and was aware
of the troubled relationship between the Bank and
federal regulatory authorities. Buenger, June 2,
2004, Tr. at 179-81; Quay, June 3, 2004, Tr. at 15;
FDIC Exs. 64, 228.

13. Between July 17 and August 21, 1998,
appropriate officials at Grant Thornton approved
acceptance of the Bank as a client. Quay, June 3,
2004, Tr. at 24. While the approval process was
taking place, Stanley Quay, Grant Thornton's
partner who was to be in charge of the audit, drafted
a proposal covering the services he expected Grant
Thornton to perform for the Bank. Quay, June 3,
2004, Tr. at 24-25; FDIC Ex. 75. Under this proposal,
there were two principal levels of service Grant
Thornton was to perform for the Bank: (1) An audit
of the Bank's consolidated financial statements as of
December 31, 1998; and (2) Completion of certain
“agreed-upon-procedures’ relative to elements of the
Bank's financial statements beginning quarterly as
of June 30, 1998. Quay, June 3, 2004, Tr. at 25-26.

A-39

14. On or about July 27, 1998, the OCC indicated
it had no objection to the hiring of Grant Thornton
by the Bank. Gibson, May 20, 2004, Tr. at 67-68;
FDIC Ex. 79. Grant Thornton began its work at the
Bank on or about August 12, 1998. Carmichael, May
24, 2004, Tr. at 110-11; Casey, June 1, 2004, Tr. at
99; Gibson, May 20, 2004, Tr. at 69-70; FDIC Ex. 91.

15. On September 10, 1998, Quay prepared and
signed an engagement letter by which Grant
Thornton agreed to perform an audit of Keystone's
December 31, 1998, financial statements in
accordance with Generally Accepted Auditing
Standards (“GAAS”). Quay, June 3, 2004, Tr. at 28:
FDIC Ex. 98. Billie Cherry signed the letter on
behalf of Keystone on February 5, 1999. Quay, June
3, 2004, Tr. at 28-29: FDIC Ex. 98.

16. Stan Quay was the lead Grant Thornton
partner on the engagement. FDIC Ex. 75. Susan
Buenger, a junior manager, performed substantial
work on the engagement. FDIC Ex. 75. Quay
reviewed the Formal Agreement, and was familiar
with its terms. Quay, June 3, 2004, Tr. at 18-19.

ITI. Grant Thornton's Standard of Care

17. The American Institute of Certified Public
Accountants (AICPA) is a national professional
organization for CPAs. During the time period
involved, the AICPA set the professional standards
that applied to the work of CPAs. GAAS,
promulgated by the AICPA, are the standards
applicable to auditing functions. GAAS is generally
accepted as the minimum standard of professional

A-40

conduct in performing an audit. Generally Accepted
Accounting Principles (“GAAP”) “encompass the
convention, rules, and procedures necessary to
define accepted accounting practice at a particular
time.” Carmichael, May 24, 2004, Tr. at 11-14.

18. Due professional care under GAAS requires
the auditor to exercise | rofessional skepticism.
Carmichael, May 24, 2004, Tr. at 23. Professional
skepticism is an attitude that includes a questioning
mind and a critical assessment of audit evidence.
Carmichael, May 24, 2004, Tr. at 27-29; Buenger,
June 2, 2004, Tr. at 62; Goldman, June 9, 2004, Tr.
at 19; GT Ex. 266 (AU 230.07). The auditor has the
responsibility to plan and perform the audit to
obtain reasonable assurance that the financial
statements are free of material misstatement,
whether caused by error or fraud. Carmichael, May
24, 2004, Tr. at 32-34; Buenger, June 2, 2004, Tr. at
62-63; Quay, June 3, 2004, Tr. at 151; FDIC Exs.
438, 473 (AU 110.02). “When considering the
auditor's responsibility to obtain reasonable
assurance that the financial statements are free
from material misstatement, there is no important
distinction between errors and fraud.” GT Ex. 268
(AU 312.08).

19. An auditor should have a “show me” attitude,
and not accept unsubstantiated assertions by
management. Buenger, June 2, 2004, Tr. at 63:
Carmichael, May 24, 2004, Tr. at 27-29; FDIC Ex.
728. When applying procedures to the client's
records, schedules and supporting data, the auditor
should be on guard against accepting documents at

A-41

face value. Buenger, June 2, 2004, Tr. at 63°64;
Goldman, Jine 9, 2004, Tr. at 38-39; Carmichael,
May 24, 2004, Tr. at 25.

20. If there is a high risk of fraud, the auditor
ought to employ a_ heightened professional
skepticism. Carmichael, May 24, 2004, Tr. at 29-31.
Grant Thornton had many reasons to employ a
heightened professional skepticism in its audit of
Keystone's financial statements. Grant Thornton
rated the Keystone audit maximum risk. Buenger,
June 2, 2004, at Tr. 64; Carmichael, May 24, 2004,
Tr. at 29; FDIC Ex. 174. It was the highest risk
audit on which Buenger and Quay had ever worked.
Buenger, June 2, 2004, Tr. at 64; Quay, June 3,
2004, Tr. at 189. Quay and Buenger testified that
their “fraud antenna” were up as high as they could
get. Buenger, June 2, 2004, Tr. at 64; Quay, June 3,
2004, Tr. at 189.

IV. Grant Thornton's Failure to Check the
Remittances From Servicers

21. Due prcfessional care is to be exercised in the
performance of the audit and the preparation of the
report. GT Ex. 262 (AU 150.02); GT Ex. 266 (AU
230.01).

22. The auditor has the responsibility to plan and
perform the audit to obtain reasonable assurance
about whether the financial statements are free of
material misstatement, whether caused by error or
fraud. Carmichael, May 24, 2004, Tr. at 32-36; FDIC
Ex. 473 (AU 110.02).

r , ee
A-42 |

23. The auditor should specifically assess the risk
of material misstatement due to fraud and should
consider that assessment in designing the audit
procedures to be performed. Carmichael, May 24,
2004, Tr. at 34-36; FDIC Ex. 695 (AU 316.12).

24. As already noted, the risk of material
misstatement in Keystone's financial statements due
to error or fraud was high, and Grant Thornton had
already reached that conclusion before its year-end
1998 audit of Keystone commenced. Carmichael,
May 24, 2004, Tr. at 94.

25. Buenger was responsivle for testing
Keystone's interest income during the year-end,
1998 audit. Keystone's management was reporting
$98.8 million in interest income from loans owned by
Keystone during 1998. Buenger, June 2, 2004, Tr. at
78. Over $65 million of the interest income was
fraudulent and nonexistent. Carmichael, May 24,
2004, Tr. at 41.

26. Buenger performed the interest income
testing in March, 1999. Buenger did not perform a
test of details, which would have entailed looking for
underlying support for the recorded item.
Carmichael, May 24, 2004, Tr. at 49. Buenger did
not examine remittance records of interest income. It
would only have taken a short time to check the
remittance records to verify the interest income. By
tracking the ten remittances showing income for
1998 from loan servicer Compu-Link into Keystone's
bank statement, Buenger could have verified 80-90%
of the interest income. Buenger, June 2, 2004, Tr. at

A-43

71-93; Carmichael, May 24, 2004, Tr. at 100-01;
Carmichael, May 25, 2004, Tr. at 23-25, 154-57; G.
Ellis, May 22, 2004, Tr. at 78-80, 86, 94-95; Johnson,
May 17, 2004, Tr. at 184-87; Quay, June 3, 2004, Tr.
at 154-56; Terry Depo., November 16, 2002, pp. 14-
15, 17-25, 21-34, 36-45 (FDIC Ex. 902).

27. GAAS requires an auditor to obtain the best
evidence available within the time constraints and
money constraints applicable to the engagement.
Buenger, June 2, 2004, Tr. at 90. In this case, it
would have been less time consuming and costly to
perform a test of details rather than the analytical
test that Buenger performed because the bulk of the
interest income came from one servicer. Grant
Thornton would only need to look at twelve
remittances to very effectively substantiate most of
the interest income. Carmichael, May 24, 2004, Tr.
at 100-01.

28. Instead, the primary procedure that Buenger
relied on to test interest income was an ineffective
“analytical test.” This test compared recorded
interest income for the annual period to the average
balance of loans outstanding during the same period,
as reflected in the quarterly average balances
reported in Keystone's call reports, to calculate an
annual yield. Carmichael, May 24, 2004, Tr. at 84-
85, 97-98. Buenger then considered’ the
reasonableness of this calculated expectation of the
yield based on her understanding of the industry
yield on the same types of loans. Buenger, June 1,
2004, Tr. at 180-81; Carmichael, May 24, 2004, Tr.
at 84-85, 97-98; FDIC Ex. 164.

A-44

29. The analytical test that Buenger did to test
interest income only’ considered information
provided by management. Carmichael, May 24,
2004, T:. at 90. The data that Buenger obtained in
her analytical testing was not independent of the
entity, was not from a person independent of those
responsible for the amount being audited, was not
developed under a reliable system with adequate
controls, and Grant Thornton had determined that
the prior auditors were incompetent. Carmichael,
May 24, 2004, Tr. at 98-100. Buenger used only
three items of information in her analytical test.
Goldman, June 9, 2004, Tr. at 29-30; Quay, June 4,
2004, Tr. at 10-13. The first was the average balance
of owned loans reported on Keystone's call reports.
Goldman, June 9, 2004, Tr. at 30. Buenger and Quay
knew that the OCC had imposed civil money
penalties on Keystone for filing inaccurate call
reports; in fact, the OCC said that Keystone had not
filed an accurate call report in the last seven
quarters. Quay, June 4, 2004, Tr. at 10-11. Buenger
decided not to use the call report information for
March 31, 1998 because the OCC had required the
call report to be restated, but she then proceeded to
use the other 1998 call reports despite knowing that
the OCC had determined those call reports were also
inaccurate. Buenger, June 2, 2004, Tr. at 106-09.
Thus, Buenger knew the call report information she
used was of questionable reliability. Carmichael,
May 24, 2004, Tr. at 89-90, 98-99; Goldman, June 9,
2004, Tr. at 32-33; Quay, June 3, 2004, Tr. at 151.

A-45

30. The second piece of information Buenger used
in her analytical test was a chart of Keystone's
month end loan inventories for 1998 that was
provided to her by Graham. According to Buenger's
memorandum to the file on Keystone's loan
purchasing, Keystone purchased loans throughout
the year, and then sold them into securitizations.
Buenger, June 2, 2004, Tr. at 96-98; FDIC Ex. 181.
Buenger believed Keystone was funding these
purchases with brokered deposits. Buenger, June 2,
2004, Tr. at 95. Keystone's loan inventory should
have dropped substantially at the time of the
securitizations because the loans were sold into the
securitizations. Buenger, June 2, 2004, Tr. at 97-98.
Keystone had two securitizations in 1998-one in May
for $275 million and one in September for $565
million. But according to the Graham chart, the
Keystone loan inventory only dropped slightly in
those months-with a $47 million drop in May, 1998
and a $32 million drop in September, 1998. FDIC
Ex. 164. Finally, there were large discrepancies
between the total loan inventories on Graham's
chart and the total loan inventories reflected in
Grant Thornton's workpapers on its agreed upon
procedures. FDIC Ex. 164; Buenger, June 2, 2004,
Tr. at 103-04. For example, as of June 30, 1998,
Graham's chart reflected Keystone owned $566
million in loans, but Grant Thornton's reconciliation
of loans as of the same date reflected an inventory of
only $402 million. FDIC Ex. 164; Buenger, June 2,
2004, Tr. at 103-04. Buenger realized the numbers in
Graham's chart were not reasonable, and didn't tie
to any of the other numbers of which she was aware.

A-46

Buenger, June 2, 2004, Tr. at 95-104, 130-31; Quay,
June 4, 2004, Tr. at 8-10; FDIC Exs. 164, 915.
Nevertheless, neither Buenger nor Quay asked
Graham to explain why the loan balances that he
provided Buenger made no sense. Buenger, June 2,
2004, Tr. at 103-04; Quay, June 4, 2004, Tr. at 9-10.
Even though she had determined that Graham's
chart made “no sense,” Buenger continued to use the
January through March 1998 loan inventories in
Graham's chart in her analytical test of income.
Buenger, June 2, 2004, Tr. at 104-06, 109-10;
Goldman, June 9, 2004, Tr. at 26-27, 150; Quay,
June 3, 2004, Tr. at 150-51. Buenger violated GAAS
by failing to investigate how Graham provided her
bogus loan inventories that made “no sense,” by
failing to investigate how Graham had made the $31
million “input error” on the residual valuation, and
by using information that she knew contained
material errors in her analytical test. Goldman, June
9, 2004, Tr. at 19-29, 31-32.

31. The third piece of information used by
Buenger in her analytical test was a “remittance
report,” reflecting $10 million in income from
Compu-Link during the month of December, 1998.
FDIC Ex. 165. One of Graham's subordinates,
Debbie Watkins, provided the “remittance report” to
Buenger with a letter from Forest Krumm of Compu-
Link. Buenger, June 1, 2004, Tr. at 187; Buenger,
June 2, 2004, Tr. at 64-65. The Krumm letter states
that “enclosed is a trial balance.” FDIC Ex. 165. The
letter does not reference a “remittance report” as
being enclosed. FDIC Ex. 165. The “remittance
report” contains no identifying markings to indicate

A-47

that it is a true Compu-Link record. FDIC Ex. 165.
Under GAAS, Buenger should have investigated
these anomalies, and could not rely on the
“remittance report” until she cleared them _ up.
Buenger violated GAAS by using data on the
remittance report in her analytical test, and hy
failing to investigate the anomalies in the
information she was provided. Buenger, June 2,
2004, Tr. at 64-65, 72-73; Carmichael, May 24, 2004,
Tr. at 102-05; Carmichael, May 25, 2004, Tr. at 158-
59, 169-70; FDIC Ex. 165.

32. Detailed testing is better and provides
stronger evidence than analytical testing. Goldman,
June 9, 2004, Tr. at 46-47. At trial, Buenger
professed not to know that there was a difference
between an analytical test and a test of details.
Buenger, June 2, 2004, Tr. at 71. An auditor with
Buenger's level of training and experience should
know the difference between an analytical test and a
test of details. Goldman, June 9, 2004, Tr. at 46.

33. After the OCC reported the $500 million of
missing loans in August, 1999, Grant Thornton's
first step was to look for check and wire remittances
showing the interest income, but they could not find
any evidence to support $500 million in loans.
Carmichael, May 24, 2004, Tr. at 85-86; Quay, June
3, 2004, Tr. at 154-56.

34. In August, 1999, Buenger and Quay asked
Graham and Church to provide proof of the income
from the loans, and they came back and said they
couldn't find it. Quay, June 3, 2004, Tr. at 154-56.

A-48

Graham and Church had every reason to produce
whatever proof they could to support the income
from loans. If Buenger and Quay had asked for the
same proof in March, 1999, the result would likely
have been the same: Church and Graham would not
have been able to provide proof of the income.
Buenger, June 2, 2004, Tr. at 79-90; Carmichacl,
May 24, 2004, Tr. at 101.

35. When Quay tested the more than $11 million
in income from the residuals during the year-end,
1998 audit, he performed detailed testing procedures
by actually examining the remittances, the checks,
and wires from the servicers. Quay decided that the
best way to test the residual income was to trace the
actual remittances into the cash accounts. Buenger,
June 2, 2004, Tr. at 78-79; Goldman, June 9, 2004,
Tr. at 47-48; Quay, June 3, 2004, Tr. at 152-54;
Carmichael, May 24, 2004, Tr. at 96; FDIC Ex. 188.
The fact that Quay used detailed testing procedures
to test the residual income is further evidence that
Buenger should have done the same when she tested
the interest income, especially given the fact that the
amount of interest income Keystone was reporting
was $98 million.

36. Under GAAS, AU 329.16 states the following
concerning the reliability cf data used in analytical
procedures:

The auditor should assess the reliability of the
data by considering the source of the data and the
conditions under which it was gathered, as well as
other knowledge the auditor may have about the

A-49

data. The following factors influence the auditor's
consideration of the reliability of data for purposes
of achieving audit objectives:

Whether the data was obtained from
independent sources outside the entity or from
sources within the entity.

Whether sources within the entity were
independent of those who are responsible for
the amount being audited.

Whether the system was developed under
a reliable system with adequate controls.

Whether the data was subjected to audit
testing in the current or prior year.

Whether the expectations were developed
using data from a variety of sources.

FDIC Ex. 715.

37. In Grant Thornton's audit of Keystone,
potential misstatements in interest income would be
apparent in the remittance records-as they were in
August, 1999. Detailed evidence was _ readily
available and was not voluminous. Carmichael, May
24, 2004, Tr. at 91-92; Johnson, May 17, 2004, Tr. at
184-87; FDIC Ex. 548.

38. Quay and Buenger had rated the Keystone
audit a “C” or “comprehensive” audit. Carmichael,
May 24, 2004, Tr. at 92-94, 96-97; FDIC Ex. 436.
Although Grant Thornton's audit manual states that
a “C” rated audit generally concentrates on tests of

A-50

details for income statement accounts, Quay and
Buenger did not use tests of details for a majority of
the accounts, and instead only used tests of details
for two of the accounts. Goldman, June 9, 2004, Tr.
at 51-52.

39. In March, 1999, given the high risk of
material misstatement in Keystone's financial
statements, and the fact that Keystone's $98 million
in interest income was more than 90% of Keystone's
reported income, Buenger should have tested
Keystone's interest income for 1998 by reviewing the
remittance records of interest income for 1998. Her

failure to do so was a violation of GAAS. Carmichael,
May 24, 2004, Tr. at 30, 84-85, 94-96.

40. If Buenger had followed GAAS by testing
Keystone's interest income for 1998 by reviewing the
remittance records of interest income for 1998, it is
more likely than not she would have discovered the
loan inventory fraud in March, 1999, reported it to
Keystone's board, Keystone's president Owen
Carney, and the OCC, and Keystone would have
been closed by March 30, 1999. Budnick, May 18,
2004, Tr. at 122; Buenger, June 2, 2004, Tr. at 79-80;
Carney, May 19, 2004, Tr. at 101; Carmichael, May
24, 2004, Tr. at 31, 41-42; Carmichael, May 25, 2004,
Tr. at 30-31; Gibson, May 20, 2004, Tr. at 34-37:
Johnson, May 17, 2004, Tr. at 138-44, 148, 184-87;
Potter, May 27, 2004, Tr. at 13; Quay, June 3, 2004,
Tr. at 167-68; C. Wilson, May 17, 2004, Tr. at 240;
FDIC Exs. 408, 548.

A-51

V. Grant Thornton's Failure to Properly Prepare
for the Confirmation Process

41. Keystone’s December 31, 1998 financial
statements wepresented Keystone owned loans held
for sale and loans receivable of approximately $579
million. FDIC Ex. 291 at 4. Approximately $548
million of the $579 million was ostensibly located at
large loan servicing organizations. The loans
serviced by Compu-Link and Advanta were recorded
at $469.7 million, but this amount was fraudulently
overstated by $431.8 million. Of this amount, $236
million in loans being serviced by Advanta were
recorded as assets on Keystone's books, when in fact
the loans were owned by United National Bank
(“United”). The $236 million were loans that United
was to have sold to Keystone for inclusion in the
December 1998 _ securitization that Keystone
abruptly cancelled. Carmichael, May 24, 2004, Tr. at
41; Hale Depo., August 27, 2002, 51-55, 138-39, 155-
59 (FDIC Ex. 889); J. Wilson, May 21, 2004, Tr. at
23-27.

42. The confirmation process was primary and
critical to the Keystone audit. Buenger, June 2,
2004, Tr. at 131-32; Carmichael, May 24, 2004, Tr.
at 46°47. Buenger was tasked with doing the
confirmations. Buenger, June 2, 2004, Tr. at 6-23.

43. Professional skepticism is important in
performing confirmation procedures, and evaluating
the results of the confirmation procedures. Buenger,
June 2, 2004, Tr. at 132; Carmichael, May 24, 2004,
Tr. at 48; FDIC Exs. 439, 483 (AU 330.15).

A-52

44. Buenger had never worked on an audit of a
bank involved in the securitization business before
Keystone; she had no experience regarding the
securitization business. Buenger, June 2, 2004, Tr.
at 133-34.

45. The auditor's understanding of the client's
arrangements and transactions with third parties is
key to determining the information to be confirmed.
The auditor should obtain an understanding of the
substance of such arrangements and transactions to
determine the appropriate information to include in
the confirmation request. Buenger, June 2, 2004, Tr.
at 134-35; Carmichael, May 24, 2004, Tr. at 54-55;
FDIC Ex. 439 (AU 330.25); FDIC Ex. 483 (AU
330.15).

46. An understanding of the substance of the
client's arrangements and transactions with third
parties is an important factor in determining the
information to be confirmed. Buenger, June 2, 2004,
Tr. at 135; FDIC Ex. 436 at 133.

47. Buenger violated GAAS, including AU 330.25,
by failing to obtain an adequate understanding of
Keystone's arrangements and transactions with
United, Compu-Link and Advanta. Carmichael, May
24, 2004, Tr. at 47-48, 52-56; Carmichael, May 25,
2004, Tr. at 18-21. Indeed, Buenger testified that she
had no idea Keystone had a relationship with
United. Buenger, June 2, 2004, Tr. at 135. Buenger
did not investigate the details of that relationship,
nor did she review or ask to review the written
agreements between United and Keystone. Buenger

> —_—___

A-53

knew little or nothing of the details concerning the
Bank's relationship with United. Buenger, June 2,
2004, Tr. at 135-40.

VI. Grant Thornton Failed to Confirm $85 Million in
Loans that Were Allegedly in Transit

48. In order to conduct the audit in accordance
with GAAS, Grant Thornton was required to confirm
Keystone's loans in the manner prescribed by GAAS.
Confirmation is the process of obtaining and
evaluating a direct communication from a third
party in response to a request for financial
information about a particular item affecting
financial statement assertions. Goldman, June Q,
2004, Tr. at 52-53. The confirmation response must
come to the auditor directly from the third party,
and must be in_ response to the _ auditor's
confirmation request. Goldman, June 9, 2004, Tr. at
53-54.

49. According to Keystone's books, as of
December 31, 1998, and the lead sheet of supposed
Keystone-owned loans that Buenger was trying to
confirm, the Bank owned $85 million in loans that
were being serviced by Compu-Link, but were
transferred to Advanta for servicing effective
January 15, 1999. These loans were in fact non-
existent. Neither Advanta nor Compu-Link ever
confirmed to Buenger that the $85 million in loans
existed, that the loans were owned by Keystone, or
that servicing of the loans was transferred from
Compu-Link to Advanta. Buenger did nothing to
investigate this discrepancy, but improperly relied

A-54

upon the dubious remittance statement that was
given to her with the Forrest Krumm letter,
discussed above. Buenger, June 2, 2004, Tr. at 66-67,
141-44; Quay, June 3, 2004, Tr. at 127-32; FDIC Ex.
500. Buenger failed to confirm the $85 million in
loans in accordance with GAAS. Goldman, June 9,
2004, Tr. at 52-57.

VII. Grant Thornton's Failure with Respect To the
Advanta Confirmation

50. The first confirmation response from Advanta
was received by Grant Thornton on or about January
24, 1999, and went into a folder in the confirmation
drawer in Grant Thornton's Cincinnati office. That
confirmation showed only $6 million in loans owned
by Keystone were being serviced by Advanta, rather
than the $242 million in loans Keystone was
reporting. Burke Depo., December 13, 2002, 16-21,
34-36, 129-30 (FDIC Ex. 898); Gunter Depo.,
December 20, 2002, 260-64 (FDIC Ex. 913);
Carmichael, May 24, 2004, Tr. at 58-61; French
Depo., November 19, 2002, 85-86 (FDIC Ex. 907);
Ramirez Depo., September 26, 2002, 165-71, 197-98
(FDIC Ex. 896); FDIC Exs. 175, 176, 177, 255, 500.

51. Buenger did not know she had the first
January confirmation response in the confirmation
drawer, and on March 16, 1999, she asked Advanta
to send another confirmation. Carmichael, May 24,
2004, Tr. at 61-62; FDIC Exs. 255, 500. On March
17, 1999, Buenger received another confirmation
response from Advanta, which again showed only $6
million in loans owned by Keystone being serviced by

A-55

Advanta. Burke Depo., December 13, 2002, 20-25,
32-36, 129-40 (FDIC Ex. 899); Gunter Depo.,
December 20, 2002, 260-64 (FDIC Ex. 913);
Carmichael, May 24, 2004, Tr. at 61-62; FDIC Exs.
169, 176, 177, 257, 500.

52. Both Advanta confirmation responses
identified Keystone as Investor 405. FDIC Exs. 176,
177, 500. Buenger never made any inquiry about
what the investor numbers meant. She was not
aware of the significance of the investor numbers.
Buenger, June 2, 2004, Tr. at 66.

53. The “investor” is the owner. Buenger, June 2,
2004, Tr. at 152; Carmichael, May 24, 2004, Tr. at
63; Johnson, May 17, 2004, Tr. at 180. The number
following “investor” identifies the owner of the loans.
Investor 405 was Keystone and Investor 406 was
United. Ramirez Depo., September 26, 2002, 141-42
(FDIC Ex. 896).

54. The independent auditor should be thorough
in his or her search for evidential matter and
unbiased in its evaluation. FDIC Ex. 480 (AU
326.25). A thorough and skeptical auditor would
have determined what the investor numbers meant.
Carmichael, May 25, 2004, Tr. at 65-66.

55. There was a $236 million discrepancy
between the amount of Keystone-owned loans
Advanta confirmed it was servicing in its two
confirmation responses and what Keystone's books
said. Carmichael, May 24, 2004, Tr. at 61; French
Depo., November 19, 2002, 87-92 (FDIC Ex. 907);
FDIC Exs. 176, 177, 235, 379, 500.

A-56

56. Buenger reviewed the second Advanta
confirmation response on or about March 17, 1999.
Buenger, June 2, 2004, Tr. at 155; FDIC Exs. 169,
176, 177, 500. Buenger did not notify Keystone's
management, the OCC, or even Quay of the $236
million discrepancy. Buenger testified it kind of got
put on the “backburner.” Buenger, June 2, 2004, Tr.
at 155-57; Goldman, June 9, 2004, Tr. at 58;
Carmichael, May 24, 2004, Tr. at 61-62.

57. Buenger can't tell what she was doing during
the 91 hours she billed to Keystone during the last
two weeks of March, 1999 that was more important
than resolving the $236 million discrepancy issue
with Advanta. Buenger, June 2, 2004, Tr. at 156-57;
FDIC Ex. 210. |

58. Buenger's failure to pursue the $236 million
discrepancy was a violation of GAAS. If Buenger had
followed GAAS and promptly investigated the $236
million discrepancy, she would have discovered the
fraud, which would have led to the closure of the
Bank. Budnick, May 18, 2004, Tr. at 122, 138-39,
145-46; Carmichael, May 24, 2004, Tr. at 30°31, 41-
42, 66-69; Carmichael, May 25, 2004, Tr. at 30-31;
Gibson, May 20, 2004, Tr. at 35-37, 59; Johnson,
May 17, 2004, Tr. at 148; Kaufman, May 18, 2004,
Tr. at 205-07; C. Wilson, May 17, 2004, Tr. at 240.
Buenger's evaluation and investigation of the
Advanta confirmation response demonstrated a lack
of professional skepticism and due care. Her actions
were an extreme departure from GAAS. Carmichael,
May 24, 2004, Tr. at 68-69.

|

A-57

59. Quay saw and initialed the Advanta
confirmation response on March 23, 1999. Quay,
June 3, 2004, Tr. at 133-34; FDIC Exs. 169, 176, 177,
500.

60. On April 7, 1999, Buenger called Patricia
Ramirez, the Investor Reporting Manager for
Advanta, and talked with her for three minutes. The
word “United” was not used during the Buenger-
Ramirez conversation. Buenger, June 2, 2004, Tr. at
67; Gunter Depo., December 20, 2002, 269-74 (FDIC
Ex. 913); Ramirez Depo., September 26, 2002, 182-83
(FDIC Ex. 896); FDIC Ex. 282.

61. On April 7, 1999, one minute after the phone
call between Buenger and Ramirez concluded,
Ramirez sent an e-mail to Buenger reflecting that
United, Investor No. 406, owned $236 million in
loans being serviced by Advanta. The e-mail does not
reflect that the $236 million in loans are owned by
Keystone. Gunter Depo., December 20, 2002, 269-74,
294-95 (FDIC Ex. 913); Carmichael, May 24, 2004,
Tr. at 70; FDIC Exs. 169, 500. There is nothing in
Keystone's records reflecting that Keystone owned
loans under Investor No. 406, or under the name
United National Bank, and there is nothing in the e-
mail reflecting the $236 million in loans are owned
by Keystone. Goldman, June 9, 2004, Tr. at 52-61.

62. All of the documentary information provided
by Advanta to Grant Thornton was true and
accurate. Buenger, June 2, 2004, Tr. at 162;
Carmichael, May 25, 2004, Tr. at 144-45; Goldman,
June 9, 2004, Tr. at 75; Johnson, May 17, 2004, Tr.

A-58

at 179-81; C. Wilson, May 18, 2004, Tr. at 62-63.
That information showed that United, not Keystone,
owned the $236 million in loans, and the inevitable
conclusion from that is that Keystone's financial
statements were materially misstated as a result of
fraud. Carmichael, May 24, 2004, Tr. at 72-73;
Johnson, May 17, 2004, Tr. at 121-26; FDIC Exs.
169, 178, 379, 500.

63. Buenger violated GAAS by failing to carefully
evaluate and investigate the Advanta confirmation
responses-especially the e-mail from Ramirez. If
Buenger had followed GAAS, she would have found
the fraud on April 7, 1999, and the Bank would have
been closed in April, 1999. Budnick, May 18, 2004,
Tr. at 122; Carney, May 19, 2004, Tr. at 101:
Carmichael, May 24, 2004, Tr. at 30-31, 79;
Carmichael, May 25, 2004, Tr. at 30-31; Gibson, May
20, 2004, Tr. at 34-37; Johnson, May 17, 2004, Tr. at
148; C. Wilson, May 17, 2004, Tr. at 240.

64. To comply with GAAS's requirements of
professional skepticism, Buenger should have called
Ramirez back after receipt of the e-mail to determine
why the e-mail reflected that the loans were owned
by United and requested that Ramirez cor®rm in
writing that the $236 million in loans were owned by |
Keystone. Carmichael, May 24, 2004, Tr. at 70-71,
75-76; Carmichael, May 25, 2004, Tr. at 21-22; Quay,
June 3, 2004, Tr. at 135-39. Buenger failed to take
either step; in fact, she never spoke with Ramirez
again after receipt of the e-mail. Buenger, June 2,
2004, Tr. at 66-69; Goldman, June 9, 2004, Tr. at 62.

a ea

A-59

65. In any event, the court does not believe
Buenger's testimony about the telephone call with
Ramirez for the following reasons. First and most
importantly, the physical evidence, i.e., the email,
contradicts Buenger's account of the phone call.
According to Buenger, Ramirez told her “[t]hese
belonged to Keystone at 12/31/98.”Buenger, June 2,
2004, Tr. at 28. However, one minute later, Ramirez
sent Buenger an email which stated:

“Below is the information requested from
investor 406 as of 12/31/98. Investor number
406, investor name United National Bank,
number of loans, 6,283, month end balances
$236,221,923.07.”

FDIC Exs. 754, 777. Ramirez's email is
completely at odds with the statements Buenger
attributes to her. For this reason alone, Buenger's
testimony on this point is not credible.

66. Second, Joey Johnson, an OCC examiner,
testified that, on August 25, 1999, he and other OCC
examiners met with Grant Thornton to apprise them
of the OCC's discovery of major discrepancies in the
loan balances serviced by Compu-Link and Advanta.
Johnson, May 17, 2004, Tr. at 112; FDIC Ex. 379. At
tnat meeting, Stan Quay told the OCC they had
confirmed those balances for the year ended 1998
and they all reconciled. Johnson, May 17, 2004, Tr.
at 112; FDIC Ex. 379. Thereafter, Grant Thornton
retrieved copies of the confirmations and the
confirmation requests from their Cincinnati office.

Johnson, May 17, 2004, Tr. at 112; FDIC Exs. 379,

A-60

754, 755. According to Johnson, the examiners
questioned Buenger about why she added the $236
million owned by United to the $6 million owned by
Keystone. Johnson, May 17, 2004, Tr. at 125; FDIC
Ex. 379. Buenger stated that code 406 loans were
under a “bad name” and should have been included
in the confirmed loans. Johnson, May 17, 2004, Tr.
at 126; FDIC Ex. 379. Buenger did not tell the OCC
that Ramirez had told her that the United loans
were Keystone loans. Johnson, May 17, 2004, Tr. at
126. Nor did she offer FDIC Exhibit 281, her
handwritten note of what Ramirez purportedly told
her, to the OCC. Indeed, Grant Thornton never
offered Exhibit 281 to the OCC while the Bank was
still open. Johnson, May 17, 2004, Tr. at 127-28. The
court found Johnson to be completely credible.
Furthermore, the failure of Grant Thornton to
produce Exhibit 281 to the OCC undermines
Buenger's credibility regarding what Ramirez
supposedly told her.

67. Third, during her testimony, Ramirez was
clear that she was absolutely certain regarding
ownership of the loans under investor codes 405 and
406. Putting aside the purvortedly speculative
testimony, Ramirez testified that she had never been
confused regarding the ownership of the loans.
Ramirez Depo., September 26, 2002, 143 (FDIC Ex.
896). The court found Ramirez to be a totally
credible witness. Indeed, her credibility was
strengthened by her candor in explaining that she
didn't have a specific recollection of her conversation
with Buenger.

A-61

68. Fourth, as to certain points, Buenger's
testimony regarding scrutiny of her confirmation
process during the last week of the Bank's existence
and what she did was contradicted by Michael
Gibson and Gary Ellis, both of whom the court found
to be completely credible.

69. Finally, the demeanor of Buenger on the
witness stand, when taken together with her
interests in the case, leads the court to believe she
was not entirely truthful.

70. During the trial, Grant Thornton filed a
motion to exclude the speculative testimony of
Patricia Ramirez. By Order entered September 29,
2005, that motion was denied. The court's findings
regarding the phone call between Buenger and
Ramirez do n

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Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/brief%3Amicro_IA40385015_0335%3A1. Public record. Not legal advice.