Case 2:11-cv-00746-BJR-TFM Document 850 Filed 03/30/18 Page 1 of 77 IN THE UNITED STATES DISTRICT COURT FOR THE MIDDLE DISTRICT OF ALABAMA NORTHERN DIVISION THE COLONIAL BANCGROUP, INC. and KEVIN O’HALLORAN, Plaintiffs, v. Case No. 2:11-cv-00746-BJR LEAD CASE PRICEWATERHOUSECOOPERS LLP and CROWE HORWATH LLP, Defendants. ______________________________ FEDERAL DEPOSIT INSURANCE CORPORATION, AS RECEIVER FOR COLONIAL BANK, Case No. 2:12-cv-00957-BJR Plaintiff, v. PRICEWATERHOUSECOOPERS LLP and CROWE HORWATH LLP, Defendants. DEFENDANT PRICEWATERHOUSECOOPERS LLP’S PROPOSED FINDINGS OF FACT AND CONCLUSIONS OF LAW ON DAMAGES Case 2:11-cv-00746-BJR-TFM Document 850 Filed 03/30/18 Page 2 of 77 TABLE OF CONTENTS INTRODUCTION .......................................................................................................................... 1 FINDINGS OF FACT..................................................................................................................... 6 I. The Court’s Previous Findings Concerning the Scope of the Fraud ............................... 6 II. The Parties’ Positions on Damages................................................................................ 10 III. A. The FDIC’s Position: $625 Million ...................................................................... 10 B. PwC’s Position: $306 Million............................................................................... 11 C. The experts agree that Colonial did not sustain losses as a result of moving “blue” mortgages that were funded on COLB, Warehouse, or Overline to AOT at a later date. ............................................................................................... 13 The “Blue” Aged Mortgages Acquired Outside of AOT............................................... 17 A. During the time period of the fraud, TBW also originated a large number of real, legitimate mortgages that were funded by Colonial Bank. ...................... 17 B. Real mortgages from TBW and other customers sometimes stayed on Colonial’s books longer than expected and became “aged.” ................................ 19 C. The fraudsters concealed the fake Plan B mortgages and the “junk” mortgages acquired directly into AOT, but the real, aged mortgages on the other facilities were well known at Colonial. ....................................................... 21 D. Colonial’s senior management directed that the aged mortgages be moved into AOT to hide them from regulators. ............................................................... 23 IV. The FDIC did not prove that the aged mortgages moved to AOT were fraudulent or impaired when Colonial acquired them. .................................................. 26 A. First Supposed Badge of Fraud: The “Secret Set of Books” ................................ 27 B. Second Supposed Badge of Fraud: Mortgages Not “Put Back” to TBW ............. 29 C. Third Supposed Badge of Fraud: The Fraudsters’ Statements ............................. 32 D. Fourth Supposed Badge of Fraud: The Mortgages Were Never Sold .................. 36 E. Fifth Supposed Badge of Fraud: “Exceptions” Noted in Bank Records .............. 37 F. PwC’s Answer in the Miami Case ........................................................................ 40 G. Additional Testimony About Specific Mortgages ................................................ 42 i Case 2:11-cv-00746-BJR-TFM Document 850 Filed 03/30/18 Page 3 of 77 V. The REO Mortgages ...................................................................................................... 45 VI. Future Distributions from the TBW Estate .................................................................... 47 CONCLUSIONS OF LAW .......................................................................................................... 48 I. The FDIC cannot recover as damages money that Colonial advanced to TBW for the “blue” mortgages acquired outside of AOT. ...................................................... 48 A. It is the FDIC’s burden to prove that Colonial’s losses on the blue mortgages were proximately caused by PwC’s failure to detect the fraud. .......... 48 B. The FDIC cannot redefine the fraud in the damages phase to include the blue mortgages. ..................................................................................................... 56 C. The FDIC did not prove proximate causation because it did not prove that the blue mortgages were impaired when Colonial acquired them. ....................... 58 II. Even if the FDIC met its burden of proof for some of the blue mortgages, it did not prove that all or even most of the blue mortgages were fraudulent......................... 64 III. The FDIC’s damages must be adjusted to reflect the value of the REO mortgages. ...................................................................................................................... 68 IV. The FDIC’s damages will be reduced to reflect any future recoveries.......................... 71 CONCLUSION ............................................................................................................................. 72 ii Case 2:11-cv-00746-BJR-TFM Document 850 Filed 03/30/18 Page 4 of 77 Following a three-day bench trial on damages beginning on March 20, 2018, and pursuant to the Court’s order of January 26, 2018 (ECF No. 800), PricewaterhouseCoopers LLP (“PwC”) submits its Proposed Findings of Fact and Conclusions of Law on Damages. INTRODUCTION 1. The Federal Deposit Insurance Corporation as Receiver for Colonial Bank (“FDIC”) and The Colonial BancGroup, Inc., represented by Kevin O’Halloran as Plan Trustee (“CBG”), sued PwC, CBG’s independent, external auditor, “for failing to discover a fraud perpetrated against Colonial Bank . . . by Taylor, Bean & Whitaker Mortgage Corporation (‘TBW’) and certain of Colonial’s employees.” Order on the Liability Phase of the PwC Bench Trial, ECF No. 798, at 4 (Dec. 28, 2017) (“Liability Order”). 2. The Court bifurcated the liability and damages portions of the case. A bench trial on liability was held from September 18 through October 13, 2017, and the Court issued its findings of fact and conclusions of law on December 28, 2017. Liability Order at 4. The Court sustained the FDIC’s professional negligence claim against PwC. Id. at 91. It rejected all of the FDIC’s other claims and all of CBG’s claims. Id. It also held that PwC was not responsible for Colonial’s losses on “shipped not paid” mortgages. Id. The Court then held a bench trial to determine the FDIC’s damages. 3. The fraud at issue here involved collusion between TBW executives and a couple of Colonial insiders to funnel money surreptitiously from Colonial to TBW. The Court has concluded that PwC breached its duty of care to Colonial Bank by not performing sufficient audit procedures to detect that fraud. The Court’s ruling means the FDIC may recover as damages Colonial’s fraud-related losses, i.e., the money that the fraudsters improperly funneled to TBW. Although the Court has found that PwC was negligent for failing to detect the fraud, the burden remains on the FDIC to prove the damages that flow from that finding of negligence. 1 Case 2:11-cv-00746-BJR-TFM Document 850 Filed 03/30/18 Page 5 of 77 The FDIC cannot just assume that all of Colonial’s TBW-related losses were damages and shift the burden to PwC to show which of those losses were not tied to PwC’s failure to detect the fraud. 4. For purposes of this damages phase only, PwC accepts that, given the Court’s liability findings, it is responsible for fraud-related losses in excess of $300 million. That is a harsh result, especially considering that PwC’s liability in this case results from the actions of a handful of personnel in connection with four audits for which Colonial paid PwC only about $1 million each. 5. The FDIC, however, does not stop there. Not content to recover only Colonial’s fraud-related losses, the FDIC also wants to recover another $300+ million that Colonial lost by investing, with the full knowledge and approval of Bank management, in real, non-fraudulent TBW mortgages that failed to perform as well as Colonial might have hoped. That, the FDIC cannot do. 6. In determining whether the FDIC has met its burden to prove that it is entitled to all the damages it is seeking, the Court must distinguish between three categories of losses suffered by Colonial on mortgages that were in the AOT facility when the Bank closed on August 14, 2009. The three categories are illustrated by the following diagram that PwC’s counsel used as a demonstrative during the damages trial (and whose numbers were agreed to by the FDIC’s damages expert): 2 Case 2:11-cv-00746-BJR-TFM Document 850 Filed 03/30/18 Page 6 of 77 • Fraud losses on Plan B (fake) mortgages in AOT (red). Colonial lost money when the fraudsters at the Bank secretly funneled cash to TBW in exchange for fake mortgages—which they called “Plan B” mortgages—that had no value to Colonial because the real mortgages had already been sold to someone else. The Plan B fraud started on the COLB facility in December 2003 and moved to the AOT facility in 2005. See Liability Order at 17-19; Tr. 3430:15-24 (Malek) (explaining that some of the FDIC’s claimed damages relate to “Plan B loans” that “were totally illegitimate” and “were fake and of zero value”). When the Bank closed in 2009, about $495 million, or 34%, of the mortgages on the AOT facility were fake, worthless Plan B mortgages. Tr. 3772:9-12 (Lehn). During the damages trial, the parties referred to these mortgages as the “red mortgages” to match PwC’s demonstrative. In light of the Court’s ruling that PwC was negligent in failing to uncover the fraud, PwC does not dispute that it is responsible for damages relating to the “red” Plan B mortgages. See Tr. 3773:24-3774:3 (Lehn). 3 Case 2:11-cv-00746-BJR-TFM Document 850 Filed 03/30/18 Page 7 of 77 • Fraud losses on real (“junk”) mortgages acquired directly into AOT (orange). Colonial also lost money when the fraudsters at the Bank secretly funneled cash to TBW in exchange for real but impaired mortgages—so-called “junk” mortgages—that were funded directly onto the AOT facility beginning in 2004. These were mortgages that already had problems when they were acquired by the Colonial fraudsters, who knew they were impaired and deliberately overpaid for them without the knowledge of Bank management. These mortgages were therefore part of the fraud. See Liability Order at 19; Tr. 3430:25-3431:12 (Malek) (explaining that some of the FDIC’s claimed damages relate to “junk loans” that “the fraudsters . . . knew had been rejected by other banks” and “wouldn’t be saleable,” but which the fraudsters caused Colonial to pay for “as if those loans were fully valuable”). When the Bank closed in 2009, about $562 million, or 38%, of the mortgages on the AOT facility were junk mortgages that the fraudsters had funded directly onto the AOT facility. Tr. 3525:8-14 (Malek); Tr. 3772:13-18 (Lehn). During the damages trial, the parties referred to these mortgages as the “orange mortgages.” Unlike the fake Plan B mortgages, these mortgages had value, and the FDIC was able to recover some amount of money by selling them—but not as much as Colonial had advanced to fund them. Tr. 3446:11-3447:2 (Malek). In light of the Court’s ruling that PwC was negligent in failing to uncover the fraud, PwC does not dispute that it is responsible for damages relating to the “orange” mortgages. See Tr. 3774:4-9 (Lehn). • Non-fraud losses on real mortgages moved to AOT after aging on other Colonial facilities (blue). Colonial also lost money that it advanced to TBW through its COLB, Warehouse, and Overline facilities—with management’s knowledge and approval—to fund real, legitimate mortgages that subsequently failed to be sold to an end investor. These mortgages wound up staying on Colonial’s books and becoming “aged” mortgages—worth less 4 Case 2:11-cv-00746-BJR-TFM Document 850 Filed 03/30/18 Page 8 of 77 than they were at origination, but still having value. Colonial’s management was fully aware of these aged mortgages. Management eventually directed that these mortgages be transferred into the AOT facility to hide them from regulators, but those internal transfers, while improper, did not cause any additional losses to Colonial. When the Bank closed in 2009, about $415 million, or 28%, of the mortgages on the AOT facility were aged mortgages that were originally funded outside of AOT. Tr. 3525:8-14 (Malek); Tr. 3772:19-3773:3 (Lehn). This amount represented 4,225 individual mortgages. Tr. 3684:17-19 (Malek). During the damages trial, the parties referred to these mortgages as the “blue mortgages.” Mr. Malek lumped Colonial’s losses on these mortgages, which were only moved to AOT after becoming aged, together with losses on the “junk” mortgages that were acquired directly into AOT and for which the fraudsters knowingly caused Colonial to overpay TBW. See Tr. 3431:25-3432:5. 7. PwC is not responsible for Colonial’s losses on the “blue” mortgages, which are real mortgages that were moved to AOT after becoming aged on Colonial’s other facilities. See Tr. 3774:10-16 (Lehn). As the FDIC concedes, its “burden is to show that these are fraud losses.” Tr. 4014:19-20 (emphasis added). But the FDIC did not prove these losses were part of the fraud. During the years when the fraud was taking place, Colonial also purchased billions of dollars of real, legitimate mortgages from TBW. See Tr. 293:18-294:1 (O’Halloran); Tr. 3553:17-3556:7, 3558:17-3560:11 (Malek); Ex. F-4169; see also ¶¶ 31-32, infra. The vast majority of those real mortgages performed as expected and made money for the Bank. The blue mortgages at issue here represent the small fraction of those legitimate mortgages that developed problems after Colonial acquired them and subsequently lost money. Such losses were an ordinary business risk that Colonial faced with all of its mortgage warehouse lending customers, not just TBW. Even if the losses might have been serendipitously avoided if PwC had 5 Case 2:11-cv-00746-BJR-TFM Document 850 Filed 03/30/18 Page 9 of 77 uncovered the fraud, because they were not fraud losses, they were not proximately caused by PwC’s failure to uncover the fraud. 8. The FDIC’s damages are overstated for another reason. As a general matter, the FDIC concedes that, when it seeks damages for money Colonial advanced to TBW in exchange for “junk” mortgages, its damages must be reduced to reflect money that was recovered on those mortgages after the Bank closed. But with respect to one category of mortgages—“real estate owned” or “REO” mortgages that were in foreclosure when the Bank closed—the FDIC is seeking damages for Colonial’s outlays without reducing those damages to reflect tens of millions of dollars in post-bankruptcy recoveries. The FDIC claims it is entitled to do this because it gave up its right to the REO-related recoveries as part of a settlement with TBW’s bankruptcy estate. But as the FDIC’s counsel has acknowledged, the FDIC gave up its right to those recoveries in exchange for valuable consideration, including nearly $700 million in legitimate COLB mortgages. The FDIC cannot increase PwC’s damages by trading away a right that could have reduced those damages in exchange for a right that benefited only the FDIC. FINDINGS OF FACT I. The Court’s Previous Findings Concerning the Scope of the Fraud 9. A major focus of the liability phase of the trial was describing the fraud that the FDIC and CBG claimed PwC was negligent for failing to uncover. In its order on liability, the Court described the fraud in detail. See Liability Order at 10-11, 16-19. As the Court explained, the fraud consisted of three distinct phases: • Sweeping Phase (2002-2003): “The fraud began around March 2002, when TBW began overdrafting its operating account with Colonial.” Liability Order at 10. “To prevent the overdrafts from appearing on Colonial’s overdraft reports, employees in the MWLD began ‘sweeping’ money from TBW’s investor funding account to TBW’s operating account.” Id. 6 Case 2:11-cv-00746-BJR-TFM Document 850 Filed 03/30/18 Page 10 of 77 Then they “swept the funds back into the investor funding account after the overdraft report was generated.” Id. The FDIC does “not fault PwC for failing to discover the account sweeping aspect of the TBW fraud.” Id. at 16. • Plan B COLB Phase (2003-2005): “In late 2003, the fraudsters moved TBW’s overdraft, which was approximately $120 million at this point, to the COLB Facility.” Liability Order at 10. They did so “by having TBW ‘sell’ Colonial 99% participation interests in mortgages that had already been sold to other investors,” which the fraudsters referred to as “Plan B mortgages.” Id. at 17. The Plan B mortgages made it “appear on Colonial’s books and records as if Colonial owned an interest in legitimate COLB mortgages when, in fact, the mortgages were worthless.” Id. To “prevent the Plan B mortgages from appearing on the aging reports [generated by the MWLD’s compliance department],” the fraudsters “would supply new Plan B mortgage data on the MWLD’s pipeline reports roughly every 30 days,” a practice they referred to as “ ‘refreshing’ or ‘recycling’ the transactions.” Id. at 18. • Plan B and Junk AOT Phase (2005-2008): “[I]n the summer of 2005, the fraudsters moved the Plan B mortgages from the COLB Facility to the AOT Facility.” Liability Order at 18. “During the AOT phase of the fraud, instead of Colonial paying TBW for participation interests in individual mortgages that had already been sold to other investors, Colonial paid TBW for pools of loans that were supposedly in the process of being issued as a [mortgage-backed security].” Id. at 19. “In fact, the vast majority of the pools of loans had no underlying mortgages backing them, that is, the mortgages were non-existent.” Id. “There were also pools of loans that contained so-called ‘junk loans’—real mortgages that were in default or had other problems.” Id. 7 Case 2:11-cv-00746-BJR-TFM Document 850 Filed 03/30/18 Page 11 of 77 10. Besides the sweeping in 2002 to 2003, which PwC had no duty to uncover, there was no testimony or evidence offered at the liability trial regarding alleged fraud on the Warehouse and Overline facilities. Nor was there any evidence about fraud on the COLB facility other than the fake Plan B mortgages in 2003 to 2005 and the “shipped not paid” fraud, the latter of which the Court found PwC was not responsible for. The FDIC’s lead witness, Mr. O’Halloran, testified that there was no fraud on COLB between 2005 and 2009: Q. . . . Based on your investigation and review of documents, what was the nature of the fraud that Farkas and Kissick were engaged in in 2003? A. They were working on filling up their sweeping hole and moving that into the COLB product. And they started working fraudulently in the COLB product in roughly December of 2003. Q. And how did they -- how did they do that? A. They suggested that they had COLB loans, even though they didn’t exist, they had COLB loans, and they just recorded that as part of their asset pool. .... Q. And for how long did the fraud, this fraud on the COLB, how long did that continue? A. The COLB activity went between 2003 and approximately August of 2005. And then it reemerged in 2009. Tr. 285:7-24 (emphases added). 11. “Junk” mortgages were not discussed during the liability trial. The term did not appear at all in the FDIC’s or CBG’s proposed findings of fact and conclusions of law. See ECF Nos. 784, 785. The only reason the Court was able to mention “junk” in its opinion was because PwC’s proposed findings of fact noted that the fraudsters had hidden “junk” mortgages on the AOT facility. See ECF No. 783 at 16, 19. But at no point during the liability trial did anyone suggest that any mortgage acquired outside of AOT had been “junk” when Colonial acquired it. 12. Instead, the FDIC’s liability case was singularly focused on PwC’s failure to discover that the Plan B mortgages did not exist. See, e.g., Tr. 5:13-14 (FDIC’s opening 8 Case 2:11-cv-00746-BJR-TFM Document 850 Filed 03/30/18 Page 12 of 77 statement) (“PwC falsely certified because they certified to billions of dollars of fake assets.”); Tr. 3192:2-3 (FDIC’s closing argument) (“Year after year PwC signed its name to billions and billions of dollars in fake assets that did not exist.”); Tr. 3197:11 (“In this case the issue is assets, did the assets exist?”); Tr. 3217:12-14 (“PwC, the second largest audit firm in the world certified the existence of billions of dollars of assets with no evidence that those assets existed.”). The FDIC’s witnesses maintained that focus. See, e.g., Tr. 229:8-16 (O’Halloran) (“[T]here were never any AOT loans.”); Tr. 487:1-10 (Carmichael) (“[AOT] didn’t happen. It didn’t exist. There was nothing. It was all fake.”). 13. Moreover, the FDIC did not present any expert testimony at the liability trial that PwC breached any duty of care in connection with real, aged mortgages, despite the rule in Alabama (as elsewhere) that “when negligence is asserted against a professional, a witness also qualified in that profession must present expert testimony establishing both a breach of the standard of care and causation.” Riverstone Dev. Co. v. Garrett & Assocs. Appraisals, Inc., 195 So. 3d 251, 255 (Ala. 2015); see also Collins Co. v. City of Decatur, 533 So. 2d 1127, 1134 (Ala. 1988); Gertler v. Sol Masch & Co., 835 N.Y.S.2d 178, 179 (App. Div. 2007) (affirming directed verdict for accounting firm because “there was no expert testimony to establish applicable standards of professional practice and, accordingly, there was no basis for the finding essential to malpractice liability, that [the firm] deviated from such standards”). Instead, Professor Carmichael’s testimony focused on PwC’s failure to confirm “the existence of the mortgages.” Tr. 415:4-8; accord Tr. 410:13-21 (“If the mortgages are not there, if they’re not real, if they’re fake, then the existence assertion, that’s a material misstatement . . . . The auditor gets -- has to get evidence that those mortgages really exist.”); Tr. 492:2-3 (“They didn’t confirm the mortgages existed.”). 9 Case 2:11-cv-00746-BJR-TFM Document 850 Filed 03/30/18 Page 13 of 77 II. The Parties’ Positions on Damages A. The FDIC’s Position: $625 Million 14. The FDIC is seeking $625,309,085 in damages allegedly caused by PwC’s negligence in connection with the 2003 audit. The FDIC presented the testimony of its damages expert, Kenneth J. Malek, in support of that figure. The FDIC is not separately seeking damages related to the post-2003 audits because any damages from PwC’s failure to detect the fraud in those audits are necessarily subsumed in the damages from PwC’s failure to detect the fraud in the 2003 audit. 15. Mr. Malek’s damages calculation has, essentially, three steps: • First, he calculated how much money Colonial lost (supposedly due to the fraud) between February 25, 2004, five days after PwC issued its 2003 audit opinion, and August 14, 2009, the date when the Alabama State Banking Department closed Colonial. Mr. Malek explained that PwC is not responsible for any losses before February 25, 2004 (about $229 million), because “[a] good audit couldn’t have gotten that money back.” Tr. 3417:14-20. He included a five-day “grace period” after the date of the audit opinion because “you can’t stop fraud on a dime” and because it had taken about five days to stop the fraud after it was discovered in 2009. Tr. 3417:1-11. Mr. Malek concluded that Colonial’s fraud losses that postdated the 2003 audit were approximately $1.244 billion. Tr. 3417:21-23. • Second, Mr. Malek calculated the “net income” that Colonial earned from its relationship with TBW between February 25, 2004, and August 14, 2009. Mr. Malek recognized that “of course, it’s proper to deduct that income” to determine Colonial’s net losses due to the fraud. Tr. 3418:15-16. Mr. Malek calculated that Colonial’s TBW-related net income during the relevant period was approximately $365 million. See Tr. 3418:17-19 (deducting net income reduced damages from $1.244 billion to $879 million). 10 Case 2:11-cv-00746-BJR-TFM Document 850 Filed 03/30/18 Page 14 of 77 • Third, Mr. Malek calculated the recoveries that the FDIC has received since the Bank closed in 2009 that the parties agree should reduce the damages the FDIC can recover from PwC. Mr. Malek calculated the FDIC’s recoveries to be approximately $254 million. Tr. 3418:20-3419:1. 16. Based on these calculations, Mr. Malek opined that “the damages suffered by the FDIC as a result of PwC’s negligent 2003 audit” are approximately “$625 million.” Tr. 3419:27. The following table summarizes how Mr. Malek arrived at his bottom-line damages figure: Fraud losses through 8-14-09 $1,473,868,368 Preexisting fraud losses as of 2-25-04 ($229,353,877) Fraud losses from 2-25-04 to 8-14-09 $1,244,514,491 Net income from TBW during that period (364,865,067) FDIC recoveries (254,340,340) Damages $625,309,085 B. PwC’s Position: $306 Million 17. PwC maintains that the FDIC may recover at most $306,745,851. PwC contends that Mr. Malek’s damages figure is overstated for two reasons. 18. First, PwC argues that the FDIC has not proven that its damages should include non-fraud losses that Colonial sustained on the “blue” mortgages that (i) were originally funded on the COLB, Warehouse, or Overline facilities, but (ii) later aged and were transferred to the AOT facility, where they remained when the Bank closed. See Tr. 3769:21-3770:2 (Lehn). PwC’s damages expert, Kenneth M. Lehn, calculates the non-fraud losses on aged mortgages originally acquired outside of the AOT facility after February 25, 2004, to be $400,451,848. Dr. 11 Case 2:11-cv-00746-BJR-TFM Document 850 Filed 03/30/18 Page 15 of 77 Lehn recognized, however, that if those losses are excluded when calculating the FDIC’s damages, then recoveries of $99,528,964 that the FDIC received in connection with those aged mortgages must also be excluded. Applying both adjustments reduces the FDIC’s damages by $300,922,884. See Tr. 3800:1-15, 3804:23-3805:21. 19. The FDIC accepts Dr. Lehn’s math. Although the FDIC maintains that the losses on the blue mortgages should count as fraud losses, counsel for the FDIC stipulated that Dr. Lehn correctly calculated how the FDIC’s damages should be adjusted if the blue mortgages are excluded. See Tr. 3803:11-3804:18. 20. Second, PwC contends that the FDIC’s damages should be reduced to reflect the proceeds of certain “REO” mortgages that were on Colonial’s AOT facility at bank closure and included in Mr. Malek’s computation of damages, but to which the FDIC gave up its claim in exchange for other valuable consideration. Although Mr. Malek’s methodology required him to account for the value of those mortgages, he did not do so. The proceeds of the AOT REO mortgages were $49,457,148. The FDIC has already received a portion of those proceeds (at most, about $18,793,716) as a general unsecured creditor of the TBW estate, so the value of the AOT REO that was improperly excluded from Mr. Malek’s damages calculation is $30,663,432. See Part V, infra. 21. PwC recognizes that if it prevails on both of its arguments, then the REO adjustment must be reduced to avoid double-counting. In short, if blue mortgages are taken out of the FDIC’s damages entirely, then the REO adjustment should only reflect the proceeds of “orange” REO mortgages. Because the orange mortgages represent 57.52895% of the real (nonPlan B) AOT mortgages, PwC, using Mr. Malek’s allocation methodology, attributes 57.52895% 12 Case 2:11-cv-00746-BJR-TFM Document 850 Filed 03/30/18 Page 16 of 77 of the REO adjustment, or $17,640,350, to the orange mortgages. (If PwC prevailed only on its second argument, it would be entitled to the full REO adjustment of $30,663,432.) 22. PwC’s adjustments to Mr. Malek’s damages figure are reflected in the following table, which shows the FDIC’s maximum recovery if PwC prevails on both of its arguments: FDIC’s figure Fraud losses from 2-25-04 to 8-14-09 Adjustments from excluding aged mortgages moved to AOT Adjustments from including REO recoveries (assuming PwC prevails on both arguments) Result $1,244,514,491 (400,451,848) --- $844,062,643 Net income from TBW during that period (364,865,067) --- --- (364,865,067) FDIC recoveries (254,340,340) 99,528,964 (17,640,350) (172,451,726) Damages $625,309,085 (300,922,884) (17,640,350) $306,745,851 C. The experts agree that Colonial did not sustain losses as a result of moving “blue” mortgages that were funded on COLB, Warehouse, or Overline to AOT at a later date. 23. During the trial on damages, the Court asked Dr. Lehn whether, “between the time of the acquisition of the loan [by Colonial] and either when it’s put into AOT or after it’s put into AOT,” anything could “happen to that loan” that would justify including Colonial’s losses on that loan in the FDIC’s damages. Tr. 3798:3-3799:7. Dr. Lehn answered no. He explained that although Colonial’s management might have done “something inappropriate by 13 Case 2:11-cv-00746-BJR-TFM Document 850 Filed 03/30/18 Page 17 of 77 hiding those mortgages in AOT,” the “stealing” occurred “at the inception of the funding,” only when Colonial “advanc[ed] funding to TBW and then g[ot] back something that was either worthless or worth less than the amount that [Colonial] funded.” Id.; see also Tr. 3773:7-13 (“if a mortgage is funded on COLB and then later ages and then is later moved on to AOT,” then “[t]he cash is out when the loan is initially funded” by Colonial, and there is no additional loss “when that mortgage is moved from COLB or Warehouse to AOT”); Tr. 3810:16-3811:8 (“the stealing took the form of receiving advances from Colonial Bank in exchange for either fictitious mortgages or mortgages that were defective at the point of the initial funding,” and if “there’s no evidence that the loans were defective at the time that they were initially funded, as bad as it might be that somebody might have committed a different type of fraud by hiding the -- the loans in an offline database, that’s separate from what’s at issue here, which is the stealing which occurred on the front end of these transactions”); Tr. 3818:5-3819:13, 3820:21-3821:5 (if there were evidence that a blue mortgage was impaired “at the time of initial funding,” Dr. Lehn would agree that Colonial’s losses on that mortgage should be included in the FDIC’s damages). 24. It is important to underscore that both damages experts, Dr. Lehn and Mr. Malek, agree on the answer to the Court’s question. Like Dr. Lehn, Mr. Malek considered Colonial’s “fraud losses” to be the money Colonial advanced to TBW to acquire fraudulent mortgages, and he considered those losses to have occurred at the time when Colonial advanced the funding and acquired the mortgage and not any point thereafter. See Tr. 3544:15-19 (Malek) (agreeing that he “looked at the time when . . . the loans came out to COLB or Warehouse or Overline, and that’s what [he] counted for -- that date of funding for purposes of [his] calculation”); id. at 3547:13-21 (agreeing that his calculations “assumed that the money was spent or funded by Colonial at the time that the loan came in to COLB or Warehouse or Overline” and that “when 14 Case 2:11-cv-00746-BJR-TFM Document 850 Filed 03/30/18 Page 18 of 77 the loan later got moved . . . to AOT, there was no expenditure of funding that [he] took into account by Colonial”). 25. Mr. Malek explained that he measured the FDIC’s damages using “two accepted methodologies to compute damages from fraud losses: The benefit of the bargain rule, and the out-of-pocket loss rule.” Tr. 3695:22-25. Under the benefit of the bargain rule, “the defrauded purchaser [is] entitled to recover the difference between actual value and represented value of the property.” Tr. 3696:1-4. Under the out-of-pocket loss rule, “the defrauded purchaser [is] entitled to recover the difference between the value of the property received and the consideration given.” Tr. 3696:5-8. “[U]nder either rule, the damages are identical and they are simply measured on a cash-in and cash-out basis.” Tr. 3696:9-13. Here, the “cash-out” is the money “that [Colonial] used to fund and finance the fraud losses at issue.” Tr. 3696:19-22; see also Tr. 3544:15-19, 3547:13-22 (Malek); Tr. 3771:9-25 (Lehn) (explaining that Mr. Malek’s “cash-in/cash-out” methodology counted as the cash out “the cash that was used to advance the funding to TBW”). 1 26. Consistent with that view, Mr. Malek has never suggested that anything that happened to a mortgage after Colonial acquired it—such as becoming aged, being transferred to AOT and placed on the “secret set of books,” or not being “put back” to TBW—resulted in new or additional “fraud losses” to Colonial. He has merely asserted that those subsequent events can be evidence that the mortgage was already part of the fraud when it was first acquired by 1 Mr. Malek did not, however, attempt to calculate the value of the blue mortgages at the time Colonial acquired them. Instead, he assumed that they were all impaired. See Tr. 3548:123549:8 (Malek) (stating that he “did not attempt to place a value on” the blue mortgages “at the time that they were funded by Colonial in to those facilities”). FDIC counsel’s assertion that Mr. Malek’s team quantified Colonial’s losses “on a transaction by transaction basis,” Tr. 3949:1115, refers to Mr. Malek’s tracking of cash inflows and outflows, not to any mortgage-specific findings of impairment or causation. 15 Case 2:11-cv-00746-BJR-TFM Document 850 Filed 03/30/18 Page 19 of 77 Colonial and that, consequently, the money Colonial advanced to TBW to acquire the mortgage was a fraud loss. See, e.g., Tr. 3426:2-3, 3431:8-12 (Malek) (stating that “this case involves obtaining money under false pretenses” and asserting that losses on the blue mortgages were fraud losses because TBW “took these impaired loans and put them on Colonial’s lending lines as if those loans were fully valuable, and stole money from Colonial as if those loans were fully valuable” (emphases added)); Tr. 3548:12-3549:8 (Malek) (asserting that Colonial’s losses on the blue mortgages “were all fraud losses, and no portion of them is economic losses because these were loans the fraudsters knew couldn’t be sold to another bank, as illustrated by all the things we’ve summarized from my financial investigation, the five points that we talked about” (emphases added)). 27. This can be seen clearly in how Mr. Malek dealt with mortgages that were acquired by Colonial before his damages start date of February 25, 2004, but were transferred to AOT (i.e., the “secret set of books”) after the damages start date. Mr. Malek excluded from his damages calculations any losses that Colonial sustained on these mortgages. See Tr. 3459:153460:3, 3463:4-3464:17, 3524:4-13 (Malek); Ex. F-4107; Ex. F-4356; see also Tr. 3791:253792:7 (Lehn) (noting that Mr. Malek excluded from the FDIC’s claimed damages about $15 million in losses that Colonial sustained on mortgages that were “originally funded outside of AOT” before February 25, 2004, and “then subsequently moved to AOT” after that date). If Mr. Malek’s position were that Colonial could suffer a fraud loss on a mortgage after it acquired the mortgage—for example, at the point when the mortgage was moved to AOT—then he would have had no reason to exclude these mortgages. 28. Indeed, the only argument Mr. Malek has ever made about the blue mortgages is that they are part of the FDIC’s “fraud losses” because they were impaired at inception—that is, 16 Case 2:11-cv-00746-BJR-TFM Document 850 Filed 03/30/18 Page 20 of 77 when they were originally funded by Colonial. See, e.g., Malek Expert Damages Rebuttal Report, ECF No. 535-10, at 19 (Sept. 12, 2016) (asserting that the blue mortgages were properly included in damages because “there was obviously something wrong with [them] contemporaneous with original funding” (emphasis added)); id. (the blue mortgages “did not comply with the contractual requirements between Colonial and TBW when they were placed on Colonial’s books” (emphasis added)); id. (the blue mortgages were not “good when funded”); id. (“the problem [with the ‘blue’ mortgages] was at the inception”); id. at 22 (“Colonial was a dumping ground for Junk loans that were non-conforming and non-salable at the time Colonial advanced funds on those loans” (emphasis added)); id. at 25 (“In summary, Professor Lehn ignores the evidence that loans that failed to sell on other lenders’ lines or had deficiencies at origination were placed on Colonial’s books and left to age.” (emphasis added)). Had he attempted to present a different opinion for the first time at trial, he would have been prohibited from doing so. 29. Both experts are correct about this point. Colonial only advanced money to TBW at the time it purchased an interest in a mortgage. Colonial did not advance cash after the initial funding of the mortgage and did not sustain any additional losses when a mortgage was moved to AOT. Accordingly, as will be explained in more detail below, the relevant question for purposes of determining which losses were proximately caused by PwC’s failure to uncover the fraud is whether a mortgage was part of the fraud when it was acquired by Colonial. III. The “Blue” Aged Mortgages Acquired Outside of AOT A. During the time period of the fraud, TBW also originated a large number of real, legitimate mortgages that were funded by Colonial Bank. 30. As the Court explained in its findings concerning liability, Colonial’s Mortgage Warehouse Lending Division “provided short-term funding to mortgage originator customers to 17 Case 2:11-cv-00746-BJR-TFM Document 850 Filed 03/30/18 Page 21 of 77 enable those customers to originate and fund mortgage loans until such time as those loans could be sold to third-party investors, such as Freddie Mac or Ginnie Mae.” Liability Order at 9. Colonial advanced funding to its customers through three principal facilities: (1) warehouse lines of credit, where Colonial would accept the mortgages as collateral; (2) the COLB facility, where Colonial would receive a 99% interest in the mortgages; and (3) the AOT facility, where Colonial would receive a 99% interest in a pool of mortgages that were in the process of being packaged as a mortgage-backed security. Id. at 9-10, 13-14. 31. From 2003 through 2009, when the TBW fraud was taking place, TBW also originated billions of dollars’ worth of legitimate mortgages that were funded by Colonial Bank through the COLB and warehouse lines. As Mr. O’Halloran testified during the liability trial: Q. And even as to TBW, there were lots of mortgages that TBW sold to Colonial under the COLB program that were legitimate mortgages, right? A. That’s correct. Q. And you talked about the magnitude of the -- the problem of the fraud, how many hundreds of millions of dollars of legitimate COLB transactions took place during this same period? A. There would have been billions of dollars of transactions. Tr. 293:18-294:1; see also Tr. 3553:17-3556:7 (Malek) (agreeing that “a large number” of legitimate TBW mortgages passed through the COLB and warehouse lines while the fraud was taking place but stating that he “did not quantify that” because he “was focused on the fraud”); Tr. 3558:17-3560:11 (Malek) (agreeing that “TBW was pushing a lot of volume through” but he “didn’t calculate it”); Ex. F-4169. 32. Indeed, there is no dispute that when the Bank closed in August 2009, there were nearly $700 million worth of legitimate TBW mortgages on the COLB facility, not including the additional $900 million in “shipped not paid” mortgages that Bank of America shipped to end 18 Case 2:11-cv-00746-BJR-TFM Document 850 Filed 03/30/18 Page 22 of 77 investors without paying Colonial Bank. See Tr. 3575:20-3576:13 (Malek) (agreeing that these loans existed but declining to state their value); Ex. B-182 at 120 2 (showing that the total unpaid principal balance of these mortgages was more than $696 million). Given that the MWLD processed billions of dollars of mortgages and more than 10,000 individual transactions every month, see Kissick Dep. (Ex. D-3074) at 67:2-68:17, the $700 million in legitimate TBW mortgages that were on COLB when the Bank closed represent only a small fraction of all the legitimate TBW mortgages that cycled through the Bank during the time when the fraud was also taking place. B. Real mortgages from TBW and other customers sometimes stayed on Colonial’s books longer than expected and became “aged.” 33. MWLD funding was intended to be short-term in nature. It was expected that any given mortgage would stay on Colonial’s books for only a short period of time (e.g., 30 to 45 days) before it was sold to an end investor and Colonial’s advance was paid off. If a mortgage was not paid off within a certain amount of time (e.g., 90 days) after Colonial advanced the funds for that mortgage, it was considered “aged.” See Liability Order at 18, 84; 10/14/15 Roland Dep. (Ex. D-4021) at 108:16-21. 34. If a particular mortgage wound up aged, that did not mean that Colonial had done anything wrong by advancing money for that mortgage. It was “common for all [of Colonial’s] clients” to have aged mortgages. Fite Dep. (Ex. D-4019) at 55:11-16; see id. at 73:14-20; Bowman Dep. (Ex. F-4362) at 49:25-50:7 (“Every mortgage banker has the same issue . . . . It is not an uncommon issue.”). As Sarah Roland, a compliance specialist in the MWLD, testified, a “perfectly, just average transaction can have an age problem from time to time.” 4/13/15 Roland 2 All citations to specific pages of exhibits refer to the page numbering of the PDF document (as opposed to any internal page numbering within the exhibit). 19 Case 2:11-cv-00746-BJR-TFM Document 850 Filed 03/30/18 Page 23 of 77 Dep. (Ex. D-4021) at 35:1-11. Ms. Roland explained that “[t]he fact that loans are aged, in and of itself, that doesn’t indicate there’s something fraudulent occurring.” Id. at 291:15-18; see also id. at 10/15/15, 497:21-498:6; T. Kelly Dep. (Ex. F-4364) at 399:5-9, 399:13-22 (TBW mortgages that became aged “might have been perfectly fine at the time” when they were originally funded by Colonial); Kviz Dep. (Ex. F-4366) at 218:13-25, 219:3. 35. The reasons why mortgages became aged varied. Sometimes a mortgage was not sold to an end investor because of a “documentation exception,” which could be a typo, a missing signature, or some other “[p]roblem with the paperwork.” Kissick Dep. (Ex. D-4020) at 230:5-25; see Bowman Dep. (Ex. F-4362) at 185:24-186:2 (aged mortgages could have “some type of documentation issue”). Sometimes a mortgage could not be sold because it was “delinquent,” i.e., the homeowner was not making full and timely payments—a risk inherent in all mortgages. Bowman Dep. (Ex. F-4362) at 48:18-24. In other cases, a “perfectly good,” “perfectly performing” mortgage might not be sold because market conditions made it hard to get what TBW considered a fair price. Id. at 185:19-186:23. 36. Dr. Lehn testified that “aging of loans, especially during this period, was not uncommon.” Tr. 3784:23-24; see also Tr. 3815:15-19 (“there can be circumstances where, after the fact, even though it wasn’t intended, after the fact for legitimate transactions that the loans age and they end up holding them for a long period of time”). And although Mr. Malek believed that aging can be “a symptom of a fraudulent loan,” even he had to admit that “[a]ging . . . can happen with any loan,” even a legitimate one. Tr. 3433:15-16; see also Tr. 3533:18-19 (“[I]t is true that nonfraudulent loans could have aging.”). Mr. Malek never claimed that only fraudulent loans can become aged. 20 Case 2:11-cv-00746-BJR-TFM Document 850 Filed 03/30/18 Page 24 of 77 37. Mortgage originators other than TBW, including Bayrock and Pinnacle, also had substantial numbers of aged mortgages at Colonial. See, e.g., Tr. 3591:21-3593:13, 3678:213680:24 (Malek); Tr. 3878:24-3879:13 (Lehn); Ex. D-17 at 42; Ex. P-1277. TBW had more aged mortgages than other customers, but that was to be expected given that TBW was by far the MWLD’s largest customer. See Liability Order at 9. The number of TBW mortgages funded by Colonial that wound up aged was consistent with the overall volume of business TBW did with Colonial. See Tr. 3879:7-13 (Lehn); Fite Dep. (Ex. D-4019) at 65:23-66:6; Bryan Dep. (Ex. D4018) at 140:8-16, 140:18-19; 4/13/15 Roland Dep. (Ex. D-4021) at 291:6-11, 291:13; Kissick Dep. (Ex. D-4020) at 230:15-25, 340:16-21, 556:2-7. 38. Unlike the “Plan B” mortgages, which were “fake” and “had no value to Colonial,” Liability Order at 17, 29, the aged TBW mortgages were real and had substantial value, although not as much as they had when they were originated. See Tr. 3649:13-3650:20 (Malek). C. The fraudsters concealed the fake Plan B mortgages and the “junk” mortgages acquired directly into AOT, but the real, aged mortgages on the other facilities were well known at Colonial. 39. Mortgages on the COLB and warehouse lines were tracked in Colonial’s ProMerit database. The ProMerit database was not hidden, but was visible to anyone at the Bank. See Tr. 3427:7-14, 3543:4-9, 3554:19-3555:16, 3643:21-3644:9 (Malek). 40. Colonial had controls in place to keep track of aged mortgages on the COLB and warehouse lines. The MWLD’s compliance group generated periodic “ ‘aging’ reports” that listed all the aged mortgages on Colonial’s books and how long each had been there. See Liability Order at 84; Fite Dep. (Ex. D-4019) at 50:2-10, 51:24-52:2, 53:4-12; Bryan Dep. (Ex. D-4018) at 119:3-21; 10/14/15 Roland Dep. (Ex. D-4021) at 110:6-16; Kissick Dep. (Ex. D4020) at 158:16-18, 159:2-5; see also Ex. D-315. 21 Case 2:11-cv-00746-BJR-TFM Document 850 Filed 03/30/18 Page 25 of 77 41. The fraudsters prevented the fake Plan B mortgages from appearing on the aging reports by surreptitiously “refreshing” or “recycling” the transactions. Liability Order at 85. But the fraudsters did not do anything to prevent real mortgages from appearing on the reports, which were then shared with numerous officers and employees of Colonial who were not involved in the fraud. See Kissick Dep. (Ex. D-4020) at 613:16-18 (“I knew they were aged loans with problems, and so did everybody else at the bank.”); id. at 546:13-546:18 (Colonial’s management “knew about the aged loans,” but “nobody knew about Plan B”); see also Ex. D-610 (2005 email from Ms. Kissick to several individuals not involved in the fraud, including members of the compliance group, forwarding a joke about “JUNC” loans). 42. The compliance group in the MWLD closely monitored the aging reports, and the portfolio manager responsible for each client had to sign off on that client’s aged mortgages every month. See Ex. D-168 at 4-5; Ex. D-297 at 4; Ex. D-315; Beahler Dep. (Ex. D-4017) at 44:17-23; Bryan Dep. (Ex. D-4018) at 120:20-121:11, 122:21-124:4, 124:14-16, 124:18-20; Fite Dep. (Ex. D-4019) at 50:21-25, 51:2-14, 74:3-24, 75:8-16, 193:17-194:11, 198:10-21, 198:24199:3, 204:14-25, 205:2-9; 4/13/15 Roland Dep. (Ex. D-4021) at 171:16-172:3, 174:20-175:15; id. at 10/14/15, 109:3-14, 111:8-25; T. Kelly Dep. (Ex. F-4364) at 217:18-23. 43. The aging reports were also monitored by Kamal Hosein and Mary Lou Bathen, the Treasurer and Assistant Treasurer, respectively, for CBG and Colonial Bank. See Ex. P-2037 (September 2007 email from Ms. Bathen to Colonial CFO Sarah Moore and Mr. Hosein attaching report that showed more than $350 million in TBW mortgages aged past 120 days); Ex. A-185 at 129 (PwC work paper from 2007 stating that Ms. Bathen “is very involved in the monitoring of the aging”); Kissick Dep. (Ex. D-4020) at 235:24-25, 236:2-8 (Ms. Bathen had “overall responsibility” and was “very involved” in monitoring aging on COLB); id. at 529:12- 22 Case 2:11-cv-00746-BJR-TFM Document 850 Filed 03/30/18 Page 26 of 77 16 (“They got my reports every single day up in Montgomery. Mary Lou Bathen and Kamal [Hosein] had access to all of our information every single day and pulled every single report . . . .”); Tr. 2280:7-2281:21 (Bathen). 44. In addition, the aging reports were shown to bank examiners from the Office of the Comptroller of the Currency (“OCC”), which was Colonial Bank’s primary federal regulator from 2004 to June 2008. Spencer Dep. (Ex. D-4022) at 90:3-8, 90:12-22. And they were kept in the Bank’s general records and were available to anyone at the Bank who wanted to see them. 10/15/15 Roland Dep. (Ex. D-4021) at 494:21-22, 495:23-496:7. 45. No one who reviewed the aging reports and saw the number of aged TBW mortgages on the warehouse lines and the COLB facility regarded those aged mortgages as an indicator of fraud, even when the aging reports showed hundreds of millions of dollars in aged mortgages. See Tr. 3680:25-3683:1 (Malek); Beahler Dep. (Ex. D-4017) at 48:13-17; Fite Dep. (Ex. D-4019) at 58:7-19, 73:14-74:2, 186:15-19, 188:13-17; 10/14/15 Roland Dep. (Ex. D-4021) at 124:2-12, 125:3-8; Spencer Dep. (Ex. D-4022) at 91:5-15, 431:11-17. That is because aged mortgages were not a part of the fraud, but an ordinary risk of doing business for a mortgage warehouse lender like Colonial. D. Colonial’s senior management directed that the aged mortgages be moved into AOT to hide them from regulators. 46. Over time, Colonial developed a practice of transferring aged mortgages from the warehouse lines and the COLB facility to the AOT facility, which did not track mortgage-level data. See T. Kelly Dep. (Ex. F-4364) at 131:19-132:25 (when “actual real loans” on COLB “aged and were not sold,” they would “eventually be dumped onto AOT into some sort of security”); id. at 133:3-18 (“as time went on . . . more and more aged loans end[ed] up being moved onto AOT”). This was done “to ‘hide’ aged mortgages so that Colonial’s regulators 23 Case 2:11-cv-00746-BJR-TFM Document 850 Filed 03/30/18 Page 27 of 77 would not become concerned about the number of aged mortgages on Colonial’s books.” Liability Order at 87. 47. Colonial’s senior management oversaw this practice. This Court found that Colonial Bank’s and CBG’s Treasurer, Kamal Hosein, “himself ‘directed’ Ms. Kissick to move hundreds of millions of dollars in unsalable COLB mortgages onto the AOT facility” in September 2007. Liability Order at 87-88. Colonial Bank’s and CBG’s Assistant Treasurer, Mary Lou Bathen, was also aware of the practice. In a September 2007 email chain, Ms. Kissick and Ms. Bathen discussed Colonial’s recent efforts to “clean up” so-called “vintage” or “seasoned” loans (euphemisms for aged mortgages) by moving them to AOT, efforts that “had Kamal’s blessing.” Ex. D-19; see also Ex. D-733; Kissick Dep. (Ex. D-4020) at 520:8-25, 521:2-9, 523:25, 524:2-8, 525:14-17, 525:18-526:22, 529:2-7, 529:10-16, 531:4-16, 543:2-15, 548:6-13, 551:13-23, 555:9-25, 556:2-7, 556:18-21; T. Kelly Dep. (Ex. F-4364) at 48:16-49:5. 48. Mr. Malek claimed that “the fraudsters” decided to hide the aged mortgages from COLB and the warehouse lines on AOT. Tr. 3558:2-5. And the FDIC, in its closing argument, claimed that “the fraudsters” moved aged mortgages to AOT “to keep [them] hidden from management.” Tr. 4010:10-14. But this Court’s prior order makes clear that it was not “the fraudsters” (Ms. Kissick and Ms. Kelly) who made the decision to move the aged mortgages, but Mr. Hosein. See Liability Order at 87-88. Indeed, the Court discussed Mr. Hosein’s misconduct in the audit interference section of its order, not in the section on PwC’s negligence in failing to uncover the fraud. Mr. Malek, moreover, acknowledged that Mr. Hosein was not a fraudster. Tr. 3574:4-12. 49. No money went out the door when Colonial transferred an aged mortgage from a warehouse line or COLB to AOT. Moving mortgages from one facility to another only required 24 Case 2:11-cv-00746-BJR-TFM Document 850 Filed 03/30/18 Page 28 of 77 “an internal accounting series of entries”; it did “not involve the advancing by Colonial of new money” to TBW or any other customer. T. Kelly Dep. (Ex. F-4364) at 397:2-6, 398:6-14; see also id. at 404:20-405:7. Colonial sent money to TBW only “when the [mortgage] was originally funded,” at which time Colonial “got a real [mortgage] back” in exchange. Id. at 398:15-22. 50. The aged mortgages that were moved to AOT were “totally unrelated to anything having to do with Plan B.” Kissick Dep. (Ex. D-4020) at 1001:24-25, 1002:2, 1002:7-11, 1002:13. Rather, as Ms. Kissick explained, they were “legitimate” mortgages for which “the market [had] dried up.” Id. at 974:21-975:14; see id. at 793:8-19 (“They might have ended up being bad loans, but they started out being Alt-A loans, most of them, and there was no Alt-A market anymore.”). 51. Indeed, roughly one-third of the blue mortgages started on Colonial’s warehouse lines of credit, where no one has ever claimed any Plan B fraud was taking place. See generally Liability Order at 16-19 (describing the phases of the fraud). The other two-thirds started on the COLB facility. See D-4015 at 75; Tr. 3651:11-3652:5, 3654:18-3655:16 (Malek). But as explained above, they were not Plan B mortgages. Everyone agrees that, in addition to the fake Plan B mortgages, countless legitimate TBW mortgages were funded on COLB during the years when the fraud was taking place. 52. Some of the aged mortgages that were moved to AOT were eventually sold to end investors. T. Kelly Dep. (Ex. F-4364) at 207:25-208:12; Kissick Dep. (Ex. D-4020) at 543:2-12. Others, however, were still on the AOT facility when the Bank collapsed. Kissick Dep. (Ex. D-4020) at 543:13-15. 25 Case 2:11-cv-00746-BJR-TFM Document 850 Filed 03/30/18 Page 29 of 77 IV. The FDIC did not prove that the aged mortgages moved to AOT were fraudulent or impaired when Colonial acquired them. 53. The fact that a mortgage wound up aged did not mean that there was anything wrong with the mortgage when Colonial acquired it. See ¶¶ 34-37, supra. Nonetheless, the FDIC maintains that all of the blue mortgages, which became aged on Colonial’s COLB, Warehouse, and Overline facilities and were then moved to AOT (at management’s direction) to hide them from regulators, were defective ab initio and therefore part of the fraud. Mr. Malek testified that he believed the mortgages that were moved to AOT after becoming aged on other Colonial facilities were fraudulent because they bore five “badges of fraud.” See Tr. 3432:6-10. 3 54. Before delving into Mr. Malek’s “badges of fraud,” it is worth pointing out one basic reason why the FDIC’s position cannot be right. Mr. Malek conceded that, setting aside the “shipped not paid” mortgages that the Court found PwC is not responsible for, “as of bank close . . . there was nothing stolen on the COLB” facility. Tr. 3933:1-4 (emphasis added). The FDIC has also conceded that “at the time of Colonial Bank’s failure,” there was no fraud on the “Overline” facility. FDIC’s Mot. to Preclude PwC from Presenting a New Setoff Theory, ECF No. 840, at 11. Nor is the FDIC seeking damages for any mortgages that were on the warehouse lines of credit when the Bank closed. In other words, the FDIC’s position is that even though TBW was routinely “dumping” fraudulent mortgages into COLB, Warehouse, and Overline from 3 In his reports, Mr. Malek represented that he would not be offering testimony on liability or causation. See Tr. 3511:14-24, 3549:9-14. PwC objected to Mr. Malek’s testimony about his “badges of fraud” as improper liability and causation testimony that was beyond the scope of his report and his role as a damages expert, but the Court overruled that objection. See Tr. 3432:614, 3439:14-25, 3780:22-3781:12. PwC understands, of course, that this was a bench trial, and the Court allowed evidence that probably would not have been admitted in a jury trial. When considering the weight to give Mr. Malek’s testimony, the Court can properly take into account that he was designated solely as a damages witness but then testified at trial about liability and causation issues—and in a way that was inconsistent with the testimony of the FDIC’s other witnesses who testified about those issues. 26 Case 2:11-cv-00746-BJR-TFM Document 850 Filed 03/30/18 Page 30 of 77 at least 2004 through 2009, at the moment when the FBI raid brought the fraud to a sudden halt, it just so happened that all of the fraudulent mortgages were on AOT and all of the mortgages on the other facilities were legitimate. If true, that would be a remarkable coincidence. 55. Moreover, even if the fraudsters had dumped impaired mortgages on COLB, Warehouse, and Overline before AOT existed, it would not have made sense for them to continue doing so once AOT was available starting in April 2004. Colonial’s ProMerit system tracked mortgage-level detail for all mortgages on COLB, Warehouse, and Overline, whereas it did not track that level of detail for AOT. See Tr. 3543:4-9, 3554:19-3555:16, 3643:21-3644:9 (Malek); Liability Order at 87. That made AOT the ideal hiding place for fake or junk mortgages. Mr. Malek suggested that the fraudsters might have continued to use COLB even after AOT was available because “some days [TBW] had room on the AOT line when it needed to steal money and other days it had room on the COLB line.” Tr. 3433:5-10. But he did not provide any facts or analysis to substantiate that suggestion, nor is PwC aware of any such evidence. 56. In any event, for the reasons explained below, none of Mr. Malek’s “badges of fraud” established that all of the blue mortgages were defective and fraudulent when originally funded by Colonial. A. First Supposed Badge of Fraud: The “Secret Set of Books” 57. Mr. Malek’s first indicator that the blue mortgages were fraudulent was that, after the mortgages aged and were moved to AOT, the fraudsters kept track of them in a “secret set of books.” Tr. 3432:18-20. Mr. Malek admitted that the mortgages were put on the “secret set of books” only after they were moved to the AOT facility to hide them from regulators. Tr. 3543:4-9, 3655:2-8. He nonetheless assumed that “every single loan that was hidden in the secret set of books” at any time “was a fraudulent transaction” when Colonial acquired it, even 27 Case 2:11-cv-00746-BJR-TFM Document 850 Filed 03/30/18 Page 31 of 77 though it was not in a hidden set of books at that time. Tr. 3520:17-18; see Tr. 3557:22-23 (“If a loan is hidden in a secret database, it has to be fraud.”); Tr. 3705:20-21 (“I believe that because they went into the secret database that there was something illegitimate about them.”). He drew no distinction between mortgages that “originally went into the secret set of books” (the junk loans acquired directly on the AOT facility, or “orange” mortgages) and mortgages that “were originated on the COLB line or the mortgage warehouse line” and, after becoming aged on those lines, were “[e]ventually” moved to AOT to hide the aging from regulators and only at that point “were put in the secret set of books” (the “blue” mortgages). Tr. 3433:2-14. 58. The problem with this first “indicator of fraud” is that it ignores the difference between mortgages that started out in the “secret set of books” and those that started out legitimate and were moved to the “secret set of books” months or years after Colonial acquired them. As Mr. Malek admitted, before the blue mortgages were moved to AOT, they were tracked in Colonial’s ProMerit database and appeared on aging reports that were read widely within the Bank. See id.; see also Tr. 3558:9-16 (agreeing that “what was in COLB wasn’t in a secret database” but “in the ProMerit database that was available at the Mortgage Warehouse Lending Division broadly” and adding that “both the fraudsters and the rest of the bank were looking at aging reports”). By Mr. Malek’s own logic, which assumes that the fraudsters would not want fraudulent mortgages to be “visible” to non-fraudsters within the Bank, Tr. 3432:18-20, the fact that these mortgages were tracked in ProMerit and appeared on aging reports is evidence that they were not part of the fraud when they were originally funded. 59. That these mortgages were later taken “off the books” to hide them from regulators after they developed aging issues does not mean they were fraudulent when they were acquired. As Dr. Lehn explained, “the act of hiding the loan, although it may be inappropriate, 28 Case 2:11-cv-00746-BJR-TFM Document 850 Filed 03/30/18 Page 32 of 77 probably was inappropriate . . . does not mean that the losses associated with that loan,” which occurred “when it was initially funded,” were part of the fraud. Tr. 3776:21-3777:6; see also Tr. 3797:5-3799:15. Further, Mr. Malek ignored the Court’s finding that at least a large portion of the aged mortgages moved to AOT were moved at the direction of Mr. Hosein, a non-fraudster. See Liability Order at 87-88; ¶¶ 47-48, supra. 60. Moreover, Mr. Malek acknowledged that some of the mortgages that were moved to AOT were later sold to end investors for full value, so that Colonial did not suffer any loss on those mortgages. See Tr. 3662:18-3665:2. If only fraudulent mortgages were moved to AOT, then Colonial should not have been able to recover full value for any mortgage after it was moved to AOT. B. Second Supposed Badge of Fraud: Mortgages Not “Put Back” to TBW 61. For his second indicator that the blue mortgages were fraudulent, Mr. Malek testified that when a mortgage became aged, “Colonial had a right to send the [mortgage] back to the originator, either TBW or the good customers, and demand and receive an immediate refund.” Tr. 3434:9-12. He claimed that Colonial exercised that “put back” right with other customers, and he implied that the only reason why Colonial did not exercise that right with respect to aged TBW mortgages is because those mortgages were part of the fraud. Tr. 3434:1315 (“Because of the fraud, the fraudsters prevented Colonial from doing that and, therefore, perpetuated the loss.”); Tr. 3435:13-16 (“With legitimate customers, the non-fraudulent ones, Colonial did put [the aged mortgages] back . . . Because of the fraud, Colonial didn’t put them back to TBW.”). 62. Mr. Malek was mistaken. To begin, as Mr. Malek eventually admitted, Colonial did not have the right to put back mortgages that were funded on Warehouse and Overline. As to those mortgages, it could only make margin calls requiring TBW to send cash (a process 29 Case 2:11-cv-00746-BJR-TFM Document 850 Filed 03/30/18 Page 33 of 77 sometimes called “curtailment”), which it did from time to time. See Tr. 3723:5-24 (Malek); Tr. 3783:14-3784:2 (Lehn); see also Tr. 4022:12-15 (in closing argument, FDIC conceded that “[y]ou do see some entries in that database” where “Colonial would do haircuts from time to time”). Mr. Malek acknowledged that curtailment was economically similar to putting back the mortgages. Tr. 3545:2-18. 63. Counsel claimed, without citing any evidence, that this happened “less and less” as “time wore on,” Tr. 4022:12-15, but the FDIC made no effort to prove or quantify that assertion. Cf. Deng v. Scroggins, 169 So. 3d 1015, 1028 (Ala. 2014) (“arguments of counsel are not evidence” capable of supporting a damages award). In fact, Mr. Malek’s own schedule shows that Colonial made at least 800 margin calls on aged TBW mortgages that were funded outside of AOT (on COLB, Warehouse, and Overline). See Ex. F-4100. Therefore, at a minimum, this supposed badge does not apply to the 33.26% of blue mortgages that were funded on Warehouse and Overline, which represent $100,098,168 of the $300,922,884 in damages for the blue mortgages. D-4015. 64. As for COLB, Ms. Kissick explained that Colonial did not require its COLB customers to repurchase aged mortgages because the OCC had told Colonial that it could not do so and still account for the COLB transactions as purchases under FAS 140. See Tr. 3665:243667:7 (Malek). The FDIC’s only response was to proclaim that “Kissick was talking about that. But that’s not true.” Tr. 4018:8-9. But Ms. Kissick was deposed after her guilty plea and told the truth about countless other aspects of the fraud, and there is no indication that she was lying about this point. The Court has previously found that Ms. Kissick testified honestly about her role in the fraud. See Liability Order at 71. The Court finds her testimony explaining why Colonial did not put back aged mortgages to TBW truthful as well. Given that Ms. Kissick 30 Case 2:11-cv-00746-BJR-TFM Document 850 Filed 03/30/18 Page 34 of 77 “drove th[e] train” on deciding whether aged mortgages should be put back to customers, T. Kelly Dep. (Ex. F-4364) at 175:25-176:7, her sworn explanation for why the mortgages were not put back carries more weight than the FDIC’s speculation. Ms. Kissick’s testimony about the instructions she received from the OCC makes clear that Colonial had a perfectly innocent reason for not requiring TBW to repurchase legitimate, aged mortgages. 65. Indeed, the FDIC’s theory—that the only reason Colonial did not put back the mortgages is that Ms. Kissick was compromised by her involvement in the fraud—makes no sense when one recalls that the aged mortgages were tracked on ProMerit and on regular aging reports and were well known to numerous individuals at Colonial who were not compromised, including members of senior management who directed that the mortgages be moved to AOT rather than put back to TBW. See ¶¶ 39-48, supra; Tr. 3877:19-3878:19 (Lehn) (noting that “this was information [management] had, and an issue that they attempted to manage and manage in what they thought was the most appropriate way, which is not to put it back on TBW”). Dr. Lehn also pointed out that, in addition to the OCC’s instructions, there were powerful business reasons for a bank like Colonial not to put back aged mortgages to its largest customer during the housing crisis. See Tr. 3778:17-3779:8, 3783:2-13; see also Tr. 3864:13-15 (“[F]orbearance is not an unusual thing in the business world, especially with major customers that might be going through financial difficulties.”). 4 4 The FDIC’s designation of deposition testimony from Wes Kelly of PwC (see Ex. F-4365) is improper. Mr. Kelly’s testimony, which concerns work PwC did on aged COLB mortgages in 2007, goes to liability, not damages. To the extent the FDIC relies on that testimony to suggest that Colonial was “putting back” aged COLB mortgages to customers other than TBW, the FDIC ignores the evidence showing that at various points in 2007 other customers had millions of dollars in COLB mortgages that were aged more than 120 days. See, e.g., Ex. D-17 at 42; see also ¶ 37, supra. 31 Case 2:11-cv-00746-BJR-TFM Document 850 Filed 03/30/18 Page 35 of 77 66. Accordingly, Colonial’s decision not to put back the blue mortgages to TBW is not evidence that any of those mortgages, much less all $415 million of them, were part of the fraud at inception. C. Third Supposed Badge of Fraud: The Fraudsters’ Statements 67. For his third indicator that the blue mortgages were fraudulent, Mr. Malek claimed that the fraudsters’ testimony “shows that the fraudsters knew the loans they were dumping on Colonial had been rejected by other banks or wouldn’t be saleable to other banks; and they recognized this was part of the fraud.” Tr. 3436:1-7. All of the testimony Mr. Malek cited, however, relates to the “orange” mortgages—the ones that were acquired directly into AOT and which PwC agrees were part of the fraud. None of this testimony establishes that the “blue” mortgages—the ones that were moved into AOT only after they became aged on the COLB or warehouse lines—were part of the fraud. See Tr. 3784:9-17 (Lehn) (“I read every word of the excerpts that [Mr. Malek] provided, and in none of them is there any evidence that anyone said that TBW was dumping junk loans on the COLB line. There is testimony that they were dumping them on the AOT line, but not on the COLB line . . . .”). 68. First, Mr. Malek cited various email exchanges. For instance, he testified about an email exchange from April 12, 2004, about Colonial purchasing aged mortgages from TBW that had originally been funded by Washington Mutual, another bank. See Tr. 3439:12-3443:14, (discussing Ex. P-1907). In the exchange, Ms. Kelly asks, “Why are we always the dumping ground?” and Ms. Kissick tells Mr. Farkas, “We need to get these issues resolved . . . We cannot continue to be the dumping ground.” Ex. P-1907 at 1 (ellipsis in original). Mr. Malek testified that this email exchange had to refer to “dumping” impaired mortgages on “[t]he warehouse line and the COLB line” because the AOT facility did not “exist yet” and “was not set up as a separate line of credit for TBW until 2005.” Tr. 3440:9-14. 32 Case 2:11-cv-00746-BJR-TFM Document 850 Filed 03/30/18 Page 36 of 77 69. On cross-examination, it became clear that Mr. Malek was mistaken. TBW began using the AOT facility in April 2004, around the same time as the emails on which Mr. Malek relied. See Tr. 3675:15-3678:11. Mr. Malek’s own schedule shows that Colonial advanced money to TBW through the AOT facility as early as April 28, 2004. Ex. F-4135 at 1. And although that money was not actually advanced until a few weeks after the April 12 emails, other evidence shows that AOT trades—including trades involving “WaMu” or Washington Mutual— were under discussion in March 2004. See Ex. D-569 at 3. In sum, there is no basis to conclude that the references in Ex. P-1907 to Colonial being a “dumping ground” refer to anything other than “orange” mortgages, those that were acquired directly into AOT. 70. If anything, the fact that the references to Colonial being a “dumping ground” for impaired mortgages occurred right around the time when the AOT facility was first being used confirms that the “dumping” problem was uniquely associated with AOT. But even if the April 2004 emails were evidence that TBW was “dumping” impaired mortgages on COLB at that time, there is no evidence whatsoever that TBW continued to do so after the fraud shifted to AOT in the summer of 2005. See Liability Order at 11 (“In the summer of 2005, the fraudsters moved the fraud from the COLB Facility to the AOT Facility.”). As noted above, of the FDIC’s claimed losses on blue mortgages, about two-thirds relate to mortgages that originated on COLB, and approximately 95% of those relate to COLB mortgages that were purchased in 2006 to 2009, after the fraud had shifted from COLB to AOT. See Tr. 3657:6-3659:9 (Malek); Ex. D-4015 at 75; Ex. D-4016 at 42. 71. For the same reasons, none of the other emails Mr. Malek cited, all of which post- date the emails from April 12, 2004, suggest that the blue mortgages (aged COLB and warehouse mortgages that were moved to AOT) were fraudulent when Colonial acquired them. 33 Case 2:11-cv-00746-BJR-TFM Document 850 Filed 03/30/18 Page 37 of 77 See Tr. 3443:17-3445:22, 3447:3-9 (discussing Ex. P-2094, an email exchange from April 22, 2004, in which Lee Farkas and Desiree Brown consider asking Colonial to purchase aged mortgages from TBW, without any evidence of what actually happened); Tr. 3448:2-3449:8 (discussing Ex. P-2114, an email exchange from July 2005 in which Ms. Kissick and Ms. Kelly discuss “clean[ing] up” aged mortgages by moving them to AOT, without any indication that those mortgages had problems when they were originally acquired); Tr. 3449:9-3450:14 (discussing Ex. P-2100, an email exchange from July 2006 in which Ms. Brown tells Mr. Farkas that “Colonial is full of total junk” and Mr. Farkas replies that “[t]his aged loan problem is now out of control,” without distinguishing between aged loans moved from other lines to AOT and aged loans acquired directly into AOT). 5 72. Second, Mr. Malek cited Ms. Kissick’s statement of facts from her criminal plea, Ex. P-1754. See Tr. 3452:20-3454:13. Specifically, he pointed to paragraphs 12 and 13, where Ms. Kissick stated that the fraudsters “caused Colonial Bank to hold in its accounting records AOT trades backed by assets that TBW was unable to sell” and “took steps to cover up the fictitious and impaired Trades on AOT.” Ex. P-1754 at 6. But on cross-examination, Mr. Malek admitted that those paragraphs were about the “orange loans” (the mortgages acquired directly into AOT) and that they didn’t “say one way or the other” whether the “blue loans” (the 5 On redirect, the FDIC’s counsel showed Mr. Malek the testimony of Desiree Brown about the July 2006 emails, in which she was asked “where were these loans that are total junk” and responded that “they could be on any of the lines. Probably the majority of them were on AOT.” Tr. 3728:3-7. Neither the emails in question, Ex. P-2100, nor Ms. Brown’s testimony says that the “junk” Ms. Brown was referring to were mortgages that were impaired when Colonial acquired them, as opposed to mortgages that became impaired later. See also id. at 3843:10-14 (Lehn) (stating, in regard to Ms. Brown’s testimony, “it could have been that there’s a legitimate loan being funded by Colonial Bank, it’s placed on the COLB line, and then it ages and it’s referred to as junk because it’s aged. It doesn’t mean that at the time it was funded it was defective”). 34 Case 2:11-cv-00746-BJR-TFM Document 850 Filed 03/30/18 Page 38 of 77 mortgages moved to AOT) were fraudulent when Colonial acquired them. See Tr. 3671:63672:9. He also admitted that in her deposition, Ms. Kissick testified that the real (not Plan B) TBW mortgages that aged on the COLB facility “were legitimate”: “They were just loans that, all of a sudden, the market dried up.” Tr. 3672:10-20. Mr. Malek’s only response was that Ms. Kissick’s testimony on this point supposedly did not “agree with some of the other testimony that [he had] cited.” Tr. 3672:21-24. The Court finds that Ms. Kissick is a more reliable source when it comes to the parameters of the fraud. 73. Third, Mr. Malek cited Ms. Kelly’s deposition testimony, in which she stated that Colonial became a “dumping ground” for impaired TBW mortgages that had become aged at other banks. See Tr. 3454:14-3455:1; T. Kelly Dep. (Ex. F-4364) at 81:8-83:7. Ms. Kelly’s testimony establishes only that impaired TBW mortgages were “dumped” onto the AOT facility. In other words, it supports the undisputed fact that the “orange” mortgages, which were acquired directly into AOT, were fraudulent. But Ms. Kelly’s testimony does not establish that the blue mortgages, which were acquired outside of AOT, were fraudulent when acquired or that any loss occurred when they were transferred from other facilities to AOT. On cross-examination, Mr. Malek admitted that the portion of Ms. Kelly’s testimony on which he relied did not establish that any TBW mortgages were fraudulent when they were acquired onto the COLB or warehouse lines. He also admitted that Ms. Kelly had “testif[ied] elsewhere that she didn’t really know whether TBW was dumping bad loans onto COLB.” Tr. 3674:8-3675:14. Indeed, with respect to so-called “crap” mortgages that aged on COLB, Warehouse, or Overline and were then moved to AOT, Ms. Kelly agreed that she was “not able to say that when these crap loans were originally funded, they were, in fact, crap; they might have been perfectly fine at that time.” T. Kelly Dep. (Ex. F-4364) at 399:5-9, 399:13-22. 35 Case 2:11-cv-00746-BJR-TFM Document 850 Filed 03/30/18 Page 39 of 77 74. Mr. Malek’s reliance on the deposition testimony of TBW’s former president, Ray Bowman, was misplaced for similar reasons. See Tr. 3450:25-3452:19. Mr. Bowman testified that when a lender other than Colonial required TBW to repurchase aged mortgages, TBW would “turn to Colonial” as the “lender of last resort” or the “dumping ground for TBW’s aged receivables,” and that Ms. Kissick “had to” go along because of the fraud. Bowman Dep. (Ex. F-4362) at 184:16-185:8, 187:18-24. As with Ms. Kelly’s testimony, however, there is nothing in Mr. Bowman’s testimony that suggests he was talking about blue mortgages originally funded through COLB and the warehouse, as opposed to “orange” mortgages acquired directly into AOT. D. Fourth Supposed Badge of Fraud: The Mortgages Were Never Sold 75. For his fourth indicator, Mr. Malek testified that the blue mortgages must have been fraudulent because they “were never sold” to an end investor. Tr. 3436:14. This is just another way of saying that they were aged mortgages, since a mortgage aging on Colonial’s books necessarily means that the mortgage was not sold to an end investor. 76. As explained above, however, aging happened with all customers (including Bayrock and Pinnacle as well as TBW) and was not necessarily a sign that a mortgage was fraudulent when Colonial acquired it. See ¶¶ 34-37, supra. Even Mr. Malek acknowledged that aging was a problem that affected legitimate mortgages as well as fraudulent ones. See, e.g., Tr. 3433:15-16 (“Aging . . . can happen with any loan . . . .”); Tr. 3533:18-19 (“[I]t is true that nonfraudulent loans could have aging.”); see also Tr. 3784:23-24 (Lehn) (“[A]ging of loans, especially during this period, was not uncommon.”). Mr. Malek also admitted that other Colonial customers besides TBW had significant problems with aged mortgages. See Tr. 3591:21-3593:13, 3678:21-3680:24; see also Ex. D-17 at 42; Ex. P-1277. And he recognized that even when Colonial’s aging reports showed hundreds of millions of dollars in aged TBW 36 Case 2:11-cv-00746-BJR-TFM Document 850 Filed 03/30/18 Page 40 of 77 mortgages, the non-fraudsters at the Bank only viewed that as “something that needed to be addressed from a customer management standpoint,” not as a sign of fraud. Tr. 3680:25-3683:1 (Malek). 77. Mr. Malek also exaggerated how long most of the blue mortgages stayed on Colonial’s books without being sold. On direct examination, he testified that the only mortgages he had “counted as the damages” were “the ones that hung around from as early as 2003 until bank close.” Tr. 3436:22-24. But on cross-examination, he admitted that most of the mortgages at issue were not nearly that old. Indeed, 95% of the aged COLB mortgages that were on AOT when the Bank closed had been originated in 2006 or later, at a time when turmoil in the housing market made aging especially likely. Tr. 3657:6-3659:9; see Ex. D-4016. E. Fifth Supposed Badge of Fraud: “Exceptions” Noted in Bank Records 78. For his final indicator, Mr. Malek testified that TBW’s database (called “Rules”) and Colonial’s ProMerit database included “exceptions”—notations that suggested there were problems with some of the blue mortgages. He claimed that those exception notations meant that the mortgages had problems before Colonial acquired them and therefore must have been part of the fraud. Tr. 3438:1-25. He had his staff prepare a report identifying which mortgages had exceptions noted in either database. See Tr. 3692:24-3693:18; Ex. F-4100. 79. Mr. Malek acknowledged that this fifth indicator applied to only 2,113 mortgages, or approximately 50% of the blue mortgages. Tr. 3693:15-3694:6, 3704:2-22. Mr. Malek agreed that “for the other 50 percent of the blue loans, there was no exception noted in the ProMerit database or in the TBW database for those loans.” Tr. 3694:3-6; see also Tr. 3786:1220 (Lehn) (“[B]y [Mr. Malek’s] own criteria, half of them, roughly 2100, weren’t marked exceptions and, therefore, under his criterion, would not be indicative of junk on arrival.”); Tr. 37 Case 2:11-cv-00746-BJR-TFM Document 850 Filed 03/30/18 Page 41 of 77 3801:17-23 (same). These mortgages account for only about $150 million of the more than $300 million in damages the FDIC is seeking on the blue mortgages. See ¶ 150 n.12, infra. 80. Further, only 1,047 mortgages, or less than 25% of the blue mortgages, had notes in TBW’s database that included the words “Do Not Sell” or the abbreviation “DNS.” Tr. 3703:15-24. And only three were marked “Do not sell per Lee Farkas,” whereas others referred to individuals who have not been implicated in the fraud. Tr. 3684:17-3689:7; see Ex. F-4100. These mortgages account for only about $75 million of the more than $300 million in damages the FDIC is seeking on the blue mortgages. See ¶ 150 n.12, infra. 81. Even as to the 50% of blue mortgages for which Mr. Malek’s staff found some type of exception noted in the records of either TBW or Colonial, there is no evidence that those exceptions existed or were entered into the records before Colonial acquired the mortgages. With regard to the exceptions in Colonial’s ProMerit database, many of those were first entered into the database long after Colonial acquired the mortgage, which is consistent with ordinary aging and inconsistent with Mr. Malek’s view that the mortgages were all “junk on arrival.” See Tr. 3691:1-3692:13 (Malek); Tr. 3849:17-25 (Lehn). Mr. Malek did not calculate how many of the ProMerit exceptions were first noted more than 90 days after Colonial acquired the mortgage. Tr. 3692:14-18. Moreover, the exceptions noted in ProMerit were “not part of the secret books” but instead were “known” and “used by management.” Tr. 3786:21-25 (Lehn). 82. As for the exceptions in TBW’s Rules database, there is no way to know when those exceptions were first entered into the system. See Tr. 3847:17-23, 3849:11-21 (Lehn) (“[T]he main thing is that we haven’t been able to tie any of these exceptions to dates . . . And without the dates, I’m not even sure what you do with the data from the Rules database.”). Counsel for the FDIC first implied that it was reasonable to assume that the exceptions were 38 Case 2:11-cv-00746-BJR-TFM Document 850 Filed 03/30/18 Page 42 of 77 noted in TBW’s database before the mortgages were sold to Colonial because after that point, the mortgage “left TBW’s books” and “TBW had nothing more to do with [it].” Tr. 3852:9-17. That was incorrect. Even after the transfer to Colonial, TBW was responsible for servicing the mortgages and would have continued to keep records on them, making it impossible to know whether any exceptions in the TBW database were entered before or long after Colonial advanced funding for the mortgage. See Tr. 3876:4-3877:1 (Lehn); see also Tr. 2706:18-24 (Naumann); Ex. A-372 at 8 (¶ 8). 83. In closing argument, counsel took a different tack, arguing that it would “make[] no sense” for TBW to record a “do not sell” notation for a mortgage it was servicing. Tr. 4019:18-21. But “arguments of counsel are not evidence,” Deng, 169 So. 3d at 1028, and in any event counsel was again mistaken. When a mortgage was owned by Colonial and being serviced by TBW, TBW was still responsible for trying to sell the mortgage to an end investor so that it could be taken off Colonial’s books. See, e.g., Tr. 3435:5-8, 3437:8-9 (Malek). As was established at length in the liability trial, even after selling a 99% participation interest in the COLB mortgages to Colonial, TBW retained a 1% interest in the mortgages and would continue to find end investors for the mortgages on behalf of Colonial Bank. See Tr. 2517:18-2519:17 (Naumann); Ex. A-372 at 4 (¶ 2), 17 (¶ 14), 20-21 (¶ 18). 84. TBW thus would have known and recorded the status of COLB mortgages long past the sale of the participation interest to Colonial. If the mortgage developed a problem after Colonial had funded the mortgage but before it was sold to an end investor, it would make perfect sense for TBW to note in its records that the mortgage could not be sold until the problem was corrected. There also is no testimony from a knowledgeable witness about what the notes in TBW’s database, many of which are vague or cryptic, actually mean. See, e.g., Tr. 3853:10-24 39 Case 2:11-cv-00746-BJR-TFM Document 850 Filed 03/30/18 Page 43 of 77 (Lehn). The FDIC cannot meet its burden by asking the Court to assume that all of the notes mean that the mortgages had problems at the time they were sold to Colonial. F. PwC’s Answer in the Miami Case 85. Counsel for the FDIC also asked Mr. Malek on redirect about an answer and defenses that PwC filed in 2015 in response to a separate lawsuit that was filed in state court in Miami by TBW’s bankruptcy trustee. See Ex. P-2879; Tr. 3710:20-3712:9, 3719:16-3720:16. The FDIC also relied heavily on the Miami pleading in its closing argument. Tr. 3950:23951:14, 3952:3-17, 3956:2-3, 3969:15, 4009:7-14. The FDIC characterized the pleading as having “admitted” that Colonial’s losses on the blue mortgages “are fraud losses.” Tr. 3950:3-4. And it argued that PwC “should be held to that,” Tr. 3951:12, just as the FDIC was held to its admissions in the Bank of America litigation, Tr. 3952:3-17. 86. Specifically, the FDIC relied on allegations, made in support of PwC’s affirmative defenses in the Miami case, that “TBW sold Colonial Bank interests in mortgage loans that were foreclosed, real estate owned, or otherwise impaired,” that the fraudsters referred to these mortgages as “crap” loans, and that there were “crap” loans “on the COLB and AOT facilities.” Ex. P-2879 at 20. 87. The FDIC’s reliance on the Miami pleading is misplaced. The Court has recognized that pleadings in a prior case are “admissible” but “not binding or conclusive.” Liability Order at 44. PwC made the allegations in the Miami case years ago, before much of the relevant discovery in this case had taken place. Moreover, those allegations do not support the FDIC’s current claim that all of the COLB and warehouse mortgages that became aged must have been fraudulent or impaired when Colonial acquired them. And in this case, PwC has presented substantial evidence that contradicts the FDIC’s claim. That includes uncontroverted evidence that many billions of dollars of legitimate, profitable mortgages flowed through the 40 Case 2:11-cv-00746-BJR-TFM Document 850 Filed 03/30/18 Page 44 of 77 COLB facility during the period of the fraud and that aging was common even with legitimate mortgages. See ¶¶ 31-32, 34-37, supra. 88. This distinguishes the Miami answer from the FDIC’s pleadings in the Bank of America litigation, which the Court credited because the FDIC had made no effort to contradict or clarify its previous claims. See Liability Order at 44. At most, the allegations in the Miami answer may suggest that PwC believed in 2015 that some unspecified number of “junk” mortgages were known to be on the COLB facility, without any indication of whether those mortgages ended up in AOT at bank close (and therefore fall within the blue mortgages) or were sold in the interim. Here, however, it is not PwC’s burden to show that there were never any fraudulent mortgages funded through COLB. Rather, it is the FDIC’s burden to show that all of the blue mortgages for which it is seeking damages were fraudulent. PwC’s allegations in the Miami answer do not help the FDIC carry that burden for any of the blue mortgages, let alone for anything close to the full $415 million the FDIC is seeking. 89. The FDIC also cited a paragraph in the Miami answer in which PwC admitted that COLB customers were “required, upon request by Colonial Bank, to repurchase the loan if, among other things, a takeout investor did not purchase it.” Ex. P-2879 at 4 (¶ 22); see Tr. 4017:8-4018:3. But there is no daylight at all between that statement and PwC’s position in this case. PwC agrees that the COLB contracts gave Colonial the right to put back aged mortgages to TBW if certain representations and warranties were breached. But as explained above, the evidence in this case shows that Colonial had legitimate business reasons, unrelated to the fraud, 41 Case 2:11-cv-00746-BJR-TFM Document 850 Filed 03/30/18 Page 45 of 77 for not exercising that put-back right (including the OCC’s instruction that doing so would jeopardize Colonial’s preferred accounting treatment). See ¶¶ 64-65, supra. 6 G. Additional Testimony About Specific Mortgages 90. In addition to his “five indicators,” Mr. Malek testified—for the first time on redirect—that the blue mortgages included a few “fraudulent loans that Lee Farkas himself had taken out from Colonial” to purchase “a nightclub” and “a farm.” Tr. 3707:2-3708:23. He claimed that the fraudsters referred to these mortgages as “Lee loans” and that Mr. Farkas had “submit[ted] fake documents to get this money,” including using someone named “John Welch” as a “straw purchaser.” Id. 91. Mr. Malek did not mention the so-called “Lee loans” in either of his expert reports, and his testimony about them at trial was conclusory and well beyond his expertise as a damages expert. No fact witness testified about the circumstances surrounding these mortgages. Mr. Malek’s testimony does not establish that the mortgages in question were fraudulent. Nor was Mr. Malek able to recall how many “Lee loans” were included in the FDIC’s claimed damages; he could only say that he believed they were “in the 5 to $20 million range.” Tr. 3759:6-3760:1. 92. In fact, Mr. Malek’s own damages schedules show only four mortgages that were loans to Lee Farkas or John Welch, and only two of those mortgages were included in the 6 The FDIC also cross-examined Dr. Lehn (over PwC’s objection) about allegations in a complaint that the SEC filed against Ms. Kissick in 2011. See Tr. 3822:25-3825:15. Mr. Malek did not testify about the SEC complaint, and Dr. Lehn stated that bare allegations in a complaint were not “something that [he], as an expert, would rely upon.” Tr. 3824:21-22. Needless to say, the SEC complaint is classic inadmissible hearsay that cannot be considered by the Court for the truth of the matters alleged therein because it is simply an allegation made by a non-party. See, e.g., Steed v. EverHome Mortg. Co., 308 F. App’x 364, 369 n.2 (11th Cir. 2009). It also predates all of the extensive discovery and depositions that have been taken in this case. See Tr. 3872:1120 (Lehn). 42 Case 2:11-cv-00746-BJR-TFM Document 850 Filed 03/30/18 Page 46 of 77 FDIC’s claimed damages. See Ex. F-4100 at 19 (Loan ID 1062596); id. at 22 (Loan ID 1138864). The other two were originally funded by Colonial before Mr. Malek’s damages start date of February 25, 2004, so although they remained on Colonial’s books and were moved to AOT after that date, Mr. Malek did not include them in his damages calculations. See id. at 6 (Loan IDs 477897 and 477905). 93. Even if the Court were to credit Mr. Malek’s testimony, the FDIC’s claimed top- line losses on those two mortgages are only $2,039,347 (including $481,524 on Loan ID 1062596 and $1,557,823 on Loan ID 1138864). See Ex. F-4134 at 2, 150. Because that amount is 0.509% of the FDIC’s $400,451,848 of claimed fraud losses related to the blue mortgages after February 25, 2004, the FDIC’s recoverable damages related to those two mortgages (after adjusting for recoveries) would be 0.509% of $300,922,884, which is only $1,532,484. A finding that the FDIC met its burden on the “Lee loans” would not help the FDIC meet its burden on the other 4,223 blue mortgages for which it is claiming damages. 94. Counsel for the FDIC also claimed that three blue mortgages made to borrowers with the surnames Vorwerk, Boyd, and Higdon “had bogus Social Security numbers and were fictional loans.” Tr. 3857:25-3858:24. Mr. Malek did not testify about these three mortgages, nor did he mention them in his reports. The FDIC brought them up for the first time when crossexamining Dr. Lehn. And the only basis the FDIC gave for asserting that these three mortgages were fraudulent was the FDIC’s own proof of loss that it had filed in a separate insurance case. See id. (citing “the FDIC’s proof of loss”). The Court sustained PwC’s objection to the FDIC’s attempt to examine Dr. Lehn about that document. Tr. 3858:25-3859:18. The FDIC’s proof of loss is inadmissible hearsay; the FDIC obviously cannot rely on its own self-serving assertions, 43 Case 2:11-cv-00746-BJR-TFM Document 850 Filed 03/30/18 Page 47 of 77 made to support an insurance claim in another case, as substantive evidence to meet its burden of proof in this case. 95. In any event, even if the Court were to find that the FDIC had proven that the Vorwerk, Boyd, and Higdon mortgages were fraudulent, the FDIC’s claimed top-line losses on those three mortgages are only $1,611,877 (including $528,718 on the Vorwerk mortgage, Loan ID 685500; $603,179 on the Boyd mortgage, Loan ID 685513; and $479,980 on the Higdon mortgage, Loan ID 685524). See Ex. F-4100 at 8 (listing Loan IDs for all three mortgages); Ex. F-4134 at 64 (listing claimed losses on those Loan IDs). Because that amount is 0.403% of the FDIC’s $400,451,848 of claimed fraud losses related to the blue mortgages after February 25, 2004, the FDIC’s recoverable damages related to those two mortgages (after adjusting for recoveries) would be 0.403% of $300,922,884, which is only $1,211,258. 96. In sum, of the 4,225 blue mortgages for which the FDIC is seeking damages, there are only five mortgages, with total damages of about $2.7 million, as to which the FDIC has even attempted to present any specific evidence that the mortgages were fraudulent or impaired when Colonial advanced funding for them. Even as to those five mortgages, the FDIC’s attempts to meet its burden of proof rested on speculation and hearsay. 97. There is certainly no basis to extrapolate from the evidence the FDIC offered about those five mortgages to the other 4,220 blue mortgages for which the FDIC is seeking damages. The FDIC did not present any evidence or argument that the two mortgages where Lee Farkas was the borrower, or the three that allegedly were associated with fake Social Security numbers, were representative of the thousands of other blue mortgages that were taken out by ordinary homeowners. 44 Case 2:11-cv-00746-BJR-TFM Document 850 Filed 03/30/18 Page 48 of 77 V. The REO Mortgages 98. When Colonial Bank closed in August 2009, there were a large number of TBW- originated mortgages on Colonial’s books that were in foreclosure or “REO” status. REO stands for “real estate owned” by a lender following foreclosure. Tr. 3528:25-3529:6, 3915:10-17 (Malek). 99. The TBW bankruptcy trustee sold the properties subject to the REO mortgages. Most were sold in bulk at auction for about $81.2 million, a sale the bankruptcy court approved on December 17, 2009. See Tr. 3915:24-3918:22; Ex. D-4001 at 3, 8, 44. The net amount recovered by the TBW estate, excluding costs and fees, from the sale of the REO properties was “approximately $78 million.” Ex. B-182 at 5 (¶ 14c). 100. Some of the REO mortgages were on AOT, while others were on the Overline facility. In this case, the FDIC is seeking damages only for mortgages that were on the AOT facility when the Bank closed. A comparison of the list of REO mortgages in Ex. D-4000 and the list of “junk” mortgages on AOT in Ex. F-4134 shows that 63.4066% of the value of the REO sold at auction related to AOT REO rather than Overline REO. See Tr. 3924:6-3927:8 (Malek). Accordingly, 63.4066% of the TBW bankruptcy trustee’s recovery on the REO mortgages, or $49,457,148, can be attributed to AOT REO. 101. The FDIC, as receiver for Colonial, had a claim to the proceeds from the sale of the REO properties. But the FDIC gave up that claim as part of a settlement with the TBW bankruptcy trustee. The settlement agreement provided that, “in exchange for the treatment specified herein,” the FDIC would “disclaim its interest” in the REO properties and any proceeds thereof. Ex. B-182 at 19 (§ 1.5); see also Tr. 3920:23-3924:5 (Malek). The settlement agreement was executed on August 11, 2010. See Ex. B-182 at 11. The bankruptcy court approved the settlement on September 14, 2010. See Order Approving Settlement, In re Taylor, 45 Case 2:11-cv-00746-BJR-TFM Document 850 Filed 03/30/18 Page 49 of 77 Bean & Whitaker Mortg. Corp., No. 3:09-bk-7047, ECF No. 1936 (Bankr. M.D. Fla. Sept. 14, 2010). 102. In exchange for the FDIC disclaiming its interest in the REO properties and making other concessions, the TBW bankruptcy trustee agreed to recognize the FDIC’s ownership interest in more than 3,800 legitimate (not “Plan B”) TBW mortgages that were on Colonial’s COLB facility. Ex. B-182 at 14; see id. at 48-120 (listing the mortgages). The unpaid principal balance on those legitimate COLB mortgages was more than $696 million. Id. at 120. Because those mortgages were not part of the fraud, Mr. Malek understandably did not include the proceeds from those mortgages as a recovery in his damages analysis. Tr. 3931:14-20 (Malek). 103. During the liability phase of the trial, counsel for the FDIC explained how the FDIC was able to convince the TBW trustee to recognize the FDIC’s ownership of nearly $700 million in legitimate COLB mortgages. Counsel stated: [Y]ou’re really looking here at a settlement. We paid them something. We gave them consideration to TBW to agree to let us have these loans. . . . What happens is we gave up some things and they gave up some things, and in the joinder there was mutual consideration where each party paid the other party to allow that party to have certain legal rights. Tr. 3167:18-3168:3. 7 Part of the consideration that the FDIC gave up so that TBW would recognize the FDIC’s ownership of the legitimate COLB mortgages was the FDIC’s claim to the proceeds of the REO mortgages. See Ex. B-182 at 14. 7 Although arguments of counsel are not evidence, concessions made by counsel in open court are binding. See, e.g., United States v. Rusan, 460 F.3d 989, 993-94 (8th Cir. 2006). 46 Case 2:11-cv-00746-BJR-TFM Document 850 Filed 03/30/18 Page 50 of 77 104. In short, the FDIC traded away REO-related recoveries that would have reduced its damages claim against PwC in exchange for COLB-related recoveries that did not reduce its damages claim against PwC. 105. As a result, the TBW estate distributed to the FDIC at most 38% of the proceeds of the AOT REO mortgages, or $18,793,716. That was the share to which the FDIC was entitled as an unsecured creditor of the estate with no legal interest in the REO mortgages. See Tr. 3919:3-3920:20, 3927:9-3930:10 (Malek). Mr. Malek included that partial recovery in his damages analysis. Accordingly, the portion of the AOT REO proceeds that was improperly excluded from Mr. Malek’s damages calculation is (at least) $30,663,432. 106. When the blue mortgages are taken out of the FDIC’s damages, the REO adjustment must be reduced to reflect only the proceeds of “orange” REO mortgages. Because the orange mortgages represent 57.52895% of the real (non-Plan B) AOT mortgages, one can assume that 57.52895% of the REO adjustment, or $17,640,350, is attributable to the orange mortgages. This is the same pro rata allocation methodology Mr. Malek generally used to allocate the FDIC’s recoveries to different categories of mortgages. See, e.g., Tr. 3697:5-15 (Malek); Tr. 3794:8-15, 3803:14-15 (Lehn); Ex. D-4002 at 2 (Malek’s damages schedule with notes exemplifying his approach to pro rata allocation). VI. Future Distributions from the TBW Estate 107. Mr. Malek has recognized the need to adjust the FDIC’s damages downward when the FDIC recovers additional compensation for Colonial’s fraud-related losses via distributions from TBW’s bankruptcy estate. For example, shortly before the damages trial, Mr. Malek updated his damages calculations to reflect nearly $58 million the FDIC had received in distributions from TBW’s estate since October 2016. See Tr. 3697:16-3698:9. 47 Case 2:11-cv-00746-BJR-TFM Document 850 Filed 03/30/18 Page 51 of 77 108. It is expected that the FDIC will receive additional recoveries from the TBW estate in the future. At present, the estate has roughly $37 million in cash, and the FDIC will be entitled to about 38% of any future distributions from that fund. Tr. 3701:7-16. The estate also has less than $4 million worth of AOT mortgages that it intends to sell, the proceeds of which will be distributed to the FDIC. Tr. 3698:18-3699:1. 109. Mr. Malek agreed that “if the FDIC does recover or receives additional recoveries in the future from TBW, [it would] be appropriate to revise [his] calculation of damages to reflect those recoveries.” Tr. 3701:25-3702:4. CONCLUSIONS OF LAW I. The FDIC cannot recover as damages money that Colonial advanced to TBW for the “blue” mortgages acquired outside of AOT. A. It is the FDIC’s burden to prove that Colonial’s losses on the blue mortgages were proximately caused by PwC’s failure to detect the fraud. 110. The FDIC spent a good deal of time at trial discussing “but-for” causation, that is, whether Colonial would have sustained the losses at issue but for PwC’s failure to discover the fraud. For example, the FDIC’s counsel wrapped up his direct examination of Mr. Malek this way: Q. And if PwC had done a proper audit in 2003 and the fraud had been uncovered, would there ever have been additional Plan B loans on the COLB? A. No. Q. Would there ever have been additional junk loans on the COLB? A. No. Q. What about Plan B on the AOT? A. No. Q. Junk loans on the AOT? A. No. Q. Okay. Would there ever have been a secret set of books? A. No. 48 Case 2:11-cv-00746-BJR-TFM Document 850 Filed 03/30/18 Page 52 of 77 Tr. 3508:15-3509:2. Counsel also displayed this portion of Mr. Malek’s testimony during his closing argument. See also Tr. 3870:22-3871:25 (FDIC counsel asserting that “[i]n a but-for world, the TBW-Colonial relationship is over” and so “none of the blue, none of the orange, none of the whatever -- red was the other color, none of those losses occur”). 111. To recover damages for the blue mortgages, however, the FDIC must do more than show but-for causation. “A well-established principle of Alabama law is that, to recover in tort, a plaintiff must establish that the defendant’s misconduct was the ‘proximate cause’—and not just the ‘remote cause’—of the plaintiff’s injuries.” United Food & Commercial Workers Unions, Emps. Health & Welfare Fund v. Philip Morris, Inc., 223 F.3d 1271, 1273 (11th Cir. 2000) (emphasis added); see Hilliard v. City of Hunstville Elec. Util. Bd., 599 So. 2d 1108, 1111 (Ala. 1992) (distinguishing between but-for and proximate causation); A. Howell, Alabama Personal Injury & Torts § 14.1 (2017 ed.) (a negligent defendant is responsible only for those “damages and injuries which are proximately caused by his negligence”). 112. The Court has already held that proximate cause is required in this case. The Court’s liability order stated: “[T]he existence of a causal connection between the defendant’s action and the injury is not sufficient to establish liability; the defendant’s action must also have been the proximate cause of the injury. Proximate cause exists if the injury is the natural and probable consequence of the negligent act which an ordinarily prudent person ought reasonably to foresee would result in injury.” Liability Order at 46 (quoting Vines v. Plantation Motor Lodge, 336 So. 2d 1338, 1339 (Ala. 1976)) (citation, brackets, and quotation marks omitted). 8 8 At various points in the damages trial, counsel for the FDIC claimed that the Court had “already found proximate cause.” Tr. 3375:5, 3387:22; see also Tr. 3946:16-18. On the contrary, the Court’s liability order said that “[t]he issues of causation and damages,” except for the issue of intervening cause with respect to the “shipped not paid” damages, were “reserved for 49 Case 2:11-cv-00746-BJR-TFM Document 850 Filed 03/30/18 Page 53 of 77 113. Proximate cause embodies the principle that a defendant is not liable for “every conceivable harm that can be traced to [its] alleged wrongdoing.” Regence BlueShield v. Philip Morris, Inc., 40 F. Supp. 2d 1179, 1183 (W.D. Wash. 1999) (Rothstein, J.). It “require[s] consideration of the ‘foreseeability or the scope of the risk created by the predicate conduct,’ and require[s] the court to conclude that there [is] ‘some direct relation between the injury asserted and the injurious conduct alleged.’ ” Cty. of L.A. v. Mendez, 137 S. Ct. 1539, 1548-49 (2017) (quoting Paroline v. United States, 134 S. Ct. 1710, 1719 (2014)). 114. The “famous old English case” of Gorris v. Scott, 9 L.R. (Exch.) 125 (1874), illustrates the difference between but-for and proximate cause. See Movitz v. First Nat’l Bank of Chicago, 148 F.3d 760, 762 (7th Cir. 1998) (Posner, J.) (discussing Gorris). Sheep being transported by ship were swept overboard in a storm, which would not have happened if the defendant had complied with his legal duty to provide pens for the sheep in order to prevent the spread of disease. The defendant’s breach was a but-for cause of the loss of the sheep, but it did not proximately cause the loss “because the duty was to take precautions against a different kind of loss from the one that materialized.” Id. at 763. Similarly, in Movitz, the plaintiff lost his investment in an office building when the Houston real estate market collapsed. He claimed that if the bank advising him had reported certain structural defects in the building, he would not have gone through with the purchase. The Seventh Circuit held that even if the bank’s negligence was a but-for cause of the plaintiff’s loss, it was not a proximate cause because the the damages phase.” Liability Order at 42. Moreover, even if the Court had found proximate cause in the general sense that PwC’s failure to uncover the fraud caused some injury to Colonial, the FDIC would still have to prove proximate causation for the specific damages it is seeking. 50 Case 2:11-cv-00746-BJR-TFM Document 850 Filed 03/30/18 Page 54 of 77 structural defects the bank had failed to report were not themselves responsible for the loss of the investment. Id. 115. The Eleventh Circuit applied these proximate-cause principles under Alabama law in Hammonds v. United States, 418 F. App’x 853 (11th Cir. 2011). There, the plaintiff had a dental procedure at a Veterans Administration facility shortly after getting a hip replacement. The dentist breached his duty of care by not making sure that the plaintiff took an antibiotic before the procedure “in order to prevent infection of his artificial hip joints.” Id. at 855. After the procedure, the plaintiff developed an infection—not in his hip, but in his heart. The plaintiff argued that the United States, which had employed the dentist, was liable for damages related to the heart infection because preventing that infection would have been “an unintended benefit of properly administered antibiotics.” Id. at 856. But the Eleventh Circuit agreed with the defendant that “the only reason” the dentist had a duty to administer an antibiotic was the “particular risk” of a hip infection. Id. Because the plaintiff’s damages were not a result of the specific “risk giving rise to [the dentist’s] duty of care,” the dentist’s breach of that duty was not a proximate cause of the damages, even though the damages “might have been serendipitously avoided if the standard of care had not been breached.” Id. at 854, 857-58. 116. Although the distinction between but-for and proximate causation may not be relevant in every case, it comes up often in auditor and accountant liability cases. The requirement of proximate causation is critical in these cases because it protects accountants and auditors from becoming insurers for their clients’ ordinary business risks. 117. The authors of the Restatement use an example involving negligent accounting to illustrate the principle that for a defendant’s negligence to be the proximate cause of an injury, the injury must “arise[] from the risks that made the negligent conduct a breach of duty.” 51 Case 2:11-cv-00746-BJR-TFM Document 850 Filed 03/30/18 Page 55 of 77 Restatement (Third) of Torts: Liability for Economic Harm § 5, cmt. i & ill. 18 (Tentative Draft No. 2, 2014). In the example, a firm’s auditor negligently fails to report objections that a state regulatory agency made to one of the firm’s dividend payments, and an insurer writes coverage for the firm that it would not have written had it known of the objections. Later, one of the firm’s officers embezzles some of the firm’s assets, and the insurer must cover the losses. The Restatement provides that even though the auditor’s negligence in failing to report the state agency’s objection was a but-for cause of the insurer’s losses, it was not a proximate cause because embezzlement “was not among the risks that made the audit negligent.” Id. § 5, ill. 18. 118. McCabe v. Ernst & Young, LLP, 494 F.3d 418 (3d Cir. 2007), provides a real- world example. The plaintiffs in McCabe were officers and shareholders of a private company that merged with a public company, whose stock price then plummeted. They sued the public company’s auditor, Ernst & Young (“EY”), claiming that if EY had reported certain negative information about the company, the plaintiffs would not have agreed to the merger. Id. at 42022. The Court held that to establish proximate causation, the plaintiffs had to show not just that the merger would not have gone through absent EY’s negligence (which would have established only but-for causation), but that “the very facts misrepresented or omitted by [EY] were a substantial factor in causing [the plaintiffs’] economic loss.” Id. at 438; see id. at 428-29. Because the plaintiffs had not shown that the negative information EY failed to report was the reason the stock price had fallen, they had not raised a triable issue on proximate cause. Id. at 438. 119. Maxwell v. KPMG, LLP, No. 03-cv-3524, 2007 WL 2091184 (N.D. Ill. July 19, 2007), aff’d, 520 F.3d 713 (7th Cir. 2008), is also instructive. After a consulting company merged with an internet company, “the technology bubble burst” and the merged company filed 52 Case 2:11-cv-00746-BJR-TFM Document 850 Filed 03/30/18 Page 56 of 77 for bankruptcy. Id. at *1. The bankruptcy trustee sued the consulting company’s auditor, KPMG, claiming that if KPMG had reported that the consulting company’s earnings were overstated, “the merger would not have happened” and the consulting company “would have survived the technology crash.” Id. at *1, *3. The court granted summary judgment to KPMG based on a lack of proximate causation. It explained that the causation requirement in auditor malpractice cases “goes beyond simply proving ‘but for’ causation because an accountant cannot be held liable if subsequent events over which the accountant had no control—such as the plaintiff’s bad luck or poor management decisions—caused the losses.” Id. at *4. The risk that the merger would prove disastrous because of market fluctuations was not one “that KPMG should have foreseen,” nor was it “the kind [of loss] that the . . . disclosure requirement was intended to prevent.” Id. at *6. 9 120. The proximate cause requirement means that, even assuming Colonial would not have acquired the blue mortgages if PwC had found the fraud (but-for causation), PwC still is not responsible for the losses on the blue mortgages unless the fraud is also why Colonial lost money on those mortgages. The Court found PwC negligent for not doing enough to protect Colonial against a “particular risk,” namely, the risk of fraud. Hammonds, 418 F. App’x at 856. Losses that occurred for a different reason (e.g., because of the turbulent housing market) are just losses that “might have been serendipitously avoided” if PwC had uncovered the fraud and 9 McCabe and Maxwell use the term “proximate causation” interchangeably with the term “loss causation.” There is no meaningful distinction; loss causation is just proximate causation in the specific context of claims under § 10(b) of the Securities Exchange Act of 1934. See FindWhat Inv. Grp. v. FindWhat.com, 658 F.3d 1282, 1309 (11th Cir. 2011) (loss causation is “simply ‘an exotic name’” for the common-law requirement that a plaintiff prove that the defendant’s conduct is “both the but-for and proximate cause of the plaintiff’s later losses”); see also McCabe, 494 F.3d at 439 (holding that “for the same reasons that the [plaintiffs] failed to create a genuine issue as to loss causation . . . they also failed to create a genuine issue as to proximate causation”). 53 Case 2:11-cv-00746-BJR-TFM Document 850 Filed 03/30/18 Page 57 of 77 Colonial had ended its relationship with TBW. Id. at 854. Such losses were “not a foreseeable consequence” of PwC’s failure to uncover the fraud “because the duty was to take precautions against a different kind of loss.” Movitz, 148 F.3d at 763; see also Mendez, 137 S. Ct. at 1549 (proximate cause analysis must focus on the risks foreseeably associated with the specific violation that gave rise to liability). 121. Despite spending much of its time on but-for causation, the FDIC does not appear to dispute that proximate cause requires it to prove that the losses it is seeking to recover represent money that was diverted from Colonial as part of the fraud. In the FDIC’s opening statement, counsel said the FDIC would establish proximate cause by showing that Colonial lost money “due to mortgage originator fraud,” the “exact risk” PwC had identified and failed to protect against in its audits. Tr. 3372:18-3373:8; see also Tr. 3375:2-4 (arguing that “the natural consequence of PwC not finding the fraud . . . was [that] the fraud continued, and it caused losses” (emphasis added)). And in his closing argument, FDIC counsel reiterated that point, see Tr. 3947:10-15, and acknowledged that “our burden is to show that these are fraud losses.” Tr. 4014:19-20 (emphasis added). Similarly, Mr. Malek responded to questions about proximate cause by stating that “if a fraud is failed to be discovered [sic], then it is a natural and expected consequence that the fraudsters would continue to steal.” Tr. 3518:9-11 (emphasis added). Under the FDIC’s and Mr. Malek’s own logic, for the FDIC to recover the money Colonial lost on the blue mortgages from PwC, it must prove that the money was “stolen” as part of the fraud that the Court found PwC negligent for failing to uncover. 122. In closing argument, FDIC counsel cited Grant Thornton, LLP v. FDIC, 535 F. Supp. 2d 676 (S.D. W. Va. 2007), aff’d, 435 F. App’x 188 (4th Cir. 2011), for the proposition that an auditor who fails to discover a fraud is “liable for losses from the time that the fraud 54 Case 2:11-cv-00746-BJR-TFM Document 850 Filed 03/30/18 Page 58 of 77 should have been discovered until it was actually discovered.” Tr. 3955:15-22. The FDIC mischaracterizes the holding of Grant Thornton, and its reliance on that decision is misplaced. There, both the district court and the Fourth Circuit recognized that the FDIC had to prove proximate cause, not just but-for cause. See 435 F. App’x at 194. 123. Moreover, in affirming the district court’s proximate cause finding in Grant Thornton, the Fourth Circuit repeatedly emphasized that its unpublished and non-precedential decision was “driven by [the] unique facts” of that case and should not be understood as announcing a general “rule of auditor liability.” Id. at 191; see id. at 195 (“[T]he specific facts of this case distinguish it from the typical case in which an audit is undertaken.”); id. at 196 (decision was based on “the particular and unique facts of this case”). It held that because Grant Thornton was not hired “in the ordinary course, but at the insistence of federal regulators,” and because it knew that the regulators’ concern about Keystone’s solvency was “the sole reason for its engagement,” the district court “did not clearly err” in ruling that the negligent audit was a proximate cause of operating losses that the bank incurred over a short period of less than five months after the audit (not “an unlimited period of time”). Id. at 195-96. The court explained that under the unique circumstances of that case, the risk of loss due to “continued operation of a Bank that was in fact woefully insolvent and hemorrhaging losses” was within the scope of natural and foreseeable risks that the auditor had a duty to protect against. Id. Here, PwC was hired in the ordinary course, and the Court found that PwC was negligent for failing to uncover a specific fraud. PwC, therefore, can be held responsible only for losses that were proximately caused by the fraud it failed to uncover. The FDIC does not really claim otherwise; it concedes that its “burden is to show that” the losses it is seeking to recover “are fraud losses.” Tr. 4014:19-20. 55 Case 2:11-cv-00746-BJR-TFM Document 850 Filed 03/30/18 Page 59 of 77 124. At times, Mr. Malek attempted to get around the proximate-cause requirement by asserting that “the entire relationship between TBW and the bank was illegitimate and fraudulent.” Tr. 3418:11-13 (emphasis added); see also Tr. 3519:19-3520:8 (claiming that every transaction between Colonial and TBW was illegitimate because “the entire relationship was illegitimate”). That is just a different way of talking about but-for causation: the claim is that “but for” the relationship, Colonial would not have purchased any mortgages from TBW, including mortgages that were fully valuable. No one disputes that while the fraud was going on, Colonial was also purchasing from TBW billions of dollars of mortgages that were real, legitimate, and not affected by the fraud. See ¶¶ 31-32, supra. Losses Colonial sustained on those mortgages are not “fraud losses.” B. The FDIC cannot redefine the fraud in the damages phase to include the blue mortgages. 125. To determine whether the blue-mortgage losses were fraud losses, the Court has to know what the fraud consisted of. The nature and scope of the fraud that PwC failed to uncover was one of the main subjects of the liability phase of this trial, and the Court addressed it at length in its ruling following that trial. At no point during the liability trial did anyone claim that aged mortgages that were transferred from the COLB, Warehouse, and Overline facilities to the AOT facility (the “blue” mortgages) were part of the fraud that PwC should have uncovered. See ¶¶ 9-13, supra. 126. There were good tactical reasons why the FDIC and CBG did not argue in the liability phase that the blue mortgages were part of the fraud. The evidence was clear that Mr. Hosein, CBG’s and Colonial Bank’s Treasurer, had directed the largest transfer of these mortgages into AOT. See Liability Order at 87-88. And there was no dispute that Mr. Hosein’s conduct could be imputed to Colonial Bank. Consequently, if the FDIC and CBG had argued 56 Case 2:11-cv-00746-BJR-TFM Document 850 Filed 03/30/18 Page 60 of 77 that the transfer of aged mortgages to AOT was part of the fraud, they would have been shooting themselves in the foot on PwC’s defenses of contributory negligence (as limited by the Court’s pretrial ruling on audit interference) and in pari delicto. Although the Court had ruled at summary judgment that the FDIC was exempt from these defenses, it had also directed the parties to present all of their evidence regarding the defenses in case the Court’s ruling was overturned on appeal, so the FDIC had every incentive not to define the fraud in a way that would have made rulings for PwC on audit interference and in pari delicto all but inevitable. See Order Denying Motion to Certify, ECF No. 735, at 6. 127. Having made the tactical choice not to define the fraud to include the blue mortgages at the liability phase, the FDIC cannot now recover damages based on a vastly expanded definition of the fraud. See Amoco Oil Co. v. Gomez, 379 F.3d 1266, 1267, 1276-78 (11th Cir. 2004) (vacating judgment because damages awarded “did not flow from” a breach found at the liability phase of bifurcated trial); see also Segar v. Smith, 738 F.2d 1249, 1285 (D.C. Cir. 1984) (district court acted properly in refusing to reopen liability determination at remedial stage of bifurcated proceedings); Mills v. Maine, 853 F. Supp. 551, 554 (D. Me. 1994) (rejecting State’s reliance, at damages phase, on statutory provision that was “relevant to liability, not damages, and was not raised by the State during the liability phase of this dispute”); Lee v. Tenn. Valley Auth., No. 99-cv-459, 2007 WL 470353, at *4-5 (E.D. Tenn. Feb. 9, 2007) (defendant could not raise a defense during damages phase that it had not raised during liability phase); Trans Ocean Van Serv. v. United States, 200 Ct. Cl. 122, 155 (1972) (in damages phase, 57 Case 2:11-cv-00746-BJR-TFM Document 850 Filed 03/30/18 Page 61 of 77 it was “too late” for defendant to “present for consideration an entirely new issue affecting liability”). 10 128. It would be improper and prejudicial to allow the FDIC to redefine the fraud at the damages phase. When making decisions about what witnesses to call and what arguments to pursue at the liability trial, PwC relied on the way the FDIC put on its liability case. For example, if the FDIC had argued at the liability phase that the fraud included Colonial’s decision to transfer aged mortgages from COLB to AOT or its decision not to put back aged COLB mortgages to TBW, then PwC would have introduced testimony and evidence to counter those arguments. 129. Because the FDIC waited until the damages phase to argue that aged mortgages moved to AOT were part of the fraud, the Court is faced with deciding that issue based on the testimony of the FDIC’s damages expert, who assumed that the FDIC would prevail on its claims of liability and causation as he understood them, Tr. 3511:14-24, 3549:9-14, and who did not even read any of the testimony from the liability trial, Tr. 3760:9-15. The FDIC cannot use Mr. Malek to redefine the scope of the fraud that was established at the liability trial. C. The FDIC did not prove proximate causation because it did not prove that the blue mortgages were impaired when Colonial acquired them. 130. Even setting aside how the FDIC tried its liability case, the FDIC cannot establish proximate causation for the losses on the blue mortgages—it cannot prove that those losses were “fraud losses” as opposed to ordinary business losses—unless it proves that the mortgages were 10 The FDIC will have an opportunity to present a broader theory of the fraud in its upcoming case against Crowe, should the FDIC’s counsel wish to pursue that strategy. The FDIC did not dispute PwC’s assertion that the FDIC’s designated audit expert in the Crowe trial, Ralph Summerford, is prepared to testify about Crowe’s alleged negligence with respect to aged COLB mortgages (whereas Professor Carmichael did not mention aged mortgages when he testified in the PwC liability trial). See Tr. 4006:21-4007:14; see also Order of Presentation for Crowe Bench Trial, ECF No. 842 at 1-2 (FDIC listing Mr. Summerford as its first witness). 58 Case 2:11-cv-00746-BJR-TFM Document 850 Filed 03/30/18 Page 62 of 77 defective or impaired when Colonial acquired them. As Mr. Malek testified, the “fraud consisted of the transfer of interest[s] in . . . property” based on “false pretenses that [TBW] used to steal money.” Tr. 3430:11-13. TBW stole money from Colonial when Colonial advanced money to TBW and did not receive full value in return. 131. For example, if Colonial paid TBW $100 for a nonexistent Plan B mortgage, then TBW stole $100 from Colonial. And because Colonial’s $100 loss flowed directly from the fraud, it was proximately caused by the failure to uncover the fraud. This was true for 100% of the “red” mortgages; every one of them involved stealing by TBW and a loss to Colonial proximately caused by the failure to detect the fraud. 132. Similarly, if Colonial paid TBW $100 for a real but impaired mortgage that had already been returned to Colonial by another bank and was only worth $80, then TBW stole $20 from Colonial. And because Colonial’s $20 loss flowed directly from the fraud, it was proximately caused by the failure to uncover the fraud. This was true for 100% of the “orange” mortgages, the ones that were acquired directly onto AOT; they were all worth less than Colonial paid when it advanced the money for those mortgages to TBW. 133. But if Colonial paid $100 for a real, unimpaired mortgage that was worth $100, then TBW did not steal anything, and Colonial did not lose anything. And if that same $100 mortgage later aged and declined in value for reasons unrelated to the fraud (e.g., the housing crisis)—as numerous witnesses testified was common even for legitimate mortgages, see ¶¶ 3437, supra—those losses were not fraud losses. Moreover, if management then moved the aged mortgage to AOT to hide it from regulators, that action, though improper, did not cause any additional losses to Colonial. See ¶ 49, supra. 59 Case 2:11-cv-00746-BJR-TFM Document 850 Filed 03/30/18 Page 63 of 77 134. For the vast majority of the real mortgages that Colonial acquired from TBW outside of AOT, the mortgages performed as expected and Colonial never lost money—in fact, it made money. See ¶¶ 31-32, supra. The blue mortgages at issue here represent the tiny fraction of those real mortgages that aged, lost value, were moved to AOT, and remained on AOT at bank close. The question is why they lost value. For each blue mortgage, there are two possibilities. One is that Colonial knew the mortgage was already impaired when Colonial acquired it, so that Colonial paid, for example, $100 for a mortgage that was only worth $80. In that case, the mortgage would be like an orange mortgage, and Colonial’s loss would have been proximately caused by the fraud. The other possibility is that the mortgage was perfectly fine when Colonial acquired it but later declined in value for reasons unrelated to the fraud. In that case, the fraud would not have proximately caused Colonial’s loss. 135. For reasons explained at length in the findings of fact above, the FDIC did not meet its burden to prove that the blue mortgages were impaired when they were initially funded by Colonial. The FDIC claimed that the blue mortgages must all have been impaired ab initio because they all bore at least four of Mr. Malek’s five “badges of fraud.” But Mr. Malek’s “badges” testimony was insufficient to establish that the blue mortgages were part of the fraud when Colonial acquired them. To recap: • One of Mr. Malek’s badges was the fact that the mortgages became aged instead of being sold to an end investor. But the Court heard a great deal of evidence and testimony, including from Mr. Malek himself, that aging could affect legitimate mortgages as well as fraudulent ones, especially during the housing crisis. See ¶¶ 75-77, supra. • Another supposed badge was that the mortgages were moved to AOT and put on the “secret set of books.” But this only showed that after the mortgages developed 60 Case 2:11-cv-00746-BJR-TFM Document 850 Filed 03/30/18 Page 64 of 77 problems and became aged, Colonial’s senior management wanted to hide them from regulators. It did not show that the mortgages were defective at inception. See ¶¶ 57-59, supra. • Another supposed badge was that, for the COLB mortgages, Colonial did not exercise its contractual right to “put back” the mortgages, or require TBW to repurchase them. But there was uncontroverted testimony that Colonial had legitimate business reasons for not exercising that right, including the OCC’s warning that doing so would jeopardize Colonial’s treatment of the COLB transactions as purchases under FAS 140. That testimony was reinforced by evidence that members of Colonial’s management who were not involved in the fraud knew about the aged mortgages but did not insist that they be put back. The FDIC gave the Court no basis to infer that any blue mortgage that was not put back to TBW must have been fraudulent from the start. See ¶¶ 61-65, supra. • A fourth supposed badge was statements by the fraudsters that referenced a practice of TBW “dumping” impaired mortgages on Colonial. But not a single one of those references specified that impaired mortgages were being dumped anywhere other than AOT, and the earliest references to dumping occurred (not coincidentally) at the same time that Colonial was setting up the AOT facility in 2004. See ¶¶ 67-74, supra. Nor did PwC’s answer in the Miami case, which the FDIC relied on heavily in closing argument, support the FDIC’s claim that the blue mortgages were all defective at the time of acquisition. See ¶¶ 85-88, supra. • Finally, Mr. Malek claimed that half of the blue mortgages had some type of “exception” noted in either TBW’s or Colonial’s records (which meant that the other half did not). But he could not say that any of those exceptions were noted before Colonial advanced funding for the mortgage, and many of them were noted long after that date. So this supposed 61 Case 2:11-cv-00746-BJR-TFM Document 850 Filed 03/30/18 Page 65 of 77 “badge” could not prove that even the 50% of blue mortgages to which it applied were impaired ab initio. See ¶¶ 78-83, supra. 136. In closing argument, the FDIC tried to introduce a new damages theory: that even if the blue mortgages were perfectly legitimate and unimpaired when Colonial acquired them, the FDIC could still recover damages based on Colonial’s failure to put back the mortgages to TBW after the mortgages developed problems. Counsel stated: Your Honor had asked about the initial funding date, does that matter. I said: No, it doesn’t matter for our losses because we have the right all along the way. But in any case, I wanted to be clear, the evidence -- the evidence is clear that there was -- there were problems at initial funding. . . . But I don’t think Your Honor has to find that to find that we’re entitled to recover all of our losses because they had the right to put it back to Colonial [sic—presumably counsel meant TBW] all along the way, up until the time it got into this offline database. Tr. 4021:9-20; see also Tr. 4013:14-17 (the Court’s suggestion that the mortgages could have been fine “at inception” but “gotten bad by not being returned when something went wrong with them”). This new theory would only apply to the blue mortgages that were originally funded on COLB, since TBW had no put-back right for mortgages that were funded on the Warehouse and Overline facilities, including the $139,803,946 of blue Warehouse and Overline mortgages for which the FDIC seeks recovery in this case. In all events, the FDIC’s new theory is improper and inconsistent with the evidence. 137. For one thing, as explained above, treating Colonial as having suffered a fraud loss when the Bank made the decision not to put back an aged mortgage to TBW, even if the original advance for the mortgage was not a fraud loss, would be inconsistent with Mr. Malek’s damages methodology as described both at trial and in his pretrial disclosures. As the starting point for his calculations, Mr. Malek recognized that Colonial’s losses occurred when it 62 Case 2:11-cv-00746-BJR-TFM Document 850 Filed 03/30/18 Page 66 of 77 advanced the initial funding for a mortgage. He therefore excluded from his damages calculations mortgages that were initially funded before the relevant damages start date, even if Colonial in theory could have put back those mortgages to TBW after the start date. And he defended his decision to include the blue mortgages by claiming that they were flawed at inception. See ¶¶ 24-28, supra. 138. Moreover, and consistent with Mr. Malek’s methodology, the FDIC did not present the type of evidence that would be necessary if the FDIC were seeking damages based on the failure to put back the blue mortgages. To recover damages on that theory, the FDIC would have had to prove, among other things, when Colonial should have put back the mortgages and how much (if anything) it would have been able to recover from TBW at that point in time. For example, consider blue mortgages that Colonial acquired on the COLB line in 2007. Suppose the initial advance of funding for the mortgages was not a fraud loss, but the mortgages later developed problems, failed to sell, and became eligible to be put back to TBW at some point in 2008. There is no evidence in the record that if Colonial had tried to exercise its put-back right in 2008, TBW would have been willing or able to repay Colonial. Cf. Tr. 3435:17-23 (Malek) (claiming that TBW “didn’t have enough money” to repurchase aged mortgages from Colonial as early as 2004). 139. Further, as discussed above, the FDIC’s new theory that Colonial suffered fraud losses when it failed to exercise its put-back rights, as opposed to when it initially advanced funding for the mortgages, is inconsistent with the evidence that shows virtually everyone at Colonial (not just the fraudsters) was aware of the aged TBW mortgages when they were on the COLB or Warehouse facilities, yet no one insisted that the aged mortgages be put back to TBW. 63 Case 2:11-cv-00746-BJR-TFM Document 850 Filed 03/30/18 Page 67 of 77 See ¶¶ 39-48, 65, supra. That is no doubt one of the many reasons why Mr. Malek did not expound this new damages theory and why the FDIC did not try its case on that theory. II. Even if the FDIC met its burden of proof for some of the blue mortgages, it did not prove that all or even most of the blue mortgages were fraudulent. 140. Mr. Malek’s badges of fraud, individually or collectively, do not support the FDIC’s claim that all the blue mortgages were impaired when Colonial advanced the initial funding for those mortgages. The FDIC also claimed to have identified seven specific mortgages that were originally acquired outside of AOT that it claimed were fraudulent: four so-called “Lee loans” made to Mr. Farkas or a straw buyer acting on his behalf (only two of which were actually included in the FDIC’s claimed damages), and three mortgages that the FDIC claimed (without presenting any admissible evidence) had “bogus Social Security numbers.” See ¶¶ 90-96, supra. 141. As explained above, the FDIC’s evidence concerning these individual mortgages was exceptionally weak. Mr. Malek’s testimony about the “Lee loans” was vague and conclusory, and the FDIC had no admissible evidence at all concerning the three other mortgages (which led to an ill-advised attempt to use the FDIC’s own proof of loss as evidence for counsel’s unsubstantiated assertions). As to these seven individual mortgages, which account for only about $2.7 million in damages, the FDIC’s evidence was insufficient. But even if the FDIC had met its burden as to these mortgages, or as to some other identifiable subset of the blue mortgages, there would be no basis for the Court to extrapolate from that subset to the full universe of 4,225 blue mortgages. 142. As the party seeking damages, the FDIC “has the burden of establishing the existence and amount of those damages by competent evidence.” Johnson v. Harrison, 404 So. 2d 337, 340 (Ala. 1981). The “reasonable certainty” standard cited by the FDIC in its closing argument does not relax the FDIC’s burden of proof on the issue of proximate cause. See 64 Case 2:11-cv-00746-BJR-TFM Document 850 Filed 03/30/18 Page 68 of 77 Hillcrest Ctr., Inc. v. Rone, 711 So. 2d 901, 908 (Ala. 1997) (“The ‘reasonable certainty’ standard provides that ‘recovery will ensue despite the fact damages cannot be calculated with mathematical certainty or without difficulty where they are clearly proximately caused by the wrong.” (emphasis added) (quotation marks omitted)). 143. The FDIC must meet its burden for all of the damages it seeks. See Corson v. Universal Door Sys., Inc., 596 So. 2d 565, 570-72 (Ala. 1991). In Corson, the defendant, a former employee of the plaintiff, was found to have breached a non-competition agreement by soliciting business from the plaintiff’s customers. After the liability determination, the trial court held that it was the defendant’s obligation to show that his breach had not caused the plaintiff to lose business and awarded damages. The Alabama Supreme Court reversed. It first held that the plaintiff had the burden of proof on causation and damages and that the trial court had erred by shifting that burden to the defendant. Id. at 570-71. It then held that the plaintiff had to prove causation and damages as to each customer, and that although the evidence met the plaintiff’s burden as to one customer, it was insufficient as to the others. Id. at 572. 144. Here, any evidence the FDIC may have presented as to some of the blue mortgages cannot carry its burden as to the other blue mortgages. There is no dispute that during the years at issue, Colonial purchased from TBW billions of dollars of legitimate mortgages on which it made money. See ¶¶ 31-32, supra. The Court cannot assume that any mortgage on which Colonial lost money was fraudulent, as it is also undisputed that even legitimate mortgages sometimes lose money. See ¶¶ 34-37, supra. Therefore, it is the FDIC’s responsibility to show which particular losses were due to the fraud. It has not done that. 11 11 The FDIC argued that whereas Colonial lost money on its relationship with TBW from 2004 to 2009, Colonial earned a profit on its relationships with other mortgage originators during the 65 Case 2:11-cv-00746-BJR-TFM Document 850 Filed 03/30/18 Page 69 of 77 145. This is not a case where the FDIC tried to meet its burden through random sampling and statistically valid extrapolation. In some cases, courts have allowed a party to attempt to show the prevalence of fraud through statistical sampling. See, e.g., United States v. Rosin, 263 F. App’x 16, 21, 28-29 (11th Cir. 2008) (in healthcare fraud case, jury heard testimony from “an expert statistician, qualified to perform random samplings,” who “selected a statistically random sample of 70 surgical slides from which he extrapolated loss findings”); In re Chevron U.S.A., Inc., 109 F.3d 1016, 1020 (5th Cir. 1997) (before extrapolating from a particular data set, a court must find that the data set is “representative of the larger group . . . based on competent, scientific, statistical evidence that identifies the variables involved and that provides a sample of sufficient size so as to permit a finding that there is a sufficient level of confidence that the results obtained reflect results that would be obtained from trials of the whole”); United States v. Vista Hospice Care, Inc., No. 3:07-cv-604, 2016 WL 3449833, at *12-14 (N.D. Tex. June 20, 2016) (recognizing that courts have disagreed about when statistical techniques are permissible to prove fraud). 146. Here, the FDIC does not purport to have analyzed any sample of the 4,225 blue mortgages in a way that would support generalizing from that sample to the larger universe. Cf. U.S. ex rel. El-Amin v. George Wash. Univ., 533 F. Supp. 2d 12, 50 (D.D.C. 2008) (“There may same period. See Tr. 3712:11-3717:7. The FDIC apparently wants the Court to infer from that 30,000-foot comparison that any transaction Colonial did with TBW that resulted in Colonial losing money—including funding the blue mortgages—must have been part of the fraud. The evidence does not support that inference. For one thing, the FDIC’s focus on whether Colonial’s overall relationship with a customer (e.g., TBW) is profitable tells the Court nothing about whether any fraud losses were incurred on a subset of loans with that customer. Moreover, even if Colonial lost money on the blue mortgages, the Court cannot assume that the losses were due to fraud as opposed to the housing crisis or other market factors. The FDIC did not present any evidence that the other mortgage originators Colonial did business with were similarly situated to TBW in terms of, for example, their exposure to the hard-hit Florida real estate market. 66 Case 2:11-cv-00746-BJR-TFM Document 850 Filed 03/30/18 Page 70 of 77 be another acceptable method of obtaining a reliable sample, besides consulting an expert statistician, but the Relators have not explained what it is and—most importantly—they have not done it.”). 147. Nor did the FDIC attempt to parse the blue mortgages in any other way. Mr. Malek and his team could have done a loan-by-loan analysis of whether the blue mortgages were impaired at funding. Or they could have divided the blue mortgages into subcategories based on shared characteristics and attempted to explain why certain mortgages, or certain subcategories of mortgages, bore reliable hallmarks of fraud. The FDIC chose not to do this. See Tr. 3548:123549:8 (Malek) (stating that he “did not attempt to place a value on” the blue mortgages “at the time that they were funded by Colonial in to those facilities”). Instead, the FDIC made a tactical decision to pursue an all-or-nothing approach to the blue mortgages, and that approach has resulted in a failure of proof. 148. As part of its all-or-nothing approach, the FDIC is asking the Court to assume that, if there is evidence that any blue mortgage was ever fraudulent when funded, then all the blue mortgages must have been fraudulent when funded, and to shift the burden to PwC to prove which blue mortgages were not part of the fraud. See Tr. 3819:14-18 (FDIC counsel suggesting that Dr. Lehn’s testimony would not be helpful to the Court because he had not “personally analyzed the $415 million of loans and affirmatively concluded that they were legitimate and not impaired when funded”). 149. That is not allowed. See Corson, 596 So. 2d at 570-72. There is no evidence that the tiny handful of blue mortgages that either had Lee Farkas listed as a borrower or had (according to the FDIC, which presented no admissible evidence to that effect) fake Social 67 Case 2:11-cv-00746-BJR-TFM Document 850 Filed 03/30/18 Page 71 of 77 Security numbers were representative of the broader universe of 4,225 blue mortgages for which the FDIC is seeking damages. 150. Accordingly, the FDIC’s damages must be reduced by $300,922,884, which the parties agree is the portion of the FDIC’s claimed damages that is attributable to the blue mortgages. See ¶¶ 18-19, supra. 12 III. The FDIC’s damages must be adjusted to reflect the value of the REO mortgages. 151. Separate and apart from the issue of the blue mortgages, the FDIC overstated its damages by over $30.6 million due to Mr. Malek’s failure to properly calculate the net losses on the REO mortgages that were in the AOT facility when the Bank closed. Mr. Malek ignored the value of the AOT REO mortgages because the FDIC had traded away the proceeds from those mortgages in a settlement agreement with TBW. Regardless of the settlement, however, Mr. Malek was required to account for the value of the AOT REO mortgages when calculating the FDIC’s net losses. See ¶¶ 98-104, supra. 152. The damages the FDIC has the burden of proving are net losses, not gross losses. See Corson, 596 So. 2d at 572 (trial court erred by awarding damages based on gross rather than net loss); see also United States v. Anchor Mortg. Corp., 711 F.3d 745, 749 (7th Cir. 2013) 12 Despite the FDIC’s all-or-nothing approach, PwC has put in evidence that would allow the Court to award damages if it were convinced that the FDIC had met its burden as to some, but not all, of the blue mortgages. For example, if the Court concluded that the FDIC had met its burden as to the seven individual blue mortgages it mentioned at trial, the claimed damages on those mortgages are $2,743,742. See ¶¶ 93, 95-96, supra. If the Court were to conclude that the FDIC had met its burden as to some larger subset of the blue mortgages, the Court could apply a proportionate reduction to the FDIC’s damages. For example, if the Court found that the FDIC had met its burden as to the 1,047 mortgages that had some type of “Do Not Sell” or “DNS” notation in TBW’s records, but not as to the other 3,178 mortgages (see ¶ 80, supra), it could reduce the FDIC’s damages by (3,178/4,225 * $300,922,884) = $226,350,988. Likewise, if the Court found that the FDIC had met its burden as to the 2,113 blue mortgages with some type of exception noted in either Colonial’s records or TBW’s records, but not as to the other 2,112 mortgages (see ¶ 79, supra), it could reduce the FDIC’s damages by (2,112/4,225 * $300,922,884) = $150,425,830. 68 Case 2:11-cv-00746-BJR-TFM Document 850 Filed 03/30/18 Page 72 of 77 (“Basing damages on net loss is the norm in civil litigation.”). Thus, contrary to the FDIC’s assertion, PwC is not asking for a “setoff,” which is a reduction in damages based on a settlement with a joint tortfeasor. See Crews v. McLing, 38 So. 3d 688, 693 (Ala. 2009); A. Howell, Ala. Personal Injury & Torts § 3:41 (2017 ed.). 153. Nor does PwC assert that the FDIC should have settled with the TBW estate on different terms. Rather, Mr. Malek overstated the FDIC’s net loss on the AOT REO mortgages by failing to take into account the value of the REO mortgages that the FDIC already had before it settled with TBW. For this reason, the FDIC’s argument that PwC is “second guessing” the settlement is inapposite. 154. It is improper for Mr. Malek to ignore the proceeds of the AOT REO mortgages when calculating net losses. When Mr. Malek calculated the FDIC’s damages, he counted the money Colonial had advanced to TBW to acquire the mortgages that eventually became REO on AOT. But he did not count the value of the AOT REO mortgages that were on Colonial’s books when the Bank closed. Proceeds that were traded away for other valuable consideration count just as much as cash that the FDIC decided to keep. Indeed, Mr. Malek agreed that his methodology required measuring the “value of the property received” by Colonial from TBW, which includes “the recoveries on the loan.” Tr. 3696:1-18 (emphasis added). 155. Consider a plaintiff who buys stock in a company because of the defendant’s negligent misrepresentations. The stock declines in value, but it also pays a dividend. In calculating her damages, the plaintiff will have to offset the amount she gained from the dividend payment against the amount she lost from the decline in the stock’s value. But suppose the plaintiff assigns her right to receive the dividend to a business partner in exchange for a steak 69 Case 2:11-cv-00746-BJR-TFM Document 850 Filed 03/30/18 Page 73 of 77 dinner. It would be absurd for the plaintiff to argue that because she traded away her right to the dividend payment, it no longer counts as an offset against her damages. 156. Or consider a plaintiff who relies on a defendant’s negligent representations when buying a rental property, which subsequently declines in value. In calculating her damages, the plaintiff will have to include an offset for any rental income she earns from the property. She obviously cannot avoid that offset by assigning her right to receive rental payments from the tenants to a third party in exchange for other valuable consideration. 157. The same is true here. The $78 million of proceeds the TBW trustee was able to recover on the REO (63% of which was AOT REO) fairly represents the value of the REO when given to TBW. Instead of keeping those proceeds—which Mr. Malek indisputably would have used to reduce the FDIC’s damages—the FDIC traded them away in a bargained-for exchange for other valuable consideration, which notably included nearly $700 million of legitimate COLB mortgages that Mr. Malek did not count as a reduction to the FDIC’s damages. Mr. Malek overstated net losses on the REO mortgages by ignoring their value that the FDIC traded away. Because Mr. Malek considered only the cost of the REO mortgages and not their value, the FDIC did not carry its burden of proof as to its net loss on the REO mortgages. 158. When he was examined about this issue, Mr. Malek repeatedly stated that he saw “no connection” between the provision of the settlement agreement giving the FDIC the right to $700 million in COLB mortgages and the provision giving the TBW trustee the right to the proceeds from the REO mortgages. The connection is apparent: what the FDIC gave up in the agreement was consideration for what it received, as FDIC counsel admitted during the liability trial. Tr. 3167:18-3168:3. But whether or not there was a “connection” between the two items is not relevant. Again, PwC is not seeking an offset for what the FDIC received in the settlement. 70 Case 2:11-cv-00746-BJR-TFM Document 850 Filed 03/30/18 Page 74 of 77 Rather, it is pointing out that Mr. Malek should have considered the value of the REO that the FDIC had before the settlement when computing the FDIC’s net loss. 159. After subtracting out the Overline REO and the share of the REO recovery that the FDIC received as an unsecured creditor, the value of the AOT REO that was improperly excluded from Mr. Malek’s damages calculation is $30,663,432. See ¶ 105, supra. 160. Because the Court has already ruled that PwC is entitled to a reduction in the FDIC’s damages to exclude the blue mortgages, the reduction at issue here must be limited to the value of the orange AOT REO. Accordingly, the Court will reduce the FDIC’s damages by an additional $17,640,350. See ¶ 106, supra. IV. The FDIC’s damages will be reduced to reflect any future recoveries. 161. As Mr. Malek agreed, whatever damages the FDIC is entitled to recover from PwC will have to be reduced to account for any amounts the FDIC recovers via future distributions from the TBW bankruptcy estate. See ¶ 109, supra. If, after this Court enters an order fixing the amount of the FDIC’s damages, the FDIC receives additional recoveries from the TBW estate, PwC will be entitled to an appropriate reduction in the FDIC’s damages. The FDIC shall promptly notify PwC and the Court of any such recoveries. 71 Case 2:11-cv-00746-BJR-TFM Document 850 Filed 03/30/18 Page 75 of 77 CONCLUSION Based on the foregoing, the Court HEREBY AWARDS the FDIC damages against PwC in the amount of $306,745,851, 13 which amount will be reduced as necessary to reflect any future recoveries by the FDIC. 13 During closing arguments, the Court asked counsel for the FDIC, “If the Court were to award what the [FDIC] is asking, would that fully compensate FDIC?” Counsel responded that “it’s not anywhere close” because the FDIC’s “ultimate loss on Colonial was . . . somewhere close to $3 billion, and then the loss they tried to recover here was 2.2.” Tr. 4023:17-23. That was disingenuous at best. $2.2 billion was just the starting point for Mr. Malek’s calculations, before he excluded the “shipped not paid” losses that the Court found PwC was not responsible for and made other deductions that everyone agrees were necessary to arrive at the FDIC’s claimed damages. The amount that Mr. Malek actually claims is necessary to “fully compensate” the FDIC for the losses it says were caused by PwC is about $625 million, roughly $300 million of which relates to the blue mortgages. If, as PwC maintains, the losses on the blue mortgages were not proximately caused by the fraud, then they are not fraud losses, and there is no reason for the FDIC to be “made whole” for those losses by PwC or Crowe. Instead, they are business losses that the FDIC collects substantial premiums to insure against. (As PwC has pointed out, the FDIC relies for its funding on premiums paid by insured banks, not the government. Any recovery by the FDIC will therefore benefit banks, not the public. See ECF No. 722 at 4-5.) On the other hand, if the FDIC were to prove in the Crowe case that the blue-mortgage losses were proximately caused by Crowe’s negligence, then it could be “made whole” by recovering those losses from Crowe. 72 Case 2:11-cv-00746-BJR-TFM Document 850 Filed 03/30/18 Page 76 of 77 Respectfully submitted this 30th day of March, 2018. /s/ Mark L. Levine Philip S. Beck (Illinois Bar No. 147168) pro hac vice Mark L. Levine (Illinois Bar No. 6201501) pro hac vice BARTLIT BECK HERMAN PALENCHAR & SCOTT LLP Courthouse Place, Suite 300 54 West Hubbard Street Chicago, IL 60654 Telephone: (312) 494-4400 Email: philip.beck@bartlit-beck.com mark.levine@bartlit-beck.com -andMeredith Moss (Washington, DC Bar No. 484108) pro hac vice Paul Alessio Mezzina (Washington, DC Bar No. 999325) pro hac vice KING & SPALDING LLP 1700 Pennsylvania Avenue, NW Washington, DC 20006-4707 Telephone: (202) 626-2916 Email: mmoss@kslaw.com pmezzina@kslaw.com -andTabor Robert Novak, Jr. (Alabama Bar No. ASB-9503-V72T) BALL BALL MATTHEWS & NOVAK PA P.O. Box 2148 Montgomery, AL 36102-2148 Telephone: (334) 387-7680 Email: tnovak@ball-ball.com ATTORNEYS FOR DEFENDANT PRICEWATERHOUSECOOPERS LLP 73 Case 2:11-cv-00746-BJR-TFM Document 850 Filed 03/30/18 Page 77 of 77 CERTIFICATE OF SERVICE I hereby certify that on March 30, 2018, a true and exact copy of the foregoing was electronically served by transmission of Notice of Electronic Filing generated by CM/ECF to persons registered as of issuance of filing. /s/ Mark L. Levine Mark L. Levine