* Investors may pursue claims over 2001 Winstar collapse
* 2nd Circuit says jury could find audit deficient
* Decision reverses 2010 ruling favoring Grant Thornton
By Jonathan Stempel
July 19 A federal appeals court has revived a lawsuit accusing Grant Thornton LLP of defrauding shareholders and bondholders of a broadband services company it had audited, and which went bankrupt during the telecom bubble a decade ago.
The 2nd U.S. Circuit Court of Appeals in New York said a lower court was wrong to dismiss claims that Grant Thornton deliberately ignored signs of fraud at Winstar Communications Inc, one of its largest clients, when vetting its financial statements for the 1999 fiscal year.
Grant Thornton did not immediately respond to requests for comment on the decision, which reversed a September 2010 ruling by a Manhattan federal judge.
Investors including Allianz SE funds and Fireman's Fund Insurance Co claimed to have lost close to $1.1 billion on Winstar stock and $200 million on Winstar debt when the New York-based company filed for bankruptcy on April 18, 2001.
Winstar, whose technology transmitted voice and data with radio signals rather than fiber-optic cables or phone wires, at that time blamed the bankruptcy on an alleged violation by its partner Lucent Technologies Inc of a vendor financing agreement.
The Chapter 11 filing also came one month after the investment firm Asensio & Co questioned Winstar's accounting.
Writing for a three-judge appeals court panel, Circuit Judge Raymond Lohier said that despite identifying "red flags" while spending 1,928 hours on the audit and assembling 3,000 pages of "working papers," Grant Thornton "repeatedly failed to scrutinize serious signs of fraud by an important client."
The judge said these signs included questionable timings of large transactions, which concealed declining core revenue, and Winstar's repeated failure to provide requested documents.
"A jury reasonably could determine that the audit was so deficient as to be highly unreasonable, representing an extreme departure from the standards of ordinary care," Lohier wrote.
The judge also said a jury could find that the steep decline in Winstar's share price in 2001, to 14 cents from more than $60 a year earlier, was attributable in part to the alleged fraud.
Jonathan Levine, a partner at Girard Gibbs representing Allianz and some other plaintiffs, said the case will return to the district court for a possible trial.
"We're obviously very pleased," he said. "You can't look at the quantity of the audit, but the quality."
Lucent is now part of France's Alcatel Lucent SA.
The case is Gould et al v. Grant Thornton LLP, 2nd U.S. Circuit Court of Appeals, No. 10-4028.