Before You Sue The Accountants
Document Sample
Before You Sue
The Accountants
Daniel J. Hurson
Even if it looks like a strong case,
be careful—there are some surprising defenses.
IN THE WAKE OF the corporate accounting view accountants with renewed skepticism,
scandals that have dominated the business when hardly a news cycle passes without some
news for the last few years, as well as recurring reference to accounting fraud, investigations,
announcements of large settlements in class ac-
and the occasional large-scale debacles like the
tion suits against major accounting firms, the
prospect of a malpractice case against an ac- demise of Arthur Andersen, not to mention the
counting firm would at first glance seem attrac- high-profile criminal prosecutions that have re-
tive. Juries are presumably more predisposed to cently gone to trial.
Daniel J. Hurson, formerly Assistant Chief Litigation Counsel at the SEC, practices securities enforcement and ac-
counting malpractice law in Washington, D.C. His website is www.hursonlaw.com.
25
26 The Practical Lawyer April 2006
sumption here is that you will be representing
an individual creditor, trustee, or company. For
Accountant malpractice a good primer on all liability theories, see
litigation is a minefield of Richard P. Swanson, Accountant’s Liability, ALI-
ABA Course of Study Materials, May 2004.)
arcane judicial doctrines Often, a third party such as a lender, supplier, or
layered over pleading and investor in an audit client who has relied on that
firm’s clean report on the audited financial
discovery traps that can bury statements to its detriment, will ask the logical
the best plaintiffs’ counsel. question: “Can I sue the auditors?” It seems ap-
propriate to sue for malpractice the very ac-
countants who opined that all was right with
Indeed, among the players in these sagas, the debtor’s books. Any lawyer who has tried
the accountants sometimes offer the best litiga- negligence cases, particularly professional mal-
tion target. The companies themselves have practice, might think this another trip down fa-
often tanked; the errant executives dismissed, miliar paths.
awash in legal problems, and without insur- Not exactly. Accountant malpractice litiga-
ance coverage; but the accountants (Andersen tion is a minefield of arcane judicial doctrines
notwithstanding) live on and prosper. They are layered over pleading and discovery traps that
generally deep-pocketed and amply insured, can bury the best plaintiffs’ counsel. The ac-
and the surviving “big four” firms are vast in- counting industry has, for decades, successfully
ternational organizations with billions in rev- worked the legislative chambers and litigated in
enues. Even the middle-tier accounting firms the courts to dig itself a moat of judicial and
are substantial in their own right, and are re- statutory protection more daunting than that
cently acquiring more and bigger clients as the enjoyed by any other profession. Even if the
big four shed smaller clients. In fact, the big
plaintiff breaches the fortress, he will encounter
four are dropping clients at three times the rate
the bewildering Alice-In-Wonderland worlds of
they did in 2002, either because they present li-
generally accepted accounting principles
ability concerns or because the new accounting
(“GAAP”) and generally accepted auditing
requirements imposed by the Sarbanes-Oxley
standards (“GAAS”), whose spider webs of
Act have sharply increased audit fees charged
by the big four and priced them beyond the rules, interpretations, and literal “layers” make
budgets of many smaller-cap public compa- the federal tax code look simple. Accounting in-
nies. Sorry, the Auditor Said, But We Want a dustry defense lawyers know this territory as if
Divorce, New York Times, Feb. 6, 2005. they learned it in grade school.
Your prospective client may be a bankruptcy This article represents an effort to lay out
trustee, or the board members of the audit client some of the initial factors counsel should con-
who has been required to restate past financial sider before taking on an accounting malprac-
reports that were previously given clean audit tice case. Reviewing the case law, it is clear that
opinions, or the injured company itself. (Many many cases that appear to be “good on the mer-
high-profile suits have been brought by investor its” have been dismissed or lost on summary
classes under the federal securities laws, a sub- judgment for failure to meet these often confus-
ject beyond the scope of this article. The pre- ing and conflicting legal and factual hurdles.
Suing The Accountants 27
CONSIDER THE CLIENT’S RELATION-
SHIP TO THE ACCOUNTANTS • Initially, it
is critical to understand the exact relationship If traditional standards of
between your client and the accountants, from negligence law applied,
which will flow the legal ground rules for the
case. Many accountant malpractice suits in- reasonably foreseeable victims,
volve litigation by unhappy clients against
their auditors, often for bad tax advice, errors
even those not in privity with
in GAAP accounting that require restatements the defendant accountant but
of financial reports, or for failing to catch
fraud such as embezzlement. We consider who placed reasonable reliance
these below. on its professional opinions,
Foreseeable Plaintiffs should recover. But in almost
However, unlike the typical malpractice case all states, that is not the law of
against the doctor or lawyer, many of the
largest-dollar accountant malpractice cases in- accountant malpractice.
volve aggrieved third parties, such as investors
in, lenders to, or sellers of goods or services to
companies, audited by the accountant, that “One who, in the course of his business, profes-
have subsequently failed financially. If tradi- sion or employment, or in any other transaction
tional standards of negligence law applied, rea- in which he has a pecuniary interest, supplies
sonably foreseeable victims, even those not in false information for the guidance of others in
privity with the defendant accountant but who their business transactions, is subject to liability
placed reasonable reliance on its professional for pecuniary loss caused to them by their justi-
opinions, should recover. But in almost all fiable reliance upon the information, if he fails
states, that is not the law of accountant mal- to exercise reasonable care or competence in ob-
practice. In fact, over the last 60 years or so, in- taining or communicating the information.
dividual states have diverged markedly with [T]he liability stated in Subsection (1) is lim-
regard to the liability of accountants to third ited to loss suffered (a) by the person or one of a
parties. Some states require privity, others limited group of persons for whose benefit and
“near-privity,” ” but only handful apply the lib- guidance he intends to supply the information
eral standards of foreseeability familiar to prod- or knows that the recipient intends to supply it;
ucts liability cases. A few states, New Jersey for and (b) through reliance upon it in a transaction
example, have protected accountants by over- that he intends the information to influence or
ruling liberal opinions by statute. knows that the recipient so intends or in a sub-
stantially similar transaction.”
Restatement Section 552 As noted by Professor Feinman of Rutgers
Most states, with some important excep- Law School in a recent comprehensive analysis
tions, follow the Restatement (Second) of Torts, of auditor liability: “Courts that have adopted
section 552, which defines the tort of negligent the Restatement rule regard it as prescribing an
misrepresentation, generally used in such ac- intermediate standard for liability between
tions, as follows: privity or near privity and foreseeability. As the
28 The Practical Lawyer April 2006
North Carolina Supreme Court stated in its • Massachusetts;
much-cited opinion in Raritan I (Raritan River • Minnesota;
Steel Co. v. Cherry, Bekaert & Holland, 367 S.E.2d
• Missouri (similar test);
609, 617 (N.C. 1988)]:
• New Hampshire;
“[Section 552] recognizes that liability should
extend not only to those with whom the ac- • North Carolina;
countant is in privity or near privity, but also to • North Dakota;
those persons, or classes of persons, whom he • Ohio;
knows and intends will rely on his opinion, or • Pennsylvania (but not always);
whom he knows his client intends will so rely.
• Rhode Island;
On the other hand, as the commentary makes
clear, it prevents extension of liability in situa- • South Carolina;
tions where the accountant ‘merely knows of • Texas;
the ever-present possibility of repetition to any- • Tennessee;
one, and the possibility of action in reliance • Washington; and
upon [the audited financial statements], on the
• West Virginia.
part of anyone to whom it may be repeated.’
Restatement (Second) of Torts, Sec. 552, Comment Nebraska is “unclear.” Id. n.165. Wisconsin
h. As such it balances, more so than the other and Mississippi courts have adopted a more lib-
standards, the need to hold accountants to a eral standard, applying general negligence
standard that accounts for their contemporary principles of foreseeability. Id. at 40-41. Cali-
role in the financial world with the need to pro- fornia follows the Restatement but severely lim-
tect them from liability that unreasonably ex- its liability, narrowly interpreting the accoun-
ceeds the bounds of their real undertaking.” tant’s knowledge requirement by holding that
the auditor must have “undertaken to inform
Feinman, Liability of Accountants For Negligent
and guide a third party with respect to an iden-
Auditing: Doctrine, Policy, And Ideology, 31 Fla. St.
U.L. Rev. 17, 42 (Fall 2003). tified transaction or type of transaction.” Bily v.
Arthur Young & Co., 834 P.2d 745, 767-69
(1992).This interpretation has the effect of “prac-
States That Follow The Restatement
tically equating the knowledge requirement of
According to Prof. Fineman’s survey, as of
section 552 with the intended beneficiary re-
Fall 2003, the following states follow the Restate-
quirement of contract law.” Id. at 30. (Another
ment (or what amount to a similar analysis):
article that sets forth the law in multiple juris-
• Alabama; dictions is Pecini, et al, At the Interface of Law and
• Alaska; Accounting: an Examination of a Trend Toward a
• Arizona; Reduction in the Scope of Auditor Liability to Third
• Colorado; Parties in the Common Law Countries, 37 Ameri-
can Business Law Journal 171 (January 1, 2000).)
• Florida;
• Georgia;
New York: The Ultramares Rule
• Hawaii; New York has traditionally followed a re-
• Iowa strictive test, set out initially in Ultramares v.
• Kentucky; Touche, 174 N.E. 441 (N.Y. 1931), historically the
