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APPENDIX B

State and Federal Case Digest

FIRST CIRCUIT

Norman v. Brown, Todd & Heyburn, 693 F. Supp. 1259 (D. Mass. 1988)

Following Massachusetts law, the court held that a complaint alleging that an accountant knew, or should have known, of fraudulent misrepresentations made by its client to investors regarding the soundness of an investment that the client was offering for sale stated a claim for aiding and abetting common law intentional fraud against the accountant. However, a count for civil conspiracy against the accountant, a law firm, and the accountant’s client was dismissed. Under Massachusetts law, in order to state a claim of civil conspiracy, the plaintiff must allege that the defendants, acting in unison, had “some peculiar power of coercion” over the plaintiff that they would not have had if acting independently. The complaint in this case did not include such an allegation.

Rusch Factors Inc. v. Levin, 284 F. Supp. 85 (D.R.I. 1968)

Under Rhode Island law, lack of privity is no defense in an action for fraud by a lender against accountants who prepared financial statements upon which the lender relied in loaning money to the accountants’ client. In a fraud action, neither actual knowledge by the accountant of the third party’s reliance nor quantitative limitation of the class of relying persons is requisite to recovery. The same broad perimeter prevails if the misrepresenter’s conduct is heedless enough to permit an inference of fraud.

Wittenberg v. Continental Real Estate Partners, 478 F. Supp. 504 (D. Mass. 1979)

Investors in securities failed to state a claim under the federal securities laws against accountants who audited the issuing company and made statements in regard to its financial health. The claims against the accountants derived solely from statements made in an annual report of the issuing company that was first received by the plaintiffs two years after they purchased the company’s securities. Thus, the plaintiffs failed to show reliance on the statements in making the purchase. Moreover, where the plaintiffs’ allegations against other defendants involved in the same transaction were also insufficient to state a claim, a claim against the accountants for aiding and abetting the other defendants in their activities likewise failed.

SECOND CIRCUIT

O’Brien v. National Property Analysts Partners, 719 F. Supp. 222 (S.D.N.Y. 1989)

Investors alleging that an accounting firm was involved in securities fraud under federal law failed to plead with sufficient specificity that the defendant acted with “scienter” or knowledge of the falsity of its representations. The mere fact that the accounting firm’s allegedly false financial reports were included in the memoranda offering the securities for sale did not make the accountants “insiders” for the purpose of allowing undifferentiated pleading

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under federal law. Moreover, the plaintiffs failed to show how the financial reports were false or misleading, since the reports themselves explicitly disclosed that they were based on “assumptions” about how the properties underlying the securities sale were to be managed.

Vogt v. Abish, 663 F. Supp. 321 (S.D.N.Y 1987)

Interpreting New York law, the court held that accountants who failed to file an amended partnership return for their client as promised were not liable for excessive federal and state tax payments which could have been avoided if the plaintiff had filed an amended return himself after the negligence of the accountants was discovered. The plaintiff could not hold the defendants liable for damages that occurred after he became aware of the defendants’ negligence, when the plaintiff failed to mitigate those damages. The plaintiff’s contention that he could not mitigate damages by filing an amended return himself because he was not authorized to sign the partnership’s return and because he lacked the expertise to fill out the return correctly was rejected. The court noted that a partner’s signature on a return is prima facie evidence that the partner is authorized to sign it and even an incomplete amended return would have extended the filing period while the plaintiff sought help in figuring the revised return.

THIRD CIRCUIT

Baehr v. Ybuche Ross & Co., 62 Bankr. 793 (E.D. Pa. 1986)

A trustee in bankruptcy of a real estate investment trust was entitled to bring suit against the auditors of the trust for failure to detect fraud, despite the auditor’s contention that the trust’s creditors and shareholders were the real parties in interest. The court construed the pleadings to allege that the trust itself did not conduct the fraud, but was merely a conduit through which the executive officers of the trust perpetrated fraud. Under this interpretation, the trust itself was an injured party, and the bankruptcy trustee was entitled to bring suit on its behalf. In addition, the court found that the trustee stated a claim for accounting malpractice where it alleged that the auditors rendered an unqualified opinion of the trust’s financial condition, even though they had not audited the assets held by the trust and knew that no one had audited the assets. The complaint alleged that the failure to warn the trust of the lack of internal controls in this regard constituted negligence and a breach of contract.

Cammer v. Bloom, 711 F. Supp. 1264 (D.N.J. 1989)

Investors in securities who did not allege that they received audit reports prepared by independent auditors of the securities firm for use in making their decision whether to invest in the securities could not bring an action against the auditors for common-law negligent misrepresentation under New Jersey law. Without receipt of the reports, the investors could not claim to have relied on the alleged misrepresentations contained therein. However, under federal law, the allegation that the securities were traded on an open and efficient market was sufficient to state a claim for securities fraud against the auditors. A triable issue of fact then remained to determine whether the market for the securities was, in fact, efficient and would therefore give rise to a rebuttable presumption of reliance on the reports in favor of the investors.

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FOURTH CIRCUIT

Rhode Island Hosp. Trust Nat’l Bank v. Swartz, Bresenoff, Yavner & Jacobs, 455 F.2d 847 (4th Cir. 1972)

Interpreting Rhode Island law, the court found that accountants who admittedly knew that a lender was relying on financial reports prepared by them for their client were liable for malpractice, where the evidence showed that the accountants failed to discover that certain leasehold improvements listed on the client’s accounts did not, in fact, exist. A disclaimer provided by the accountants specifying that the “precise value” of the improvements was unknown did not suffice to relieve them from liability for losses incurred as a result of the nonexistence of the leaseholds. Moreover, the accountants’ statement in the reports that “fully detailed” cost records were not kept regarding the alleged improvements, was misleading in light of the fact that no cost records at all were kept.

Semida v. Rice, 863 F.2d 1156 (4th Cir. 1988)

Even assuming that Virginia would adopt the rule that third parties known to be relying on information given by an accountant to a client may have an action against the accountant for malpractice, such action could be brought only by a third party who actually relied on the information. A plaintiff who alleged that a business partner was induced to cease doing business with him in reliance on an erroneous report concerning the plaintiff prepared by the defendant accounting firm had no cause of action. In other words, since the plaintiff himself did not rely on the report, he had no action against the accountant. The court left open the possibility that he might have an action for interference with a business relationship against the accountant.

FIFTH CIRCUIT

Bank of New Orleans & Trust Co. v. Monco Agency, 719 F. Supp. 1328 (Bankr. E.D. La. 1989)

Interpreting Louisiana law, the court held that accountants were not liable to a bank lending money to their client for misrepresentations on an audit report prepared for their client. The evidence failed to show that the defendant had actual knowledge that the report was being supplied to the bank for the purposes of negotiating a loan. The court noted that there was some merit to the plaintiff’s argument that where a third party assumes a loan from another lender who was known to be relying on information generated for an accountant’s client, the accountant may be liable for misrepresentations in the information supplied. However, the evidence here contradicted the assertion that the loan was assumed from the former lender. Instead, it appeared that the loan was an entirely new transaction.

Gantt v. Boone, Weliford, Clark, Langschmidt & Pemberton, 559 F. Supp. 1219 (M.D. La. 1983)

A malpractice claim against an accountant for failure to account for taxes on the sale of corporate assets failed under Louisiana law, where the evidence showed that the accountant was specifically instructed to accrue only income from operations and was not provided information about the allocation of the sales price between assets located in Louisiana and those located in another state. This information would have been essential to determine the amount of state capital gains taxes that were due. Moreover, the accountant was justified in assuming that he was not hired to give advice on taxes, since he was told by the plaintiff’s attorney that the

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attorney specialized in tax law. The accountant could reasonably have assumed that the client did not hire him to duplicate the efforts of the client’s attorney, a tax specialist.

SIXTH CIRCUIT

In re Bell & Beckwith, 50 Bankr. 422 (Bankr. N.D. Ohio 1985)

Interpreting Ohio law, the court held that a second auditor, who was called in to relieve a first auditor of duty and who failed to detect or disclose deficiencies in the first auditor’s work, had itself breached its duty of care. This, in turn, had the effect of cutting off the chain of causation between the first auditor’s initial negligence and the ultimate financial injury to the client which resulted in its bankruptcy. The evidence showed that the second auditor’s failure to detect the deficiencies in the first auditor’s work greatly exacerbated the harm to the client. Under this ruling, the first auditor was relieved of liability for those injuries.

In re DeLorean Motor Co., 56 Bankr. 936 (Bankr. E.D. Mich. 1986)

A member of the Board of Directors of a corporation that engaged the accounting services of the defendant accounting firm stated a claim of malpractice against the firm, despite the fact that the firm’s contract was with the corporation and not with the members of the Board of Directors individually. The court held that, as a Board member, the plaintiff was required to review and evaluate the reports of auditors regarding the financial health of the corporation. He was, therefore, within the class of persons who foreseeably would rely on the reports generated by the auditor. Therefore, the defendant breached a duty to the plaintiff when it allegedly failed to discover and disclose that one of the officer’s of the corporation was engaged in fraudulent acts.

SEVENTH CIRCUIT

Burdett v. Miller, 957 F.2d 1375 (7th Cir. 1992) (Illinois law)

Although certain categories of relationships impose fiduciary duties per se, such as between a guardian and a minor ward, or a lawyer and client, accountants do not automatically owe fiduciary duties to their clients. However, when a client reposes trust and confidence in the accountant, who uses that trust and superior knowledge or expertise to take advantage of the client, a fiduciary duty exists. Here, an accountant was held liable for breaching fiduciary duties owed to his client when he failed to tell her that he was recommending investments that were unsuitable for her circumstances, that had no prior record of operation, and in which he had some personal financial interest. In its opinion, the court noted that “clear and convincing evidence” is required to establish a fiduciary relationship outside of a per se category. In addition to investment losses, the disappointed investor was allowed to recover the present value of net tax benefits anticipated on the investments. The accountant was not entitled to a credit for the plaintiff’s tax deductions for investment write-offs.

Frymire v. Peat, Marwick, Mitchell & Co., 657 F. Supp. 889 (N.D. Ill. 1987)

Investors in an allegedly fraudulent partnership scheme stated a cause of action for common law fraud against the auditors of the company that sold the partnerships when they included in the pleading the type of facts they believe were omitted from the audit done by the

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defendant, the type of document in which the facts should have appeared and the way in which the omissions made the documents misleading. The plaintiffs alleged that the auditors failed to include in their report the existence of a subsidiary corporation of the company the plaintiffs invested in, which was used to funnel their money into loans to failing partnerships rather than the purchase of shares in the partnerships. They also alleged that the undisclosed subsidiary was used to inflate the balance sheets of the parent corporation, making it appear to be financially far stronger than it actually was and, thus, misleading the plaintiffs into the belief that it was a sound investment.

Frymire-Bernati v. KPMG Peat Marwick, 2 F.3d 183 (7th Cir. 1993)

The appeals court reversed a jury verdict against the accountant for $1 million in compensatory and $2 million in punitive damages, and ordered the case remanded for a new trial on a state law misrepresentation count. The court rejected the plaintiff’s claim under § 10(b) and Rule 10b-5 on the grounds that the plaintiff had failed to produce any evidence that the auditor knew that the financial statements would be used by the audit client to sell stock to the plaintiffs. The court ruled that the plaintiff was not entitled to an inference of such knowledge merely because the accounting firm prepared 450 copies of the certified financial statements, noting that the plaintiffs had failed to adduce evidence that this number of financial statements was anything out of the ordinary, such that any accountant should have known that his or her client planned to use the statements to sell stock to third parties. The court used the “in connection with” the purchase or sale of securities element of a federal antifraud claim to impose this federal privity limitation on claims against accountants. Significantly, however, the court remanded the case for a trial on plaintiff’s state law misrepresentation claim, noting that the accounting firm’s audit workpapers did not show that the auditors had done anything to “check up” on an important aspect of the audit client’s business, thereby justifying an inference that the accountants had acted with such reckless indifference to the truth as to justify an inference of scienter.

Toro Co. v. Krouse, Kern & Co., Inc., 827 F.2d 155 (7th Cir. 1987)

Interpreting Indiana law, the court held that, in the absence of actual knowledge that a third party would rely on information generated for a client and in the absence of any conduct linking them to that third party, accountants may not be held liable to the third party for negligence in preparing the information.

EIGHTH CIRCUIT

Garnac Grain Co. v. Blackley, 932 F.2d 1563 (8th Cir. 1991) (Missouri law)

An accountant was not allowed to assert an audit client’s comparative fault as a defense on a claim that the auditor negligently failed to detect embezzlement from the client by an employee. The court reasoned that principles of comparative fault do not apply on tort claims for purely economic losses, as compared to losses for bodily injury or property damage. It was also held that evidence of the audit client’s reimbursement by a fidelity bond insurer was not admissible at trial, on grounds that receipt of this payment amounted to receipt from a collateral source and was not evidence that the audit client sought protection against embezzlement from insurance, rather than through its auditors.

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Robertson v. White, 633 F. Supp. 954 (W.D. Ark. 1986)

Applying principles of Arkansas law, the court determined that Arkansas courts would not extend liability for the negligence of an accountant to third parties not in privity with him or her. However, an action might be brought by third parties against an accountant for fraud or such gross negligence as amounts to fraud. In addition, while the members of a class representing a cooperative were not entitled to sue the cooperative’s accountants because of lack of privity between them, the cooperative itself could sue the accountants since it was the accountant’s client and was, thus, in privity with them.

TCF Banking and Sav., F.A. v. Arthur Young & Co., 706 F. Supp. 1408 (D. Minn. 1988)

The plaintiff, a lender of the defendant accountant’s client, was not required to prove the defendant’s actual knowledge of the plaintiff’s reliance on its audit of the client in order to prove a malpractice claim. The plaintiff needed only to show either that the defendant intended to induce creditors to loan money to the client in exchange for a security interest in stock owned by the client, or that the defendant knew its client would use the audit report to induce creditors to loan money to the client. The court held that, if it can be shown that the defendant’s representations were made for the purpose of inducing third parties to rely and act upon the reliance, then liability to such third parties can attach.

NINTH CIRCUIT

Seafirst Corp. v. Jenkins, 644 F. Supp. 1152 (WD. Wash. 1986), later proceeding, 644 F. Supp. 1160 (1986)

A triable issue of fact existed as to whether the alleged negligence of accountants in issuing an unqualified audit report on the plaintiff company caused the plaintiff to make risky loans that resulted in severe financial injury. The plaintiff’s theory was that the unqualified nature of the audit lured it into complacency about its own internal controls on its loan procedures. The plaintiff contended that a “qualified” audit would have been viewed by management as a “red flag” that would have caused them to reevaluate their loan procedures and the risky loans would not have been undertaken. Despite the defendant’s argument that it could not be held liable as an insurer of risks which its client took in the exercise of its business judgment, the court found that causation might, under the circumstances, be proven and a summary judgment on the issue was not proper.

Smolen v. Deloitte, Haskins & Sells, 921 F.2d 959 (9th Cir. 1990) (federal and California law)

The seller of a business failed to meet the burden of showing that he actually and justifiably relied upon allegedly overstated financial statements in selling his business, when the seller had independent knowledge of the inaccuracy of the financial statements and, at most, claimed to have relied only on “informal verbal comments” in deciding to sell his business. The lack of actual or justifiable reliance precluded the seller from recovering under § 10(b) of the federal securities laws, as well as on his common law state claims for professional negligence and misrepresentation.

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In re Worlds of Wonder Sec. Litig., 694 F. Supp. 1427 (N.D. Cal. 1988)

Under § 11 of the Securities Act of 1933, liability for false or misleading statements in the registration materials or prospectus of a corporation must be predicated on express attribution of the material to the defendant. Investors in corporate securities failed to state a claim under federal law against an accounting firm for allegedly misleading statements in the corporation’s prospectus where the plaintiffs were unable to identify the specific portions of the prospectus that were prepared by the accounting firm and that were false or misleading.

TENTH CIRCUIT

Farlow v. Peat, Marwick, Mitchell & Co., 666 F. Supp. 1500 (W.D. Okla. 1987)

Purchasers of securities failed to state a claim under federal securities laws for aider and abettor liability against accountants who provided accounting services to the firm issuing the securities. The court noted that the plaintiffs failed to allege that the accountants gained, other than by receipt of standard fees for accounting services, from the bilking of the buyers of the securities of their client. Nor were there allegations that the accountants received proceeds from the securities’ sales, received fees for rendering advice in connection with the sales, or reviewed or approved any of the materials used to sell the securities. The plaintiffs cited in their complaint only one of the offering memoranda of the securities that contained an audit report prepared by the defendants. This was not sufficient to satisfy federal pleading standards.

Stephens Indus. Inc. v. Haskins & Sells, 438 F.2d 357 (10th Cir. 1971)

The buyers of a car rental business had no cause of action against the accountants of the sellers for the alleged misrepresentation of the status of the Accounts Receivable of the business. Interpreting Colorado law, the court held that third parties not in privity with an accountant may not maintain an action against the accountant for negligence. Moreover, there was evidence in this case that the accountants had exercised proper care in conducting their assignments. The evidence showed that the accountants were specifically instructed not to conduct a full audit on the Accounts Receivable by their employers and that they appended qualifying statements to their report which specifically advised that the Accounts Receivable had not been adjusted to reflect collectibility.

ELEVENTH CIRCUIT

Cocklereece v. Moran, 532 F. Supp. 519 (N.D. Ga. 1982)

In the absence of any agreement of any kind between a borrower and accountants for a bank that defrauded the borrower of collateral he posted for a loan, the borrower had no cause of action against the accountants for willful breach of contract.

Seaboard Surety Co. v. Garrison, Webb & Stanaland, 823 F.2d 434 (11th Cir. 1987)

Interpreting Florida law, the court held that a surety company that brought an action against the accountants of the surety’s principal was a third-party beneficiary to the accountants’ contract with the principal. Therefore, the surety’s action against the accountants was for breach of contract and did not sound in tort. A jury’s verdict for the defendants based on a finding that

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the defendants had not breached their contract with the principal to perform an audit with reasonable care was therefore definitive with respect to the rights of the surety. The surety’s argument that Florida had recognized a duty flowing from the accountants to third parties “independent” of the duty owed by the accountants as a contractor was explicitly rejected.

DISTRICT OF COLUMBIA CIRCUIT

Zoelsch v. Arthur Andersen & Co., 824 F.2d 27 (D.C. Cir.)

German investors failed to state a claim against an American accounting firm under American federal securities laws for fraud in connection with the sale of securities, where the only allegation was that the accounting firm supplied information to a German firm which then used that information in drawing up a prospectus for securities that turned out to contain misleading statements. Under these circumstances, it could not be said that the accountants’ services were rendered in connection with “the purchase or sale of securities.” It was simply too attenuated to presume that the accountants could foresee that the information supplied by them would be used to sell securities.

ALABAMA

Blumberg v. Touche Ross & Co., 514 So. 2d 922 (Ala. 1987)

Where an accounting firm expressly promised to use generally accepted accounting principles and generally accepted auditing standards in its contract with its client, it was liable both in tort and in contract for failure to do so. Therefore, the client had the choice of remedies when seeking compensation. Where a possible tort claim was barred by the statute of limitations, the client was permitted to bring the action under the state’s longer contract limitations period. This was considered particularly appropriate, since the accounting firm had previously relied on the argument that the action sounded in contract when it moved for a change of venue in the case.

Colonial Bank of Alabama v. Ridley & Schweigert, 551 So. 2d 390 (Ala. 1989)

Accountants who audited the financial statements of a mortgage company were not liable for negligence to a creditor of the mortgage company that relied on the statements. The record failed to disclose any evidence that the accountants were aware, at the time they audited the financial statements, that the audits were to be used by the client specifically to influence the plaintiff creditor. Nor was there any evidence that the accountants engaged in any conduct linking them to the creditor or that they were aware that the creditor was relying on the audits. The audited statements were provided solely to the mortgage company, and the plaintiff was merely one of a number of creditors listed thereon. The accountants, therefore, had no duty of care to the plaintiff creditor with respect to the accuracy of the statements.

ALASKA

Selden v. Burnett, 754 P.2d 256 (Alaska 1988)

The Alaska Supreme Court addressed the question of what kind of relationship is necessary to subject an accountant to a duty of care toward a non-client who received the

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accountant’s advice secondhand as a tip. The case involved a couple who invested in a scam on the basis of information that was passed to them by clients of an accountant who had privately encouraged his clients to invest in the scheme for tax purposes. The court held that when an accountant in the course of giving personal tax advice verbally recommends a particular investment to a client, the accountant owes a duty of care to third parties only if the accountant specifically intends the third parties to invest relying on his or her advice, and only if the accountant makes this intent known. Thus, if an accountant were to give investment advice to the representative of a group of investors, explicitly intending the information to be for the benefit and guidance of each member of the group, the accountant would owe a duty of care to each member. However, the accountant would owe no duty to non-members to whom the information might subsequently be relayed. Under this rule, a non-client who obtains personal investment advice secondhand will rarely be entitled to damages from the accountant who provided the advice.

Thomas v. Cleary, 768 P.2d 1090 (Alaska 1989)

To recover in a malpractice action against an accountant, a plaintiff must prove duty, breach of duty, proximate causation and actual loss or damage resulting from the breach of duty. A plaintiff who alleged that his accountant was negligent in failing to file a corporate tax return on his behalf could not recover for the alleged negligence where the Internal Revenue Service had never sent him a deficiency notice nor imposed any tax assessment as a result of the absent corporate return. The court held that only when the tax deficiency is assessed will the tort action accrue. Until then, the plaintiff has suffered no damage and has no cause of action.

ARIZONA

Lewin v. Miller Wagner & Co., 151 Ariz. 29, 725 P.2d 736 (Ariz. App. 1986)

Evidence that an accountant overlooked or forgot the consequences of the alternative minimum tax when advising his client on tax strategies, thereby causing a ten-fold increase in the amount of taxes his client had anticipated, was sufficient to sustain a jury verdict of accountant malpractice. Evidence that the accountant himself admitted having forgotten the alternative tax was admitted under the “excited utterance” exception to the hearsay rule, on testimony of the plaintiff’s attorney that the plaintiff showed up at his office without an appointment “ashen and visibly shaken’ and informed the attorney that his accountant told him that the accountant had “forgotten about the alternative minimum tax.” In addition, evidence that the accountant failed to ascertain his client’s tax goal when giving tax advice was another significant factor in the finding of malpractice.

Sato v. Van Denburgh, 123 Ariz. 225, 559 P.2d 181 (Ariz. 1979)

Following Arizona’s traditional rule that a cause of action accrues when the plaintiff knows, or in the exercise of reasonable diligence should have known, of the defendant’s negligent conduct, the court ruled that an investor’s claim against his accounting firm was time-barred. In this instance, the plaintiff knew well before the two-year period for filing a tort claim that the accountants had been negligent. Moreover, there was nothing in the complaint that would allow the inference of a “continuing malpractice” that extended into the limitations period. The plaintiff was told in 1966 that negligence in the accounting of the investor’s

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business had occurred. The plaintiff took no action until 1975. The mere fact that the alleged negligent figures were carried on the investor’s books for several years after 1966 did not establish that the negligence was continuing, nor did it alter the fact that the plaintiff knew of the negligence and could have brought suit in 1966.

ARKANSAS

Swink v. Ernst & Young, 3 22 Ark. 417, 908 S.W.2d 660 (1995)

The “management head” of a firm sued an outside auditor for preparing an inaccurately audited financial statement, on the grounds that the work was not done for the firm but rather for its management.” The court rejected the claim for lack of privity, citing Ark. Code Ann. § 16-114-302 (Supp. 1993). The court rejected the further claim that the manager was the third-party beneficiary of the contract between the auditor and the firm, on the grounds that doing so would eviscerate Arkansas’s privity statute. Finally, the statute of limitations on the accounting malpractice claim was held to begin running when “wrongful acts occur, not when they are discovered.”

CALIFORNIA

Bily v. Arthur Young & Co., 222 Cal. App. 3d 289, 230 Cal. App. 3d 835, 271 Cal. Rptr. 470 (Cal. Ct. App. 1990)

The court reaffimed the rule that an independent auditor will be liable to those third parties who reasonably and foreseeably rely on negligently prepared and issued unqualified audited financial statements, regardless of whether the third parties were in contractual privity with, or their reliance was actually foreseen by, the auditor. In assessing the conduct of an independent auditor under this rule, generally accepted accounting principles (GAAP) and generally accepted auditing standards (GAAS) do not define an accountant’s professional standard of care, but rather are evidence to be considered along with other factors in determining whether the standard of care was met. The degree to which an independent auditor is justified in relying on the audit client’s internal accounting controls will depend on the auditor’s assessment of the sufficiency of those controls. In the absence of strong internal controls, an independent auditor must examine the client’s entries more carefully and make more tests to verify the accuracy and fairness of the client’s financial statements.

Bily v. Arthur Young & Company, 3 Cal. 4th 370, 834 P.2d 745, 11 Cal. Rptr. 51 (1992)

In adopting Restatement (Second) of Torts § 552 to limit the scope of an accountant’s liability to nonclients who claim to have relied on audited financial statements, the court expressly rejected the more expansive rule of liability afforded by the “reasonably foreseeable” doctrine. The court emphasized that an auditor relies heavily upon information supplied by the client, is called upon to exercise a “high degree of professional skill and judgment” in planning and undertaking an audit engagement, and faces possible ruinous financial exposure to unintended and unforeseen users of financial statements, who are themselves often in the best position to prevent their own losses or spread the risk of those losses. The court further ruled that a nonclient can never sue an accountant for a negligently rendered audit, on an unvarnished negligence theory, but must instead rely upon the theory of negligent misrepresentation. In

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doing so, the court emphasized the “indispensability of justifiable reliance on the statements contained in the [auditor’s] report” as a predicate to a nonclient’s recovery against an auditor.

Electronic Equip. Express Inc. v. Donald H. Seiler & Co., 122 Cal. App. 3d 834, 176 Cal. Rptr. 239 (198 1)

Under California law, a cause of action for accounting malpractice accrues when the plaintiff both sustains appreciable and actual harm and discovers, or with reasonable diligence should have discovered, the wrongful acts. The statement of a company president in this case that he discovered on a certain date that financial statements prepared by the defendant accounting firm did not present a true picture of the company’s financial condition did not establish as a matter of law that the cause of action accrued on that date. The president would also have to have been aware at that time that the inaccurate statements resulted from negligence.

International Mortgage Co. v. John P Butler Accountancy Corp., 177 Cal. App. 3d 806, 223 Cal. Rptr. 218 (1986)

In a case of first impression, the court held that in California an independent auditor owes a duty of care to reasonably foreseeable third parties who rely on negligently prepared and issued unqualified audited financial statements. A question of fact then remained on remand to determine whether reliance on the negligently prepared financial statements was reasonably foreseeable by a potential customer of the audited firm.

COLORADO

Professional Rodeo Cowboys Ass’n v. Wilch, Smith & Brock, 42 Colo. App. 30, 589 P.2d 510 (1978)

Sufficient evidence of negligence existed to affirm a judgment against an accounting firm for malpractice where the firm’s errors caused its client, a professional cowboys’ association, to name the wrong cowboy the winner of its world champion contest. As a result of the mistakes, the association was required to retain counsel and settle the dispute by naming two cowboys champion and awarding two prizes. The court held that these costs were recoverable by the association, in addition to the cowboys’ counsel costs which were part of the overall settlement of the winnings dispute. However, the court found claims for lost income to the association allegedly as a result of a lost television contract and damage to its business reputation were not compensable. Since the plaintiff was not able to show the expenses of its operation, it was not possible to establish net profits from which a net loss resulting from the alleged injuries could be calculated.

DELAWARE

Isaacson, Stolper & Co. v. Artisan’s Sav. Bank, 330 A.2d 130 (Del. Super. Ct. 1974)

The limitations period on a cause of action against an accountant for failure to apply for a tax concession began to run at the time the client was informed by the Internal Revenue Service that a tax deficiency existed. Noting that the plaintiff’s relationship with the accountant was one of confidence and reliance on the defendant’s expertise, not only in the field of general accounting but also as to tax problems, the court found this rule particularly applicable to a

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taxpayer who does not know a loss has been suffered until the taxing authority asserts a claim. In such a triangular situation, the court found, it would clearly work an injustice to expect the client to anticipate, or even be aware of, a possible injury.

FLORIDA

Coopers & Lybrand v. Trustees of Archdiocese of Miami, 536 So. 2d 278 (Fla. App. Ct. 1988)

For failure to discover defalcations or fraud, the liability of an accountant under Florida law is limited to losses which are the proximate result of the accountant’s breach of duty. An accounting firm that negligently failed to discover that stop-loss insurance coverage for members of religious orders in its client’s religious organization had lapsed due to the fraudulent retention of the members’ premiums by the diocese’s health plan administrator was liable for the amount of premiums paid by the members that did not reach the insurance company. However, the accounting firm was not liable for benefit payments which might have been covered if the stop-gap policy had actually been in force as intended. Such coverage, ruled the court, was merely speculative.

Devco Premium Finance Co. v. North River Ins. Co., 450 So. 2d 1216 (Fla. App. Ct. 1984)

Under Florida law, an accounting firm is entitled to assert the defense of comparative negligence in a malpractice action instituted against the firm by a client. In this case, an insurance premium finance company was found to be 80 percent responsible for its own demise due to miscalculation of delinquent accounts receivable, even though its accounting firm had failed to disclose the mounting problem. The court found that a prudent client would not have relied so heavily on the accounting firm’s monthly “write up” services, but rather would have taken steps to assure the availability of the actual reports on aging accounts receivable that would have provided the quality control vital to the prosperity of an insurance premium finance company. Moreover, the plaintiff company attempted to install an in-house computer system to keep track of delinquent accounts, but failed to staff it properly, thus contributing to the delay in discovering the true state of the accounts receivable by the firm.

First Florida Bank v. Max Mitchell & Co., 558 So. 2d 9 (Fla. 1990)

Florida has adopted the rule that in the absence of privity of contract, an accountant is liable only to those persons or classes of persons who the accountant knows will rely on his or her opinion. Under this rule, an accountant who negotiated a loan for his client and personally delivered financial statements he had prepared for his client to a bank with the knowledge that the bank would rely upon them in considering whether or not to make a loan to the client was held to have vouched for the integrity of the audits and was therefore liable to the bank for negligence in the preparation of the statements.

GEORGIA

Badische Corp. v. Caylor, 356 S.E.2d 198, 257 Ga. 131 (Ga. 1987)

Under Georgia law, third parties may not recover against an accountant for the accountant’s negligence in preparing audited financial statements where it is merely foreseeable that the third parties would rely upon the financial statements. Rather, liability will extend only

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to those limited number of persons or class of persons for whom the information was intended, either directly or indirectly. In making a determination of whether the reliance by a third party is justifiable, Georgia courts will look to the purpose for which the report or representation was made. If it can be shown that the representation was made for the purpose of inducing third parties to rely and act upon the reliance, then liability to the third party may attach. The additional duty that this rule imposes may be limited by appropriate disclaimers which would alert those not in privity with the supplier of the information that they may rely upon it only at their peril.

Consolidated Management Serv. v. Halligan, 186 Ga. App. 621, 368 S.E.2d 148 (Ga. Ct. App. 1988), aff’d, 258 Ga. 471, 369 S.E.2d 745 (Ga. 1988)

A client’s criminal conviction for tax fraud did not preclude a civil suit against his accounting firm for malpractice arising out of the same transactions that resulted in the criminal conviction. The prior conviction did not work collateral estoppel against the malpractice action, nor could evidence of the prior conviction be introduced into evidence in the civil trial. Moreover, there were disputed facts as to whether the client delivered complete records of his tax situation to the accounting firm for preparation of his return that precluded summary judgment of the matter. Separately, the court determined that the limitations period on an accounting malpractice claim begins to run from the date of the breach of duty and not from the time when the extent of the resulting injury is ascertained or from the date of the client’s discovery of the error.

Deloitte, Haskins & Sells v. Green, 198 Ga. App. 849, 403 S.E.2d 818 (1991)

An accountant who negligently failed to calculate the full amount of deferred taxes due on the sale of a business was held liable to the seller of the business, who argued that he would not have sold the business if he had known the full amount of his tax liability. The seller claimed that he could have deferred paying the taxes indefinitely or legitimately avoid them altogether by taking specified action during future operations. While acknowledging that the taxes were properly due and owing, the court held that the amount awarded by the jury properly included termination bonuses paid on the sale and salary the seller would have received over the five years following the sale. The accounting firm’s argument, that the claim for future damages was speculative, was rejected because the business had been profitably operated in the past and the accounting firm had failed to offer more than speculation that the business would not have continued to operate at a profit, if it had not been sold.

McNerland v. Barnes, 129 Ga. App. 367,199 S.E.2d 564 (1973)

Under Georgia law, an accountant is not liable for negligence in the preparation and issuance of an uncertified financial statement which contains an express disclaimer of opinion, to third parties not in privity, even though their reliance on the statement is known or could be anticipated. However, an accountant may be liable to such third parties if he or she agrees to verify certain figures contained in the statement and negligently fails to do so.

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IDAHO

Idaho Bank & Trust Co. v. First Bancorp of Idaho, 772 P.2d 720, 115 Idaho 1082 (Idaho 1989)

In a case of first impression in the state, the Idaho Supreme Court held that liability for negligence by an accountant may be extended to non-clients when certain other prerequisites are satisfied. First, the accountant must have been aware that the financial reports in question were to be used for a particular purpose or purposes. Second, in the furtherance of that particular purpose or purposes the accountant must have been aware that a known party or parties was intended to rely on the reports. And third, there must have been some conduct on the part of the accountant linking him or her to that party or parties which evinces the accountant’s understanding of that party or parties’ reliance.

Owyhee County v. Rife, 100 Idaho 91, 593 P.2d 995 (Idaho 1979)

A cause of action for accountant malpractice accrues at the time of the specific act of malpractice rather than at the time the malpractice is discovered. Thus, an action against an accountant who failed to discover embezzlement by a county treasurer was time-barred when it was brought more than two years after the alleged failure to discover the fraud, in accordance with Idaho’s limitations period for “professional malpractice.”

ILLINOIS

Brumley v. Touche Ross & Co., 123 Ill. App. 3d 636, 463 N.E.2d 195 (Ill. App. Ct. 1984)

The test of the scope of an accountant’s duty to a third party is whether the accountant was acting at the direction of or on behalf of the client to benefit or influence the third party. Therefore, absent allegations that an accountant knew of the existence of an investor in his client’s corporation or that financial statements prepared by the accountant were to be used to influence the investor, the investor had no cause of action against the accountant.

Cashman v. Coopers & Lybrand, 251 Ill. App. 3d 730, 623 N.E.2d 907 (1993)

The shareholders, former directors, and former officers of a corporation sued the corporation’s accounting firm for alleged breach of contract, negligence, and fraud to recover their loss of investment in the corporation, on the grounds that the accountants negligently failed to advise the corporation on internal controls and failed to detect a lack of capital during audit engagements. The court dismissed the claim because none of the plaintiffs had standing to sue for independent losses, as there was no allegation that the accounting firm was a fiduciary to the plaintiffs or had a “special contract” with them.

Congregation of the Passion, Holy Cross Province v. Touche Ross & Co., 224 Ill. App. 3d 559, 586 N.E.2d 600 (1991), aff’d, 159 Ill. 2d 137, 636 N.E.2d 503 (1994)

An accountant who failed to report arbitrage investments by the client’s investment manager at fair market value was held liable for investment losses suffered by the client, on grounds that the client did not know it was suffering the losses because the accountant reported the value of the investments at cost. The accountant’s engagement letter with the client stated that the value of investments would be reported at market. The court also ruled that the plaintiff

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could recover economic losses, even though the claim was one for professional malpractice, because the claim sounded in negligent misrepresentation and not merely in negligence.

Holland v. Arthur Andersen & Co., 127 111. App. 3d 854, 469 N.E.2d 419 (Ill. App. Ct. 1984)

A trustee for an insurance company in bankruptcy was entitled to sue the insurer’s accountants for misrepresentation and breach of contract in rendering auditing services to the insurer, despite the fact that such actions normally may be brought only by shareholders and creditors. The fact that the complaint alleged that the shareholders and creditors in this case were prevented from taking action on behalf of the insurance company by the misconduct of the defendant accountants was significant in the court’s decision to allow the trustee to bring the action. Moreover, alleged malfeasance and fraud by the insurer’s top management would not be imputed to the trustee for the purpose of defeating the trustee’s claim against the insurer’s accountants. In making this decision, the court was persuaded first that the alleged fraud was not conducted in the interest of the corporation and, therefore, could not be considered to be an act of the corporation which could be imputed to the trustee. Second, the fact that the alleged fraud by the company’s management did not hinder the accountants from conducting their duties with respect to the company was also significant in the court’s decision.

Margolies v. Landy & Rothbaum, 136 111. App. 3d 635, 483 N.E.2d 626 (III. App. Ct. 1985)

The mere fact that a judge remarked on the unaudited nature of financial statements at issue in an accountant malpractice case and that the accountant and his client had a longstanding relationship, did not indicate that the judge used the wrong standard of care in determining the accountant’s non-liability. The judge’s remarks that the statements were unaudited were perfectly proper as the nature of the obligation undertaken by an accountant is a factor in every malpractice case. Other factors traditionally bearing on the nature of an accountant’s obligation which may affect liability include statements in or accompanying the accountant’s work which quality or explain it and the existence of a fiduciary or long-term relationship with the client. Moreover, other remarks made by the judge to the effect that an accountant owes “a very high level of professional responsibility similar to any other profession: legal, medical, or what have you” indicate that the judge did not base his decision on a diminished standard of care.

IOWA

Eldred v. McGladrey, Hendrickson & Pullen, 468 N.W.2d 218 (Iowa 1991)

The plaintiffs were not entitled to an inference that they relied on an accountant’s audit report, because they never saw the report nor received any misrepresentations concerning its contents. The claim that reliance was indirect, due to the alleged failure of the auditor to alert state regulators to the condition of an audit client, was rejected on grounds that state regulators did not repeat the “essence” of the accountant’s audit report to the plaintiffs. The court also ruled that an auditor has no duty to disclose adverse changes in an audit client’s financial position after the issuance of a properly prepared financial statement.

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Pahre v. Auditor of State, 422 N.W.2d 178 (Iowa 1988)

The accountant of an industrial loan company owed no duty of care to the company’s guarantor to provide accurate financial information concerning the company. Several factors served to distinguish this case from an analogous case in the jurisdiction in which a duty was imposed on a professional corporation for the benefit of a third party not in privity with it. First, the “aim and end” of the accountant’s work product in this case was not to benefit the plaintiff guarantor. Rather, the purpose of the audit report prepared by the defendant was to aid the client in the management of its internal affairs, so that the client could comply with Iowa Code sections 536A.14 and .15 requiring corporations to file audit reports with the state. Moreover, under that statute such reports were confidential and could not be disseminated to the public. Under these circumstances, the court found that it was not reasonable to assume that other parties beyond the client and the state auditor would be intended users of the information. Thus, the plaintiff guaranty corporation was not within the class of parties whose reliance on the audits was sufficiently foreseeable by the defendant at the time the audits were made to impose a duty of care on the defendant for its benefit.

Ryan v. Kanne, 170 N.W.2d 395 (Iowa 1969)

The lack of formal privity between an accounting firm and a company that acquired the accounting firm’s client did not bar a suit by the acquiring company against the accounting firm where the accounting firm had actual knowledge that the financial statements it prepared for the client were to be relied upon by the acquiring company. A finding of negligence against the accounting firm was affirmed based on the fact that the CPA did not determine the client’s accounts payable in the manner agreed upon, although it claimed to have done so. The fact that the accounting firm labeled its product “Unaudited Statement” did not serve to relieve it of liability for failing to use agreed upon methods, where that failure resulted in mistakes. The court concluded that the measure of damages allowable to a third party not in privity with a public accountant for negligently performing a contract to prepare and issue a statement of accounts is the same measure of damages that apply to those in privity of contract, provided the reliance of the third party on the statement is known in advance. In this case, the plaintiff acquiring corporation was entitled to be placed in the position it would have been in had the “Accounts Payable” item in the accountant’s report been correct. Thus, the defendant was liable for the amount that it had understated the accounts payable item.

KANSAS

Brueck v. Krings, 230 Kan. 466, 638 P.2d 904 (Kan. 1982)

Where alleged malpractice by an accounting firm involved the breach of implied and express warranties required by law, rather than failure to perform contractually agreed upon duties, the action sounded in tort and would be governed by Kansas’ two year limitations period for tort actions. Noting that the critical information to trigger the running of the statute of limitations is knowledge of the fact of injury rather than its extent, the court found that the plaintiffs should reasonably have been aware of the injury prior to two years before filing suit. In this case, the alleged wrong was the accounting firm’s failure accurately to assess the financial condition of a savings and loan institution. The evidence showed that much press was given to the fact that the institution was in financial distress and faltering prior to two years before the

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filing and that the institution was placed under the jurisdiction of a trustee also at that time. The court concluded that the plaintiffs should have been aware of a possible injury at least by that time. Thus, their suit brought more than two years thereafter was time-barred.

Gillespie v. Seymour, 14 Kan. App. 2d 563, 796 P.2d 1060 (Kan. Ct. App. 1990)

Under K.S.A. 1989 Supp. 1-402, which governs negligence actions against accountants, no action could be brought against the accountants for a trust by the trust’s beneficiaries, where there was no evidence that the beneficiaries engaged the services of the accountants or that the accountants knew at the time services were rendered that the beneficiaries would see or rely on the accounting. Moreover, the accountants did not owe a fiduciary duty to the trust beneficiaries, since there was no evidence of any contact, let alone agreement, between them and the beneficiaries. Rather the accountants were employed to perform independent accounting work for the trust. Likewise, no action would lie against the accountants for breach of contract, since the beneficiaries of the trust could not qualify as third-party beneficiaries of the trust’s contract with the accountants. Under Kansas law, a contract must dearly state that it is for the benefit of a third party before a third party may sue on such contract. However, the court held that the beneficiaries were entitled to bring an action for breach of trust against the accountants for conspiracy to overcharge the trust account and participation in overcharging the account.

Western Surety Co. v. Loy, 3 Kan. App. 2d 310, 594 P.2d 257 (1979)

A surety on a county treasurer’s fidelity bond who was required to pay the county as a result of the treasurer’s defalcations was subrogated to the county’s right of action against an accountant allegedly responsible for the loss. Since Kansas has recognized that a county may recover damages from a public accountant who breaks a contract by negligently conducting an audit, the surety stated a cause of action.

MAINE

Bowers v. Allied Inv. Corp., 822 F. Supp. 835 (D. Me. 1993) (Maine common law)

In a case against an accountant for audited and unaudited financial statements and other information allegedly prepared negligently by the accountant, which were used to sell securities, the court ruled that Maine’s blue sky law did not afford plaintiff a claim, because the accountant was not a “seller” of securities. However, while ruling that Maine follows § 552 of the Restatement (Second) of Torts, the court allowed the plaintiff’s claim even though the accountant did not know of the plaintiff’s alleged reliance on the accountant’s work until after the accountant’s work was completed, because the accountant knew of the plaintiff’s intent to rely before that reliance actually occurred.

MARYLAND

Feldman v. Granger, 255 Md. 288, 257 A.2d 421 (Md. 1969)

The limitations period for a “professional malpractice” claim against accountants who failed to file documents so that their client could elect sub-chapter S treatment as a small business under the tax laws began to run at the time the client discovered the negligent act. The plaintiffs argument that the period should have started at the time the full extent of its expanded

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tax liability became known was rejected as this would subject professionals to “stale claims.” The court noted that the plaintiff knew within the limitations period that it would have increased tax liability as a result of the defendant’s negligence in failing to file the requisite documents. It, therefore, knew at that time that a wrong had occurred. It was not necessary to wait until its tax deficiency was assessed in a suit against the government.

Leonhart v. Atkinson, 265 Md. 219, 289 A.2d 1 (Md. 1972)

An action for malpractice against an accountant for faulty tax advice was time-barred where it was brought more than three years after the initial notice of tax deficiency was received by the plaintiff. The limitations period did not begin to run, as the plaintiff claimed, at the time the tax court affirmed the assessment. Rather, the plaintiff was aware of the wrong at the first notice of tax deficiency and the action accrued at that time.

Wegad v. Howard Street Jewelers, Inc., 326 Md. 409, 605 A.2d 123 (1992)

A jury verdict in favor of the accountant was affirmed when the management of the client was negligent in failing to detect or prevent embezzlement by an employee. The principal owners of the audit client were told by their auditor that he had discovered cash shortages and that it was possible that someone was stealing from the business. The owners also knew that the defalcating employee was violating normal accounting practices and “enjoying luxuries which were seemingly beyond her financial means.” On appeal, denial of recovery was affirmed even though the auditor was negligent in failing to discover the embezzlement, because the owners of the plaintiff business were in at least an equal position to have apprehended the thief.

MASSACHUSETTS

Frank Cooke Inc. v. Hurwitz, 10 Mass. App. 99, 406 N.E.2d 678 (Mass. App. Ct. 1980)

A client’s contention that its accounting firm committed malpractice in failing to advise it that one of its outstanding receivables was likely to be uncollectible was not sufficient to sustain an action. The evidence showed that the note in question had already become uncollectible prior to the time the accounting firm had allegedly breached an implied promise to report relevant facts. As a result, damages caused by such an alleged breach of promise could not be proven. Moreover, the plaintiffs action was in any case time-barred, since information within its possession should have incited inquiry into the soundness of its accountant’s advice long before the alleged omission occurred. The evidence showed that minimal inquiry on the part of the plaintiff would have apprised it that an injury had occurred prior to that time.

MICHIGAN

Axel Johnson, Inc. v. Arthur Andersen & Co., 847 F. Supp. 317 (S.D.N.Y. 1994) (Michigan law)

The buyer of a business sued an accountant for damages allegedly incurred when the buyer bought the business in reliance on inaccurate financial statements audited by the CPA. The auditor sued an officer of the audit client for breaching his duty to the buyer to disclose the financial statement fraud. The court ruled that the allegation that the officer “knowingly and recklessly participated in the cover up of the fraud” stated a claim for breach of the officer’s duties to act “in good faith” and “in the best interests of the corporation.” The court also agreed

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with the accountant that the auditor was entitled to contribution for the officer’s role in certifying the accuracy of information to the auditor which was, in fact, false.

Capitol Mortgage Corp. v. Coopers & Lybrand, 142 Mich. App. 531, 369 N.W.2d 922 (Mich. Ct. App. 1985)

In a case of first impression in the state, the court held that principles of comparative negligence were applicable in cases involving alleged accountant malpractice. The court noted that, unlike contributory negligence, under comparative negligence the malfeasor is not absolved of all fault merely because the plaintiff was negligent. Rather, comparative negligence creates an incentive for both parties to use due care.

North River Ins. Co. v. Endicott, 151 Mich. App. 707, 391 N.W.2d 454 (Mich. 1986)

A professional liability insurance policy that specifically excluded the activities of an accountant when acting “as an officer, trustee, director, partner or employee” did not cover claims against the accountant arising from an alleged failure to make an accounting as required by statute as part of the fiduciary duties of a trustee. The court noted that, while the accountant’s profession may have been relevant to his selection as a trustee, it was irrelevant to his duty to provide an accounting to the trust which was the basis of the underlying action. Merely because the trusteeship accounting is rendered by an accountant does not make it a “professional accounting service” as defined by the insurance policy.

MINNESOTA

Bonhiver v. Graff, 311 Minn. 111, 248 N.W.2d 291 (Minn. 1976)

The Minnesota Supreme Court held that a receiver in bankruptcy represented the interests of the bankrupt company’s creditors and not the company itself. Thus, malfeasance by the company’s officers could not be imputed to the receiver to prevent it from suing for the alleged negligence of the company’s accountants in failing to detect the malfeasance. In a separate issue, the court held that in order to constitute an intervening cause, intervening actions must in no way be caused by a defendant’s negligence. Therefore, the failure of the state’s insurance, commissioner to discover the true state of the company’s finances would not serve to relieve the defendant accountants from liability, where the commissioner’s investigators relied on information supplied by the defendants in concluding that the company was solvent.

National City Bank v. Coopers & Lybrand, 409 N.W.2d 862 (Minn. App. 1987)

An indenture trustee of notes issued by a bankrupt corporation lacked standing to bring a malpractice action against the accounting firm which audited the corporation before its bankruptcy. The court noted that under the terms of the indenture agreements, the trustee’s powers were limited to those necessary to enforce the obligations owing to the noteholders “on the notes” or “under the indenture.” This empowered the trustee to bring suit against the obligor on the notes to collect money due on the notes, but not to bring a tort action against a third party for losses arising from the purchase or holding of the notes. Furthermore, when the notes were discharged in bankruptcy, the trustee’s representation of the noteholders ceased. The noteholders themselves would then be entitled to bring any ancillary claims they may have arising from the

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purchase, sale or retention of their notes, including an action against the accounting firm of the issuing corporation.

Olson, Clough & Straumann, CPAs v. Trayne Property Inc., 392 N.W2d 2 (Minn. App. Ct. 1986)

An accounting firm that suspended working on its client’s accounts, allegedly for nonpayment for the services, committed malpractice because it did not notify the client that it was ceasing work in a timely fashion. However, damages were not assessed, since evidence showed that the time spent by the plaintiff in completing the work left unfinished by the defendant was not worth as much as the plaintiff had agreed to pay the defendant initially. Moreover, the plaintiff’s allegations that its professional reputation as a syndicator and manager of real estate was damaged, resulting in a loss of investors, was rejected as a basis for awarding damages. The plaintiff adduced no evidence to show that a drop in investor confidence in it was in any way due to the actions of the defendant.

NorAm Inv. Services, Inc. v. Stirtz, Bernards, Boyden, Surdel & Larter, P.A., 611 N.W.2d 372 (Minn. Ct. App. 2000)

A securities clearing broker claimed to have relied upon audited financial statements contained in a 10-K S.E.C. filing in extending margin credit to customers of a retail broker. The Minnesota Court of Appeals determined that Restatement (Second) of Torts § 552 did not extend the auditor’s liability to this unforeseen and unintended user.

MISSISSIPPI

Touche Ross & Co. v. Commercial Union Ins. Co., 514 So. 2d 315 (Miss. 1987)

Despite the fact that an accountant may be liable to third parties who foreseeably may rely on information prepared for a client, an independent, unforeseeable intervening act of the client may serve to cut off the chain of causation between the accountant’s negligence and the harm suffered. Thus, an accounting firm could not be held liable for losses suffered by a third party due to criminal activity of the accounting firm’s client which began four months after the accountant completed an audit of the client upon which the third party relied. The accounting firm was reasonably entitled to assume that its client would obey the criminal law.

Wirtz v. Switzer, 586 So. 2d 775 (Miss. 1991)

For erroneously computing the windfall profit tax due on an estate, an accountant was held liable to the executrix and beneficiaries of the estate, and to the estate. The damages included extra attorneys’ fees incurred by the estate in an effort to deal with the accountant’s asserted negligence.

MISSOURI

Aluma Kraft Manufacturing Co. v. Elmer Fox & Co., 493 S.W.2d 378 (Mo. Ct. App. 1973)

A complaint that alleged that accountants prepared an audit for their client with the knowledge that the client would furnish it to the plaintiff for the plaintiff’s use in determining a

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price to offer for shares in the client corporation stated a cause of action for negligence based on misrepresentations contained in the audit. The fact that the plaintiff was not in privity with the accountants did not defeat the claim under these circumstances. The court noted that its rejection of the privity rule in this case comported with the concepts of the functions and duties of the modern public accountant and the purposes of a modern audit, and was consistent with the developments of liability of an accountant under the securities laws. Moreover, it was consistent with developments in this area in England where the doctrine of privity was born.

Lindner Fund v. Abney, 770 S.W.2d 437 (Mo. Ct. App. 1989)

Mutual funds did not state a claim against accountants for negligence in certifying the annual report of a company in which the funds invested, where the funds failed to show that they belonged to a limited foreseeable class for whose benefit the certification was intended. Missouri courts have repeatedly maintained that accountants cannot be held liable to the public at large. Rather, the rule in Missouri is that an accountant is liable to third parties for whose benefit and guidance the accountant supplies the information, or to such third persons, although not identified, to whom the accountant knows the recipient of audit services intends to supply such information. Disclosure of financial information to the public at large in an annual report does not qualify.

Mid American Bank & Trust Co. v. Harrison, 851 S.W.2d 563 (Mo. Ct. App. 1993)

A bank sought to recover for losses on a loan made to the accountant’s audit client, on the grounds that the bank relied on the negligently audited financial statements in making the loan. The court adopted § 552 of the Restatement (Second) of Torts and rejected the bank’s claim. Although the CPA knew that the audit client was supplying the financial statements to a different bank, the accountant did not know that the plaintiff would receive or rely on those statements. Citing Illustration 110 of Restatement § 552, comment h, the court ruled that, to be liable, the accountant must have “actual knowledge” of the specific identity of a potential lender.

MONTANA

McCormick v. Brevig, 980 P. 2d 603 (Mont. 1999) A sister and brother jointly inherited an interest in a family owned ranch, but had a falling out. An action was brought to dissolve their partnership, together with other claims. The brother sued a CPA claiming, in part, that a lifetime, irrevocable trust executed by his father made him the sole owner of the ranch. Although the necessary deed to transfer the ranch into the trust was never executed and the trust was legally ineffective from inception, the Montana Supreme Court nonetheless ruled that the CPA might have had a duty to either disclose the unfunded trust to the brother, despite the father’s direction not to tell the brother, or else to have withdrawn under an alleged conflict between the father’s and brother’s interests. In applying the Montana statute of limitations, the Supreme Court rejected the theory that continuing professional services by the CPA tolled the statute of limitations after the father’s death in 1982, but held that a triable issue of fact was presented on whether the brother had acted with reasonable diligence in not discovering the alleged malpractice prior to the expiration of the statute.

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Billings Clinic v. Peat Marwick Main, 797 P.2d 899 (Mont. 1990)

A medical clinic sued one of its accountants for failing to warn that a corporate reorganization might prevent the clinic from obtaining industrial revenue bond financing for future expansion, even though the accountant knew hardly anything about the expansion plans. In upholding the jury’s verdict against the accounting firm, the court noted that the clinic’s accounting expert had testified that the accounting firm had a duty to do a complete review of the impact of the reorganization, which would have entailed consideration of the impact of the reorganization on the financing. The court rejected the accountant’s effort to offset damages by the tax benefits derived on the reorganization by both the clinic and its physician owners, while allowing the clinic to recover for both higher interest charges incurred when the industrial revenue bond financing fell through, plus the loss of use of funds used to pay the higher interest. However, the court did grant an offset to the accounting firm in the amount of settlements paid by other defendants.

Thayer v. Hicks, 243 Mont. 138, 793 P.2d 784 (Mont. 1990)

The Supreme Court of Montana held that an accountant may owe a duty of care to third parties with whom he or she is not in privity of contract. However, this duty exists only if the accountant actually knows that a specific third party intends to rely upon his or her work product and only if the reliance is in connection with a particular transaction or transactions of which the accountant is aware when preparing the work product. In a procedural point, the court held that evidence of national rules and codes followed by members of the accounting profession, such as generally accepted accounting principles (GAAP) and generally accepted auditing standards (GAAS), may aid the jury in determining whether the proper degree of care was exercised. However, any deviation from the national guidelines does not automatically constitute negligence.

NEBRASKA

Citizens Nat’l Bank v. Kennedy & Coe, 232 Neb. 477, 441 N.W.2d 180 (1989)

The Nebraska Supreme Court held that an accountant’s duty of reasonable care is to his or her client and generally does not extend to third parties absent fraud or other facts establishing a duty to them. In the absence of privity there can be no liability on the part of an accountant for even gross negligence, unless it amounts to fraud. In this action, brought by a bank that had relied on a misleading financial report prepared by the defendant accountants for a client who was applying for a loan with the bank, the court held that no negligence action would lie. However, the bank’s fraud claim was remanded on instructions that it was not necessary for the bank to prove that the accountants intended to deceive it with the misrepresentations. Rather, it was necessary only for the bank to show that the misrepresentations were made recklessly without regard for their truth or non-truth.

Lincoln Grain Inc. v. Coopers & Lybrand, 216 Neb. 433, 345 N.W.2d 300 (Neb. 1984)

Under Nebraska law, the contributory negligence of a client is a defense to an accounting malpractice claim only if the negligence contributed in some way to the accountant’s failure to perform its contract and report the truth. The defendant’s allegations that the plaintiff client had

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failed to properly monitor and review financial data from one of its divisions and failed to take notice of information in its possession which should have put it on notice of possible fraud by one of its managers must be assessed to determine whether, if true, these facts hindered the defendant’s efforts to uncover the truth in the audit it was hired to perform. In any case, a defense based on assumption of the risk is inapplicable to an action charging that an accountant negligently breached an agreement to render professional accounting services. Noting that the defendant in this case was an independent, professional contractor engaged to conduct an independent audit, the court held that one who engages such an accountant cannot be said to assume the risk that the accountant will fail to adhere to proper professional standards in performing the contract.

World Radio v. Coopers & Lybrand, 251 Neb. 261, 557 N.W.2d 1 (1996)

The Nebraska Supreme Court ruled that a client victimized by a “failed audit” could sue its auditor for lost profits and lost value, on a claim that “but for” the overstatement of its financial statements it would not have conducted business in the manner in which it did. The court did, however, find that the plaintiff was not entitled to any damages for lost profits or diminished value, on the grounds that its proof at trial was mechanistic and failed to take into account the possibility that the damages were caused by intervening forces other than the auditor’s negligence. The court did allow the audit client to recover the fees paid to the auditor on the negligent audit and to a subsequent accountant for remedial work. The Nebraska Supreme Court also applied the state statute of limitations to the unique facts and circumstances presented in the case.

NEVADA

Warmbrodt v. Blanchard, 100 Nev. 703, 692 P.2d 1282 (Nev. 1984)

Plaintiffs who sued their accountants for failure to liquidate their corporation in time to avoid double taxation were not entitled to punitive damages in the absence of evidence that the accountants were guilty of “oppression, fraud, or malice.”

NEW HAMPSHIRE

Sherex, Inc. v. Alexander Grant & Co., 122 N.H. 898, 461 A.2d 138 (N.H. 1982)

In deciding for the first time the extent to which an accountant may be held liable for damages in tort to third parties for negligent misrepresentation in an unaudited financial statement, the New Hampshire Supreme Court adopted the approach expressed in Section 552 of the Restatement (Second) of Torts. Under that rule, an accountant may be liable not only to known third parties, but to an actually foreseeable class of third parties. The court also found it not unreasonable for a third party to rely on information presented in an unaudited financial statement, or in relying on an accountant to verify the substantive accuracy of the information presented in such a statement. However, whether the accountant was rendering merely a “compilation,” rather than a “review” as those terms are commonly understood within the accounting profession may affect the standard of care taken with regard to the financial statement. In addition, evidence of any express representations actually made by the accountant to the third party or any understandings existing between them would tend to modify the

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accountant’s duty, regardless of the fact that the particular financial statement allegedly relied upon by the third party was unaudited.

NEW JERSEY

Burke v. Deiner, 190 N.J. Super. 382, 463 A.2d 963 (N.J. Super. App. Div. 1983)

An accountant’s audit report of a public agency may result in liability for defamation of the public official in charge of the agency if misstatements in the report were made with knowledge that they were false or in reckless disregard of their truth or falsity. Under such circumstances, the normal qualified privilege for communications made pursuant to an interest or duty to a party having a corresponding interest in, or duty with regard to, the information does not apply. Accountants making defamatory statements in an audit are not entitled to the high protection afforded a newspaper accurately reporting defamatory statements made by a government official concerning public duties. But for the fact that the accountants in this instance were investigating a public agency, and indirectly a public official, the accountants are more like credit investigators reporting false derogatory information.

H. Rosenblum, Inc. v. Adler, 93 N.J. 324,461 A.2d 138 (N.J. 1983)

When an independent auditor furnishes an opinion with no limitation in the certificate as to whom the client may disseminate the financial statements, the accountant has a duty to all reasonably foreseeable recipients of the information from the client pursuant to its proper business purposes. In order to make out a cause of action, therefore, a plaintiff third-party recipient of the information must show that it received the audited statements from the client company pursuant to a proper company purpose and that the plaintiff, in accordance with that purpose, relied on the statements. The plaintiff must then show that such reliance was a proximate cause of its damages. The injured party would be limited to recovery of actual losses due to reliance on the misstatement and negligence of the injured party could bar or limit the amount of recovery.

Levine v. Wiss & Co., 97 N.J. 242, 478 A.2d 397 (N.J. 1984)

An accountant, selected by the litigants in a contested divorce case and appointed by the court to act as an “impartial expert” in rendering a binding valuation of a business asset for purposes of equitable distribution, may be held liable for negligence in deviating from accepted standards applicable to the accounting profession under New Jersey law. The accountants had argued that their court-appointed status and the fact that the litigants in the underlying divorce action had agreed to accept the valuation as binding elevated them beyond the status of accountants to the quasi-judicial role of “arbitrators,” who would generally be shielded from private actions for damages brought by the parties to a given dispute. However, the court found that the accountants were more akin to “appraisers” who were expected to perform a discrete function involving the ascertainment of particular facts and to whom the same standards of reasonable care applied as applied to professionals charged with furnishing skilled services for compensation. Moreover, the court found no special significance in the fact that the accountants were court appointed. A court appointment is not a “talisman for immunity,” said the court. The accountants still had a duty to apply established accounting principles to the financial facts as they found them. The submitted finding bound the parties only because they had made a specific

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decision to be bound. Where such an agreement does not call for the exercise of judicial authority, ordinarily the person selected to perform skilled or professional services is not immune from charges of negligence.

NEW MEXICO

Chisholm v. Scott, 86 N.M. 707, 526 P.2d 1300 (N.M. App. Ct. 1974)

The limitations period for a malpractice action against an accountant began to run when the client received a notice of tax deficiency from the Internal Revenue Service arising out of an error made some time earlier by the accountant. Before the deficiency notice was served, there was no injury to the plaintiff, and hence, no cause of action.

NEW YORK

Credit Alliance Corp. v. Arthur Andersen & Co., 493 N.Y.S.2d 435, 65 N.Y.2d 536, 483 N.E.2d 110 (N.Y. 1985)

A lender stated a cause of action against the accounting firm of its borrower for negligence in preparing the borrower’s audit reports, where the lender alleged facts that placed it in near privity with the defendant. The lender alleged that the defendant accounting firm not only knew of the lender’s identity, but also knew that the audit reports were specifically being prepared to induce the lender to lend to the borrower. In addition, the lender and the defendant accountants allegedly remained in direct contact, both orally and in writing, and met together throughout the period of the lending relationship for the very purpose of discussing the borrower’s financial condition and the lender’s need for the defendant’s audit of it. Moreover, it was alleged that the defendant made repeated representations personally to representatives of the plaintiff lender concerning the value of the borrower’s assets. Under these circumstances, the court held that a sufficient nexus was created between the accountants and the lender to give rise to a cause of action.

George Muhlstock & Co. v. American Home Assurance Co., 502 N.Y.S.2d 174, 117 A.D.2d 117 (N.Y. App. Div. 1986)

The professional liability insurer of an accounting firm was not liable for the firm’s expenses in defending a suit in which it was alleged that the accounting firm participated in the sale of securities, knowing that the information furnished to investors was false and misleading. Nothing in the complaint against the accounting firm asserted liability premised upon any specific act or omission in connection with the preparation or auditing of books or accounts and financial statements, or in the preparation of opinions and projections upon tax and accounting matters. Therefore, the firm’s legal duties and liabilities arose from the merchandising of securities, as opposed to the performance of professional accounting services, and were not within the scope of the insurance policy.

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Scioto Memorial Hosp. Ass’n, Inc. v. Price Waterhouse, 74 Ohio St. 3d 474, 659 N.E.2d 1268 (1996), and American Nat’l Bank v. Touche Ross & Co., 74 Ohio St. 3d 482, 659 N.E.2d 1276 (1996)

In a pair of simultaneous decisions, the Ohio Supreme Court held that the state’s comparative fault law is fully applicable to claims of professional negligence brought against accountants. In these cases, the accountants performed audit services and rendered a financial forecast for a real estate development project.

Evidence of client fault that the court considered in its opinions included the following:

• The failure of the plaintiff to purchase business interruption insurance.

• Evidence that company management was aware that an embezzling employee - who earned a mere $21,000 per year - maintained a lavish lifestyle, including ownership of a $600,000 house and a Maserati sports car.

• Evidence that the employer knew that the defalcating employee was repeatedly overdrawn on a personal checking account.

• Evidence that the employer knew that the defalcating employee failed to take the minimum required two consecutive weeks of vacation.

Security Pacific Business Credit v. Peat Marwick Main & Co., 79 N.Y.2d 695, 597 N.E.2d 1080, 586 N.Y.S.2d 87 (1992)

An unsolicited call by a lender to an auditor, during audit field work, did not amount to conduct linking the auditor to the lender in such a way as to objectively establish that the accountant knew that the lender was relying upon the auditor’s opinion. The court reached this result even though the lender called the auditor and sought assurance about the auditor’s confidence in the audit work and financial condition of the audit client, because this represented an isolated contact and did not amount to a relationship “sufficiently approaching privity” as required for a nonclient to sue an auditor in New York.

White v. Guarente, 401 N.Y.S.2d 474, 43 N.Y.2d 356, 372 N.E.2d 315 (N.Y. 1977)

The New York Court of Appeals recognized that accountants retained by a limited partnership to perform auditing and tax return services may be held responsible under certain circumstances to an identifiable group of limited partners for negligence in the execution of those professional services. The court noted that the services of the accountant in this case were not extended to a faceless or unresolved class of persons, but to a known group possessed of vested rights. Moreover, an accountant retained to prepare an audit and tax returns of a limited partnership should have known that a limited partner would necessarily rely on that information in order properly to prepare his or her own tax returns. Under these circumstances, the accountant had a duty to the limited partner to use due care in the execution of its contract with the partnership.

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William Iselin & Co. v. Landau, 527 N.Y.S.2d 176, 71 N.Y.2d 420, 522 N.E.2d 21 (N.Y. 1988)

Under New York law, an accountant will be liable to third parties for negligence in preparing uncertified reports regarding a client’s financial condition only where the third party offers evidence of a relationship between it and the accountant that approaches privity.

The court made a distinction between certified audits and the uncertified “review reports” at issue here. The former requires an auditor’s certification that the audit was performed under generally accepted accounting standards and that the statements were prepared according to generally accepted accounting principles. Review reports, by contrast, are not prepared under these principles. No physical inventory is taken. The review consists principally in inquiries of the client’s management and analysis of financial information supplied by the client. The report offers only the limited assurance that the accountant is not aware of any material modifications that should be made to the client’s financial statements in order for them to conform with generally accepted accounting practices. Thus, where the plaintiff, a lender of the defendant’s client, could not show that the defendant was employed by the client for the purpose of inducing the plaintiff to extend credit and no proof was submitted showing an intention that the plaintiff rely on the reports, the mere act of sending one of the reports to the plaintiff at an undetermined time for an unknown purpose would not satisfy the burden of showing that there was a nexus between the plaintiff and defendant that approached privity.

NORTH CAROLINA

Mastrom, Inc. v. Continental Casualty Co., 337 S.E.2d 162, 78 N.C. App. 483 (N.C. Ct. App. 1985)

An accountants professional liability insurance policy that covered damages “arising out of the performance of professional services for others in the insured’s capacity as an accountant or notary public,” did not cover the accountant’s activities in promoting and selling securities as a profit-making venture unrelated to taxation. The court rejected the accountant’s argument that its liability with regard to the sale of securities “arose out of” the performance of its professional accounting duties because information about potential investors’ financial condition uncovered in the course of regular accounting activities was use to make the pitch to each investor to purchase securities. Noting that the policy purchased by the accountant was clearly not intended to be a general liability policy, the court found nothing in the document that suggested an agreement to cover other activities of the client which might arise out of the mere acquisition of information about clients.

Raritan River Steel Co. v. Cherry, Bekaert & Holland, 367 S.E.2d 609, 322 N.C. 200 (N.C. 1988)

In a case of first impression, the North Carolina Supreme Court held that a plaintiff must show that he or she relied upon the actual audited statements prepared by an accountant in order to have a viable claim for the accountant’s negligent misrepresentation. Deciding another issue, the court held that the scope of duty owed by an accountant in North Carolina is best expressed by Restatement (Second) of Torts §552 (1977). Under this standard, an accountant is liable not only to those with whom he or she is in privity or near privity, but also to those persons, or

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classes of persons, whom the accountant knows and intends will rely on his or her opinions. Under this standard, an action was found to be against accountants who knew that audits prepared by them would be used by their client to represent its financial condition to creditors, such as the plaintiff, who would rely on the statements when deciding to extend credit to the client.

Snipes v. Jackson, 316 S.E.2d 657 (N.C. Ct. App. 1984)

The limitations period on an action by a business owner against his accountant for negligence in regard to the tax consequences of a sale of the company began to run at the time the plaintiff received notification of a tax assessment on the transaction and not at the time of the last allegedly negligent act.

OHIO

BancOhio Nat’l Bank v. Schiesswohl, 33 Ohio App. 3d 329, 515 N.E.2d 997 (Ohio Ct. App. 1986)

Under Ohio law, accountants may be held liable to third parties for professional negligence only when the third party is a member of a limited class whose reliance on the accountants’ representation is specifically foreseen by the accountants. A creditor of an accounting firm’s client was unable to present sufficient evidence that the accounting firm knew the creditor would be relying on its reports to its client to state a claim. The mere fact that the accountants knew that the creditor was the largest single creditor of their client was not sufficient to conclude that the accountants should have known the creditor would be relying on the reports in question. There was no evidence that the accountants knew that the creditor had the contractual right to require financial statements from their client. In addition, the mere fact that one of the accountants testified that he knew the creditor had relied on the accountants’ reports after the fact, did not indicate that the accountants knew the creditor would be relying on the reports at the time they were made.

Haddon View Inv. Co. v. Coopers & Lybrand, 70 Ohio St. 2d 154, 436 N.E.2d 212 (Ohio 1982)

In a case of first impression, the Ohio Supreme Court decided that an accountant may be held liable by a third party for professional negligence when that third party is a member of a limited class whose reliance on the accountant’s representation is specifically foreseen. Applying this rule, the court found that the individual limited partners of a limited partnership constituted a limited class of investors whose reliance on an accountant’s certified audits for purposes of investment strategy was specifically foreseen by the accountant. Therefore, these investors had a cause of action against the partnership’s accountant, despite the fact that they were not in privity of contract.

Richard v. Staehle, 70 Ohio App. 2d 93, 434 N.E.2d 1379 (Ohio Ct. App. 1980)

Although an accountant had no duty to his client, a small business, to advise the client on legal matters such as interpreting the federal Fair Labor Standards Act, when the accountant nonetheless undertook to do so he had a duty to offer correct advice. The measure of damages

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for negligence under these circumstances was determined to be the amount of back wages that the plaintiff was required to pay his employees due to the incorrect advice of the accountant.

Wagenheim v. Alexander Grant Co., 19 Ohio App. 3d 7, 482 N.E.2d 955 (Ohio Ct. App. 1983)

It is implied in every contractual relationship between an accountant and client that a general duty exists not to make extra judicial disclosures of information acquired in the course of their professional relationship, and a breach of that duty by an accountant may give rise to a cause of action under Ohio law. In this case, a company that provided small businesses with bookkeeping and payroll distribution services brought suit against its accounting firm after the accounting firm disclosed to several of its own clients, who happened to do business with the plaintiff, that the plaintiff was short of cash in its payroll accounts and recommended that the clients cease doing business with the plaintiff. In determining that the accounting firm was not privileged in disclosing this information to its clients, the court noted that the mere fact that the plaintiff company was insolvent did not in itself justify the disclosure of its financial status by the defendant to mutual clients without some further investigation into the business activities of the plaintiff to determine if, indeed, a fraud was being committed and if the mutual clients were in immediate danger of suffering significant financial losses from a continued association with the plaintiff. Mere silence as to one’s financial status, solvency, and credit does not generally amount to fraud.

OKLAHOMA

Wynn v. Estate of Holmes, 815 P.2d 1231 (Okla. Ct. App. 1991)

Clients of an accountant who assured the clients that they could successfully contest an IRS notice that they had underpaid their taxes were awarded recovery against the accountant for the full amount of interest charged by the IRS on the underpaid taxes. The accountant had repeatedly assured his clients that they would not suffer any economic loss as a result of the IRS proceedings. The argument that the accountant was entitled to a credit in the amount of interest the plaintiffs could have received on the unpaid taxes, while the dispute with the IRS was pending, was rejected. The court cited the collateral source doctrine, which precludes a defendant from obtaining credit for a collateral source of benefit to the plaintiff and noted that the plaintiffs did not, in fact, set aside the amount of the claimed tax debt and, hence, did not receive any interest income on their tax underpayment.

OREGON

Godfrey v. Bick & Monte, 77 Or. App. 429, 713 P.2d 655 (Or. Ct. App. 1986)

The statute of limitations on an action against an accountant for malpractice in structuring a stock transaction began to run at the time the plaintiff received a notice of tax deficiency from the Internal Revenue Service that stemmed from the transaction. Knowledge of the extent of the ultimate tax liability was not necessary for the action to ripen. The plaintiff knew harm had occurred before the final resolution of the tax controversy, i.e., settlement with the IRS. The plaintiff either had to pay the tax or incur costs in contesting it. Since the plaintiff did not take action prior to the lapse of two years after receiving the tax notice, his action for malpractice against the accountants was time-barred.

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Maduff Mortgage Corp. v. Deloitte Haskins & Sells, 89 Or. App. 497, 779 P.2d 1083 (Or. Ct. App. 1989)

Amounts that a mortgage company collected from a fidelity bond insuring against employee dishonesty were not subject to being set off the amount of recovery the mortgage company obtained in a malpractice suit against its accounting firm for failure to detect the same employee fraud. Oregon’s collateral source rule prohibits setoff under such circumstances, since amounts recovered on a bond insuring against employee dishonesty are collateral payments, not payments made for the tortfeasor.

PENNSYLVANIA

Jewelcor Jewelers and Distrib., Inc. v. Corr, 373 Pa. Super. 536, 542 A.2d 72 (Pa. Super. Ct. 1988)

The testimony of former employees of an accounting firm that accounting errors were made did not amount to judicial admissions against which no opposing evidence was allowed in a negligence suit against the accounting firm. Therefore, the defendant was allowed to introduce other evidence to explain or deny the testimony of the former employees. In a separate issue, the court ruled that the question of the plaintiff client’s contributory negligence was properly put before the jury where evidence was presented that the client’s internal inventory had been miscalculated by the client’s own employees and that the client failed to inform the defendant accounting firm of those errors in a timely manner.

Robert Wooler Co. v. Fidelity Bank, 330 Pa. Super. 523, 479 A.2d 1027 (Pa. Super. Ct. 1984)

An accounting firm was liable for negligence in failing to detect defalcations of an employee of its client where the accountant assigned to monitor the client’s internal controls was not alerted to the potential for fraud by the fact that the same employee was responsible for posting accounts receivable in the client’s sales journal, handling incoming receivables and recording daily receipts of moneys received in settlement of accounts receivable. Expert testimony in the case established that an accountant possessing reasonable skill would have seen a “red flag” in these practices that would have required further investigation. The fact that the services rendered by the accounting firm were “unaudited” was not a shield from liability if it failed to warn its client of known deficiencies in the client’s internal operating procedures which enhanced opportunities for employee fraud.

SOUTH CAROLINA

Folkens v. Hunt, 290 S.C. 194, 348 S.E.2d 839 (S.C. 1986)

A finding that an accountant was negligent in advising a partnership that certain land could not be designated a capital asset on the partnership’s books without it being deeded to the partnership was affirmed in light of evidence that the advice was untrue and that it was given without due inquiry into the status of profits from the property. The record revealed that the accountant looked merely at the record title in reaching his conclusion, even though it is generally held that whether particular property constitutes partnership property depends on the intention of the partners. In a separate count, the court determined that the accountant’s conduct in communicating the false information was not so extreme and outrageous as to result in

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liability for intentional infliction of emotional distress. The accountant had confronted the partner who held title to the questioned asset and accused him of criminal conduct in front of a third party. The court found that while this conduct might not give rise to an action for emotional distress, it could form the basis for a slander suit.

Kemmerlin v. Wingate, 274 S.C. 62,261 S.E.2d 50 (S.C. 1979)

The burden of proof in a professional malpractice action is on the plaintiff. The reasonable care and competence required of an accountant is the rendering of services with that degree of skill, care, knowledge, and judgment usually possessed and exercised by members of the profession in the particular locality, in accordance with accepted professional standards and in good faith without fraud or collusion. Since this is an area beyond the realm of ordinary lay knowledge, expert testimony will usually be necessary to establish both the standard of care and the defendant’s departure therefrom. An action brought by a corporate plaintiff alleging merely that its accountants had performed their services so negligently as to cause the corporation substantial losses, without more, was properly dismissed as an involuntary nonsuit.

SOUTH DAKOTA

Lien v. McGladrey & Pullen, 509 N.W.2d 421 (S.D. 1993)

The sole shareholders of a corporation claimed that they were negligently advised by the accountant to have the corporation redeem their preferred stock, in return for cancellation of the corporation’s indebtedness to them, resulting in unpredicted, adverse tax consequences. Although the accountant had a formal client relationship only with the corporation, a jury verdict against the accounting firm was upheld on grounds that the accountant had an implied contract to provide tax advice to the shareholders. However, the case was remanded for retrial on the question of damages, because the trial court had improperly excluded evidence that the shareholders’ increased taxes were partly offset by dividends received on the preferred stock and the benefit of having had the use of the additional taxes between the time of the redemption and the shareholders’ payment of the IRS’s tax assessment.

TENNESSEE

Bethlehem Steel Corp. v. Ernst & Whinney, 822 S.W.2d 592 (Tenn. 1991)

In adopting § 552 of the Restatement (Second) of Torts, the court broadly construed the scope of those entitled to claim membership in a “limited class” of those “specifically known” to the accountant to be relying upon financial information. The court stated that the accountant need not know by name the specific person or group of persons who will rely on his or her work for liability to attach under § 552. Rather, the court stated that “liability is limited to those persons or class of persons, as determined by current business practices and the particular factual situation, whom the accountant at the time the report is published should reasonably expect to receive and rely on the information.”

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Delmar Vineyard v. Timmons, 486 S.W.2d 914 (Tenn. Ct. App. 1972)

A union which operated a store was not entitled to recover from the store’s accountant for losses suffered by the store, where the evidence showed that the store’s managing committee not only was aware of the method by which inventory was assessed by the accountant, but had itself participated in setting up the system. Moreover, the evidence did not indicate that the accountant had overstated the inventory under the agreed-upon system. In regard to other allegations that the defendant accountant had erroneously reported the store’s accounts payable, the court held that errors and omissions of the accounts payable, standing alone, do not necessarily impose liability. Other evidence must be adduced to show the existence of circumstances that should have aroused the accountant’s suspicions that not all accounts payable were being reported to him.

McCaslin v. Wood, 1993 WL 8015 (Tenn. Ct. App. 1993)

The court affirmed judgment for the accountant against a claim that he failed to detect embezzlement, where the accountant had been engaged to prepare what the court characterized as “monthly ‘write-up’ work,” including the reconciliation of monthly bank statements, preparing tax returns, and keeping financial records necessary to determine the client’s profitability. The court approved of the admissibility of evidence showing that the owner of the business was to blame for the embezzlement by spending no more than one or two days each week at the office, placing the bookkeeper in a position of authority, failing to utilize internal controls on the bookkeeper’s activities, defrauding third parties by false and fraudulent claims, and engaging in a sexual relationship with the bookkeeper. Among other of the business owner’s practices brought into issue was the presigning of blank checks for use during his absence

TEXAS

Atkins v. Crosland, 417 S.W.2d 150 (Tex. 1967)

A taxpayer’s cause of action against his accountant for negligence did not accrue under Texas law until a tax deficiency was assessed against the taxpayer by the Internal Revenue Service.

Blue Bell, Inc. v. Peat, Marwick, Mitchell & Co., 715 S.W.2d 408 (Tex. Ct. App. 1986)

A trade creditor of an accounting firm’s client was entitled to sue the accounting firm for negligent misrepresentation of the client’s financial condition, even though the accounting firm did not specifically know the name of the creditor. Texas has adopted the rule that if, under current business practices and the circumstances of the case, an accountant preparing audited financial statements knows of or should know that such statements will be relied upon by a limited class of persons, the accountant may be liable for injuries to members of that class relying on his or her certification of the audited reports. As a trade creditor of the defendant’s client at the time the defendant prepared the financial statements in question, the plaintiff -was a member of a limited number of existing trade creditors that the defendant should have known would probably be receiving copies of the financial statements prepared for the client. However, the same facts would not support an action in fraud against the accountant, since the mere fact that the accountant should have known that the plaintiff would rely upon a misrepresentation did

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not, of itself, establish that the misrepresentation was made with the intent to induce reliance, which is one of the necessary elements of a fraud action.

Greenstein, Logan & Co. v. Burgess Mktg., Inc., 744 S.W.2d 170 (Tex. Ct. App. 1987)

An accounting firm was found liable for negligent misrepresentation when it recommended the placement of one of its partners as the comptroller of the plaintiffs company, in light of evidence that the firm’s representative who made the recommendation knew or should have known of the partner’s incompetence. Evidence showed that accounts prepared for the plaintiff by the recommended partner were so filled with errors as to be virtually unauditable. Moreover, there was evidence that the defendant firm had been told by the partner’s prior employer about confusing and disastrously inaccurate accounting work done by the partner prior to his being recommended to the plaintiff. Testimony of the plaintiffs president that he would not have hired the partner as comptroller without the defendant’s recommendation was sufficient to prove that the misrepresentation as to the partner’s competence was the proximate cause of the plaintiff’s bankruptcy due to the partner’s underestimation of the plaintiffs federal excise tax liability.

Shatterproof Glass Corp. v. James, 466 S.W.2d 873 (Tex. Civ. App. 1971)

Under Texas law, an accountant may be held liable to third parties who rely upon financial statements, audits, etc., prepared by the accountant in cases where the accountant fails to exercise ordinary care in the preparation of such statements and the third party suffers in financial loss or damage as a result.

UTAH

Milliner v. Elmer Fox & Co., 529 P.2d 806 (Utah 1974)

Under Utah law, in a malpractice action the lack of privity is not a defense where an accountant is aware of the fact that his work will be relied upon by a party or parties who may extend credit to his client or assume his client’s obligations. However, a future purchaser of shares of stock of a corporation belongs to an unlimited class of equity holders who could not reasonably be foreseen as a third party who may be expected to rely on a financial statement prepared by an accountant for the corporation. Therefore, a purchaser of worthless stock had no cause of action against the issuing corporation’s accountant.

VIRGINIA

Boone v. C Arthur Weaver Co., 235 Va. 157, 365 S.E.2d 764 (Va. 1988)

A cause of action for malpractice against an accountant in rendering advice on the acquisition and liquidation of a business did not accrue at the time the business was acquired and liquidated and a tax return filed, but rather at the time final tax liability was assessed in an Internal Revenue Service audit proceeding arising out of the matter. The deciding factor in this case was the fact that the accountant had a continuing relationship with the client in regard to the matter at issue. The accountant gave continuing attention to the matter over a period of time and the client continued to rely on the defendant’s advice and efforts to minimize the tax liability. Therefore, the so-called continuing “undertaking” doctrine applied and the limitations period on

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the action did not begin to run until actual harm was suffered, which occurred when the IRS proceeding ended and taxes were assessed.

Ward v. Ernst & Young, 435 S.E.2d 628 (Va. 1993)

The shareholder of a corporation claimed that he lost a portion of the proceeds of the sale of his stock due to an alleged error by the CPA on a postsale audit of the corporation. The court rejected the shareholder’s tort claim because he was not in contractual privity with the accountants. The court rejected the invitation to adopt Restatement (Second) of Torts § 552, opting instead for a strict privity requirement. The shareholder’s third-party beneficiary claim was also rejected, as there was no evidence that the accountant intended to confer a benefit on the shareholder in performing the audit.

WEST VIRGINIA

First Nat’l Bank of Bluefield v. Crawford, 386 S.E.2d 310 (W.Va. 1989)

Under West Virginia law, an accountant can be held liable to third parties for the negligent preparation of a financial report only to the extent that the accountant knows the third party will be receiving and relying on the information. In addition, there may be differing degrees of professional care required of an accountant depending on the type of accounting audit he or she is hired to prepare. Generally, the identification of the type of audit performed, which is customarily set out in the accountant’s report with a limiting statement or disclaimer, will be considered in determining the standard of care required. However, the actual work contracted, and not the disclaiming statement, will be the major focus. If an accountant was hired to do a full audit, he or she cannot limit liability by a disclaimer that the resulting report should be treated only as an unaudited statement. Moreover, regardless of the nature of the work undertaken, if the accountant actually discovers a materially false matter in the client’s books and fails to disclose it, the accountant may be subject to liability.

WISCONSIN

Chevron Chemical Co. v. Deloitte & Touche, 168 Wis. 2d 323, 483 N.W.2d 314 (1992)

Under Wisconsin accounting regulations, an auditor was held liable for failing to notify all known creditors of its audit client that financial statements had overstated the financial strength of the audit client. Although the audit client threatened legal action if the accounting firm disclosed the error, and for breach of its duty not to disclose confidential information to third parties, the court ruled that an accountant’s duty to confidentially treat financial information about a client is obviated by its duty to disclose, to third parties, the subsequent discovery of an error in the client’s financial statements. On this point, the court found that a provision of Wisconsin law governing accountants was dispositive regarding the disclosure duty, notwithstanding that it was different from the AICPA’s written standard.

Citizens State Bank v. Timm, Schmidt & Co., 113 Wis. 2d 376, 335 N.W.2d 361 (Wis. 1983)

An accountant may be held liable to a third party not in privity for the negligent preparation of an audit report under the principles of Wisconsin negligence law. The extent of such liability will be decided by Wisconsin’s rule that a tortfeasor is fully liable for all

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foreseeable consequences of his or her act except as those consequences are limited by policy factors. The foreseeability of reliance by third parties on financial statements made for a client by the accountant in this case was not resolved. While the accountant’s representatives repeatedly stated that they had no knowledge that the statements would be used by the client to apply for a new bank loan, the president of the accounting firm acknowledged that, as a certified public accountant, he was aware that audited statements are commonly supplied to lenders and creditors.

Fidelity & Deposit Co. of Maryland v. Verzal, 361 N.W.2d 290, 121 Wis. 2d 517 (Wis. Ct. App. 1984)

An accounting firm’s professional liability insurance policy did not cover damages arising out of the accountant’s negligence in allowing certain fraudulent acts of a bank director to go undetected, where the allegedly negligent act, an examination of the bank directors, occurred prior to the inception of the policy. The court interpreted the policy definition of “occurrence” to require that both the event giving rise to liability and the resulting damages take place during the policy period.

Inmark Indus., Inc. v. Arthur Young & Co., 141 Wis. 2d 114, 414 N.W.2d 57 (Wis. Ct. App. 1987)

Intentional misrepresentations made by the executives of a corporation to the corporation’s auditors regarding the corporation’s financial status served to relieve the accounting firm of liability to third-party investors for negligence in auditing the corporation’s books. Evidence showed that the executives intentionally concealed from the accounting firm invoices due on its general accounts as well as invoices for materials and work on certain job-book accounts. An employee testified that the concealment was necessary so that investors would come into the company. On a separate issue, the court ruled that the passage of three months’ time since the issuance of audit reports was not so great as to make reliance on such reports unreasonable.