Developments in Accountant’s Liability

CLM’s Management and Professional Liability Community recently presented a webinar that looked at developments in accountant’s liability to non-clients. Here’s a summary of some of the presentation's key points; listen to the entire webinar at www.theclm.org/webinars.

12:00:00 p.m.

THE SPEAKERS

Daniel H. Hecht, assistant vice president-senior claims counsel, Sompo International Insurance

Frank V. Kelly, partner, Rebar Bernstiel

12:01:41 p.m.

Frank Kelly

“This topic is timely based on recent business media reports talking about Tesla’s miraculous move to profitability. More than one commentator discussed how this might be due not to a miraculous move in the market but rather to accounting shenanigans.”

12:02:32 p.m.

Frank Kelly

“The privity standard is the most restrictive standard and results in the least likelihood of liability for practitioners. Only Virginia and Pennsylvania continue to follow it. Non-clients have no legal rights to sue under the strict privity rule unless a direct connection or contractual relationship exists between the accountant and the third party.”

12:03:00 p.m.

Frank Kelly

“The near privity standard was established in Ultramares Corp. v. Touche in 1931…. The New York Court of Appeals denied Ultramares’ negligence claim, but fashioned an exception to strict privity, which became known as the primary benefit rule. To win, a plaintiff must be an intended third-party beneficiary of the contract between the accountant and the client…. Ultramares has been run through the ringer over the years, and resulted in the standard being seen as a virtual privity requirement for recovery.”

12:04:02 p.m.

Frank Kelly

“In 1985, the New York Court of Appeals clarified Ultramares in a more current case called Credit Alliance. That standard sets out three elements for a non-client to be able to sue an accountant: (1) The accountant must have known that his or her work product was to be used for a particular purpose; (2) A known party or parties were intended to be able to rely on the accountant’s work product; and (3) Some conduct must have linked the accountant to the relying party. Twelve states follow a near-privity rule, although there is some variation.”

12:09:18 p.m.

Frank Kelly

“The Restatement Standard is held in 21 states and says that the accountant who has financial information owes a duty not only to that client, but to any other person or group who the accountant or client intends the information to benefit if and only if the person who is intended to benefit justifiably relies on the information in the transaction that the accountant or the client intends the information to influence and there is pecuniary loss to that reliance. No liability exists when the accountant had no reason to believe that the information would be made available to third parties or when the client’s transaction materially changes so as to increase the audit risk.”

12:19:01 p.m.

Daniel H. Hecht

“In pari delicto is a phrase that indicates parties involved in an action who are equally at fault or wrong. When this is the case, neither party can obtain affirmative relief from the court since both are equally at fault. Simply put, it means that a person engaged in a wrongful act cannot sue another person in the same wrongful act. It’s also knows as the doctrine of ‘unclean hands.’”

12:19:54 p.m.

Daniel H. Hecht

“Many claims allege a failure to discover fraud or other misconduct on the part of a corporate officer or employee. Defendants such as accountants assert that the plaintiff’s conduct bars it from recovery, under the in pari delicto principle.”

12:35:09 p.m.

Frank Kelly

“If you can limit the liability in your engagement letter to the amount of your auditor’s fees, that’s prudent. You can set a contractual reduction in the statute of limitations, which is sometimes upheld. You can contractually try to eliminate punitive or exemplary consequential or special damages. You can seek indemnification from management to the extent it complies with rules and regulations and AICPA ethics. You can specifically by contract exclude your responsibility to detect fraud, but [it’s less certain].”