Traditionally, an accountant owes no duty to a nonclient. For instance, an accountant who prepares a financial statement containing material misrepresentation would not be liable to a nonclient, such as a bank, who relied on the financial statement to its detriment. As seen in the Enron/Anderson case, however, the landscape of accountant liability is changing. If the accountant aided in the commission of the fraud, or where the accountant knew the third-party nonclient (e.g., a bank) would be relying on the statements, the accountant may be liable to the nonclient.

Aiding and Abetting a Fraud

With respect to individuals committing financial fraud or organizing Ponzi schemes, a fraud or breach of fiduciary claim against the initial fraudster or originator of the Ponzi scheme is fairly straightforward and may even be relatively simple to prove if the fraudster has been charged criminally. The more nebulous question, however, is whether the injured investors also have a viable claim against the accountants of Ponzi scheme fraudsters.

A theory under which accountants could be held liable to third-party investors is through the claim that the accountants aided and abetted the underlying fraud. New York federal courts have outlined the three elements of aiding and abetting fraud: the existence of an underlying fraud; the defendant’s knowledge of the underlying fraud; and the defendant’s provision of substantial assistance in the commission of the underlying fraud, as in McDaniel v. Bear Stearns & Co., 196 F. Supp. 2d 343, 352 (S.D.N.Y. 2002); and also Cromer v. Berger, 137 F.Supp.2d 452, 470 (S.D.N.Y. 2001) (citing Wight v. Bankamerica, 219 F.3d 79, 91 (2d Cir. 2000)). Further, “substantial assistance” exists “where a defendant affirmatively assists, helps conceal, or by virtue of failing to act when required to do so enables the fraud to proceed.”

Where the defendant does not owe a fiduciary duty directly to the plaintiffs (i.e., the nonclients), mere “inaction” by the defendant is not “actionable participation,” as in Stander v. Financial Clearing & Services, 730 F.Supp. 1282, 1287 (S.D.N.Y.1990). In other words, absent a special relationship, an accountant will not be held liable, even with knowledge of the underlying fraud, if he merely failed to warn investors of the ongoing fraud. Under such a scenario, the aggrieved party would have the additional burden of showing that the assistance rendered was “both substantial and knowing”; or stated differently, there must be “something close to an actual intent to aid in fraud,” as in Ross v. Bolton, 639 F.Supp. 323, 327 (S.D.N.Y.1986) aff’d, 904 F.2d 819 (2d Cir.1990). Merely showing that the accountant turned a blind eye is insufficient; a third-party investor must prove that the accountant actively participated in the underlying financial fraud.

In Pressman v. Raggi & Weinstein, No. 13-cv-4627, a jury in the U.S. District Court for the Eastern District of Pennsylvania found that the accountants for a Ponzi scheme were liable for helping carry out the scheme. Defendants in Pressman performed various services for the entity used to facilitate the Ponzi scheme, which included maintaining and keeping the entity’s books, preparing tax returns, and compiling financial statements and projections. During the performance of such services, defendants devised a fraudulent accounting system and knowingly misclassified revenues and expenses. Those activities were sufficient for a jury to conclude that defendants aided and abetted the Ponzi scheme.

In a case in the Southern District of Florida, a jury found a Ponzi schemer’s bank liable. Though not involving accountants, the jury in the Southern District of Florida in Coquina Investments v. Rothstein, No. 10-cv-60786, found that the bank aided and abetted the Ponzi scheme, and awarded both compensatory and punitive damages to the victims of the scheme. In that case, a regional vice president of TD Bank used key bank employees and facilities to participate in investor meetings and to induce investors to participate in, and lend credibility to, Scott W. Rothstein’s Ponzi scheme. Specifically, the bank officer consented to Rothstein’s use of TD Bank offices to show false bank statements to investors with knowledge that such bank statements were false. As a result, the jury in Coquina Investments concluded TD Bank aided and abetted the Ponzi scheme.

Negligence

Another theory under which accountants may be held liable to nonclients is through professional negligence. The threshold question in any negligence action is whether the defendant owes a legally recognized duty of care to the plaintiff. Under New York law, accountants owe a duty of care only to “those with whom they have contracted, and those with whom they have a relationship so close as to approach that of privity,” as in BHC Interim Funding v. Finantra Capital, 283 F. Supp. 2d 968, 984 (S.D.N.Y. 2003) (quoting Parrot v. Coopers & Lybrand, 95 N.Y.2d 479, 483 (N.Y. Ct. of Appeals, 2000)).

Pennsylvania employs a slightly stricter standard in its requirement of privity between a plaintiff and defendant-accountant to maintain a professional negligence action, as in Brandow Chrysler Jeep v. DataScan Technologies, 511 F.Supp 2d 529, 538 (E.D.P.A. 2007); and Williams Controls v. Parente, Randolph, Orlando, Carey, 39 F.Supp.2d 517, 523 (M.D.P.A.1999), citing Landell v. Lybrand, 107 A. 783 (Pa. 1919).

Under either state’s approach the “privity” element is critical.

New York uses a three-part test, known as the Credit Alliance test, to determine whether an accountant’s relationship with an individual is so close as to approach that of privity. The Credit Alliance test provides “the accountants must have been aware that the financial reports were to be used for a particular purpose or purposes; in the furtherance of which a known party or parties was intended to rely; and there must have been some conduct on the part of the accountants linking them to that party or parties, which evinces the accountants’ understanding of that parties’ reliance,” as in Credit Alliance v. Arthur Andersen, 65 N.Y.2d 536, 551 (1985). Further, under the first two elements of the three-part test, it is not enough to allege an accountant was aware that its report could be made available to a client’s lender or third-party investor upon request. Rather, the plaintiff must show that the accountant was well aware that a primary, if not exclusive end aim of auditing its client was to provide information to the plaintiff, as in BHC Interim Funding, 283 F.Supp.2d at 985. With respect to the third element of the test, “the plaintiff must plead some affirmative conduct by the accountant linking it to plaintiff’s alleged reliance, other than the performance of the audit itself.” Moreover, a plaintiff “must provide more than phone calls, general communications or unacknowledged assertions or reliance in order to establish linking conduct,” as in Housing Works v. Turner, 179 F.Supp.2d 177, 219 (S.D.N.Y. 2001).

A recent case examined whether an accountant’s conduct was sufficient to “link” the accountant to the nonclient to satisfy the third prong of Credit Alliance. In DeLollis v. Friedberg, Smith & Co., 933 F.Supp.2d 354 (D.Conn. 2013), the accountants specifically addressed audit reports to third parties, and the court determined this was sufficient conduct to link the accountant to the non-client. Merely showing a duty exists, however, is only the first step in successfully asserting a negligence claim, and the court in DeLollis ultimately concluded the accountants did not breach its duty to plaintiff.

Conclusion

The law relating to accountant’s liability to nonclients is still developing. While the trend appears to be expanding the persons to whom accountants may be liable, at its core, the development in the law is aimed at ensuring accountants maintain the integrity of the profession. •

By Edward T. Kang

Reprinted with permission from the October 20 edition of The Legal Intelligencer”© 2016 ALM Media Properties, LLC. All rights reserved. Further duplication without permission is prohibited, contact 877-257-3382 or reprints@alm.com