Audited vs. Unaudited

A recent decision by the U.S. Court of Appeals for the Second Circuit offers some interesting clarifications on the scope of accountant liability for securities fraud. In Lattanzio v. Deloitte & Touche LLP, 2007 WL 259877 (2d Cir. Jan. 31, 2007), the court addressed whether Deloitte could be held liable for statements in audited and unaudited financial filings.

As to the company’s unaudited financial filings, the court found that Deloitte’s regulatory obligation to review the company’s quarterly statements did not turn those statements into accountant’s statements. Even if the public understood that Deloitte was engaging in these reviews, the accountant’s “assurances were never communicated to the public.” The court also rejected plaintiffs’ argument that the reviews created a duty to correct the quarterly financial statements if false and that a breach of this duty amounted to a misstatement by Deloitte. The court noted that there is a distinct difference between the duties and liabilities created by a review of interim financial statements and those created by an audit of annual financials.

As to the company’s audited financial filings, the court dismissed the relevant claims based on a failure to adequately plead loss causation. The court held that the “plaintiffs had to allege that Deloitte’s misstatements [in the company’s annual reports concerning accounts payable and inventories] concealed the risk of [the company’s] bankruptcy.” Given that Deloitte had issued a going concern warning – along with the disclosed (if understated) collapse in the company’s value – the risk of bankruptcy was apparent. Accordingly, the court found that the plaintiffs had not alleged facts showing that Deloitte’s misstatements were the “proximate cause of plaintiffs’ loss; nor have they alleged facts that would allow a factfinder to ascribe some rough proportion of the whole loss to Deloitte’s misstatements.”

Holding: Dismissal affirmed.

Quote of note: “Public understanding that an accountant is at work behind the scenes does not create an exception to the requirement that an actionable misstatement be made by the accountant. Unless the public’s understanding is based on the accountant’s articulated statement, the source for that understanding – whether it be a regulation, an accounting practice, or something else – does not matter.”

Addition: Retired Supreme Court Justice Sandra Day O’Connor sat on the panel.

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