Tennessee District Court Pares Exchange Act Claims Against Accounting Company, Dismissing Scheme Liability Claims

On August 2, 2018, Chief Judge Thomas A. Varlan of the United States District Court for the Eastern District of Tennessee dismissed in part a putative securities class action against KPMG, LLP asserting claims under Section 10(b) of the Securities Exchange Act and Rule 10b-5 thereunder. Plaintiffs alleged that defendant KPMG, as independent auditor to Miller Energy Resources, Inc., allowed Miller Energy to file financial statements with the SEC that were not in compliance with generally accepted accounting principles ("GAAP"), generally accepted auditing standards ("GAAS"), and standards set by the Public Company Accounting Oversight Board ("PCAOB"), because the statements overstated the value of Miller Energy's Alaskan energy interests. Cosby v. KPMG, LLP, No. 3:16-cv-121 (E.D. Tenn. Aug. 2, 2018). Of note, the Court held that while plaintiffs' allegations stated a claim under Rule 10b-5(b), they did not support a claim for "scheme liability" under Rule 10b-5(a) and (c) because KPMG's claimed role in the scheme was too remote.

First, plaintiffs alleged that KPMG fraudulently concealed material information regarding the overstated value of the Alaskan energy interests, which caused Miller Energy to misstate and omit material facts in its financial reporting. KPMG argued that these allegations were insufficient because its audit only rendered an opinion as to Miller Energy's financials, and plaintiffs had not presented factual allegations indicating that KPMG did not believe the opinions contained in the audit report were true. The Court held, however, that given the degree to which accounting principles were allegedly violated, scienter had been sufficiently alleged. Id. at 19-20. The Court emphasized that, while "violations of GAAP and GAAS principles are not alone sufficient to meet the pleading standard for alleging scienter, showing gross violations is sufficient to meet the pleading standard for alleging a misstatement." Id. at 20. And the Court further concluded that, based on the pleadings, "a reasonable person could conclude that defendant was aware that the financial statements and audits were misleading because defendant consistently failed to follow GAAP and GAAS principles as well as defendant's own internal policies." Id.

The Court separately held...