Second Circuit Holds That Mere Auditor 'Review' Of Quarterly Financials Will Not Give Rise To Liability Under The Federal Securities Laws

Auditors for years have distinguished between the familiar traditional "audit," which is usually performed annually, and a quarterly "review." A "review" typically consists more of just discussion and observations rather than the performance of substantive audit procedures, and principally involves applying analytical procedures to the company's financial data, making inquiries of the company's officers responsible for financial and accounting matters, and bringing to management's attention if anything is observed that is in contravention of GAAP (generally accepted accounting principles). In a recent ruling, the United States Court of Appeals for the Second Circuit held that an auditor cannot be held liable under the federal securities laws for alleged misstatements contained in a company's quarterly financial statements that the auditor had reviewed but not audited.

In Lattanzio et al. v. Deloitte & Touche LLP, No. 05-5805, 2007 WL 259877 (2d Cir. Jan. 31, 2007), plaintiffs brought a putative class action against a company's auditor, alleging that there had been numerous misstatements in the company's yearly and quarterly financial statements, and asserting claims for breach of fiduciary duty and violations of ß 10(b) of the Securities Exchange Act of 1934 and SEC Rule 10b-5. The plaintiffs claimed to have suffered losses when the company later went into bankruptcy. The district court dismissed plaintiffs' claims and plaintiffs appealed.

The Second Circuit affirmed on several grounds. First, the court held that the auditor could not be held liable for the alleged misstatements in the company's unaudited quarterly financial statements that the auditor had simply reviewed. The court noted that, under Central Bank of Denver v. First Interstate Bank of Denver, 511 U.S. 164 (1994), a defendant can only be liable under the federal securities laws for its own material misstatements, not for aiding and abetting another's violation. The court further noted that while the quarterly financial statements at issue had been reviewed by the auditor, they "did not contain an audit opinion by [the auditor], and were not attributed to [the auditor] when they were disseminated." The court held that the auditor "is not liable for merely assisting in the drafting and filing of the quarterly statements."

The court rejected the plaintiffs' argument that since the company was required to have its quarterly statements reviewed by an auditor pursuant to 17 C.F.R...