Court Reaffirms Limits On Auditor Liability To Third Parties

 
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Originally published June 30, 2010

Keywords: auditor liability, third party, BDO Seidman, Restatement (Second) of Torts, audit report, private placement, professional liability,

On June 23, 2010, the Third District Court of Appeal for the State of Florida reversed entry of judgment on a $510 million jury verdict against BDO Seidman, LLP, and remanded the case for a new trial. BDO Seidman, LLP v. Banco Espirito Santo Int'l, __ So.3d __, 2010 WL 2507051 (Fla. 3d DCA June 23, 2010). In its opinion, the court reaffirmed a number of legal principles that are particularly relevant to public accounting firms.

First, the court reiterated that an auditor is not exposed to liability with respect to all transactions in which its client seeks to raise capital. BDO audited a factoring company, E. S. Bankest L.L.C. (Bankest), which issued $140 million in promissory notes to individual investors. Plaintiffs, as assignees of the noteholders, alleged that the noteholders had been duped into making their investments by Bankest's materially misstated financial statements, and that BDO bore responsibility by failing, through simple or gross negligence, to detect and prevent those misstatements.

Under Florida law, to make out such a claim, plaintiffs "had to comply with the test outlined in Restatement (Second) of Torts section 552," a standard that has been endorsed by the courts of many other states. As the court explained, "[u]nder that test, BDO would have potential liability only if BDO knew, at the time it was hired for a particular audit, that the audit would be used as part of a private placement memorandum which was to be given to prospective purchasers of the notes" or, alternatively, if BDO "subsequently affirmatively consented" to the inclusion of its audit report in the placement memorandum.

That test could not be satisfied with respect to a number of the notes because it was undisputed that BDO's audit reports were not attached to Bankest's 1998 and 1999 private placement memoranda. Plaintiffs sought to evade this result by arguing that purchasers of the notes had nevertheless received BDO's reports "for other reasons." But that was "insufficient to impose liability." There was no evidence that BDO knew that its reports—which were not attached to the 1998 and 1999 placement memoranda and were circulated "for other reasons"—would ever be used by investors for the specific purpose of assessing a potential investment in the 1998 and 1999 notes.

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