Corporate Wrongdoing and the In Pari Delicto Defense in Auditor Malpractice Cases: A New Approach

Table of ContentsI. Introduction 277II. Background 280A. Imputation 2801. Adverse Interest Exception 281a. The Sole Actor and Innocent Decision-Maker Exceptions 283b. Tests for the Adverse Interest Exception Vary by State 2842. Third Parties Not Acting in Good Faith 288B. In Pari Delicto 2911. Defined 2912. In Pari Delicto Applied in Conjunction with Imputation 293C. Case Law 2961. Cenco Inc. v. Seidman & Seidman 2962. NewJersey 3013. Pennsylvania 303a. Those Who Proceed in Good Faith 305b. Those Who Do Not Proceed in Good Faith ....3064. NewYork 307a. MajorityOpinion 307b. DissentingOpinion 3095. Delaware 310a. The Adverse Interest Exception and In Pari Delicto 312b. Auditors as Defendants 315III. Current Law Does Not Adequately Address the Issue 316A. Where the Law Stands at Present: Imputation Sometimes 316B. The Direction the Law Should Travel: Imputation Shoidd Apply 3181. The Adverse Interest Exception Should Not Apply 3182. Imputation Should Not Turn on Whether Auditors Were Negligent or Collusive 319C. What Is at Stake in Allowing Claims to Proceed Against Auditors 3201. Why the Law Should Insulate Auditors 321a. Current Law Should Not Be "Weakened by Exception" 321b. The Public Is Best Served by Protecting Auditors 3212. Why the Law Should Not Insulate Auditors 323a. Auditors Should Be Held Accountable for Their Work 323b. Auditor Liability Need Not Be Uncapped 324IV. ProposedSolution 324A. In Pari Delicto Should Apply Only if the Corporation Is a Wrongdoer 325B. Measuring Fault to Determine if the Corporation Is a Wrongdoer 3271. Federal Organizational Sentencing Guidelines as a Standard for Adequate Systems 3302. Applying the Guidelines as the Measure of Corporate Wrongdoing 331C. A Limited Application of In Pari Delicto Adheres to Policy Objectives 333V. Conclusion 337I. IntroductionConsider the following not-uncommon scenario: High-level employees of a public corporation fraudulently misstate the corporation's financials to make the company appear profitable and attractive to investors and lenders. The financial (misstatements are certified by an outside auditor who failed to follow professional standards in performing the audit. Eventually, the fraud is uncovered and the true state of the company's dismal financial situation is revealed. The corporation's stock price plummets and it goes bankrupt. Creditors and shareholders of the company want to recover their losses from, inter alios, the auditor who negligently performed its audit. The failure, they allege, harmed them because the negligent audit allowed the fraud to continue longer than it would have if the auditor had met its duty under the engagement.1 The auditor in this scenario has a powerful defense in its corner: in pari delicto.Under accepted agency principles, the knowledge of a corporate officer is imputed to the corporation and the corporation is deemed to have that knowledge.2 Likewise, imputation makes the corporation legally responsible for an officer's fraud.3 The officer's fraud is, in law, the corporation's fraud which makes the corporation a wrongdoer in front of the court.4 The defense of in pari delicto^ prevents a wrongdoer from seeking redress against another alleged wrongdoer.6 Because the corporation's creditors or shareholders bring their claim on behalf of the corporation, they "step into the shoes" of the corporation and any defense that can be asserted against the corporation may be asserted against them.7 In the corporate fraud context, then, these doctrines work together to immunize auditors from liability.This Note argues that auditors should not be immune from suit by or on behalf of a corporation imputed with its agent's fraud. …