Opinion ID: 1348772
Heading Depth: 3
Heading Rank: 5

Heading: Liability Prevents Future Harm

Text: Civil Code section 3274 declares that in this state money damages are not only the prescribed remedy for the violation of private rights, but also the means of securing their observance. As a particular application of this broad principle, it is generally recognized that tort liability prevents harm by deterring negligent conduct. (See, e.g., Burgess v. Superior Court, supra, 2 Cal.4th 1081-1082.) The majority fails to explain why this is not as true for independent audits of financial statements as for other professional activities. In my view, the deterrent effect of tort liability is especially important in this area. In capital markets, accurate financial reporting is indispensable for sound decisions and thus for the efficient allocation of resources. To ensure that the financial data they receive is accurate, lenders and investors insist that financial statements in all substantial transactions be verified by the unqualified opinion of a certified public accountant. In risking their capital on the basis of financial data thus verified, lenders and investors depend on the integrity and expertise of the certified public accountant in deciphering the complexities of modern financial information. When the trust of lenders and investors proves misplaced, the loss may extend well beyond the particular lenders and investors involved. Lenders who suffer substantial losses will pass the costs on to their customers and society at large through higher interest charges, tighter lending controls, higher loan application costs, and, too often, the massive costs associated with failed financial institutions. Investors who suffer losses through investment in failing businesses that appeared sound on paper will not be able to use the funds thus wasted to foster the growth of other, more deserving companies. Having suffered losses due to unreliable financial information, both lenders and investors may concentrate their funds in the most well-established businesses, to the detriment of young, start-up companies with innovative products or services. Finally, the losses resulting from misallocation of funds and the sudden collapse of reportedly sound companies have economy-wide consequences in terms of loss of employment and failure of investor confidence in the stock market. Does the rule holding negligent accountants liable to persons who reasonably and foreseeably rely on their audit reports of financial statements serve to avert these many forms of harm? I submit it does. As one commentator has put it: Negligent auditing will be deterred as accountants, realizing that their mistake will involve potentially greater financial consequences, will use even greater care to avoid them. (Paschall, Liability to Non-clients: The Accountant's Role and Responsibility (1988) 53 Mo. L.Rev. 693, 729.) This reasoning is supported by both common sense and judicial authority. (See International Mortgage Co. v. John P. Butler Accountancy Corp., supra, 177 Cal. App.3d 806, 820 [liability provides a financial disincentive for negligent conduct and will heighten the profession's cautionary techniques]; Citizens State Bank v. Timm, Schmidt & Co. (1983) 113 Wis.2d 376 [335 N.W.2d 361, 365] [Unless an accountant can be held liable to a relying third party, this negligence will go undeterred.]; Rosenblum v. Adler, supra, 93 N.J. 324 [461 A.2d 138, 152] [liability will cause accounting firms to engage in more thorough reviews, which will reduce the number of instances in which liability would ensue].) Customer demand is not sufficient to ensure the quality of independent audits. What clients of auditing services want above all is not a careful audit but an unqualified opinion to satisfy investors, lenders, and others concerned with the clients' financial health. Indeed, defendant itself acknowledges that a client may, for reasons of its own, actively seek to publish less than accurate financial information. Accountants are strongly motivated to satisfy their clients because it is they who pay the accountants' fees and provide future business. The accountant is thus caught between client pressure to produce an unqualified opinion and the moral and ethical obligation to maintain high standards of care and thoroughness. It is vital that accountants resolve this conflict in favor of careful auditing. The threat of liability to third parties reinforces the accountant's independence from the client, thereby helping to prevent loyalty to the client from consciously or unconsciously interfering with the accountant's professional judgment. To deter negligent conduct, it is not necessary that negligent parties be held liable for each and every injury resulting from their negligent acts. Liability to a limited class of victims may suffice. And in fact, most of this court's recent decisions limiting or precluding negligence liability have involved claims by secondary victims seeking recovery for collateral effects of the wrongful conduct. For example, when a defendant has negligently caused physical injury to another, this court has carefully limited the defendant's liability to third parties for emotional distress occasioned by the injury to the primary victim. ( Thing v. La Chusa (1989) 48 Cal.3d 644, 667-668 [257 Cal. Rptr. 865, 771 P.2d 814].) We have also denied recovery for loss of consortium to a child, parent, or unmarried cohabitant of a person physically injured by a defendant's negligence. (See Elden v. Sheldon (1988) 46 Cal.3d 267 [250 Cal. Rptr. 254, 758 P.2d 582]; Baxter v. Superior Court (1977) 19 Cal.3d 461 [138 Cal. Rptr. 315, 563 P.2d 871]; Borer v. American Airlines, Inc. (1977) 19 Cal.3d 441 [138 Cal. Rptr. 302, 563 P.2d 858].) In each of these situations, the defendant's liability to the primary victim, the person physically injured by the defendant's negligent conduct, provided an adequate deterrent. This case is different. The losses for which plaintiffs seek recovery are not a mere ripple effect of some primary wrong to a different party. In cases such as this one, the accountant's client is not a primary victim, for the client has not been harmed by the accountant's failure to detect mistakes in the client's own financial statements. Although the majority makes accountants liable to third parties for negligent misrepresentation when the accountants intended to influence a transaction between the third party and the client, these situations are exceptional. The net effect of the majority's holding, then, is that in the usual case, in which the accountant lacks specific knowledge of the client's intended dealings with third parties, the accountant can perform the audit and issue the audit report with virtual assurance that no liability will ensue no matter how negligently the job is done. With no liability deterrent, the incentive for care is reduced, the incidence of negligence rises, and harm to third parties multiplies.