Opinion ID: 895250
Heading Depth: 4
Heading Rank: 1

Heading: Auditor liability to third parties: an overview

Text: For over seventy years, state courts have debated the contours of liability when an auditor's negligent misrepresentation injures a third party. See generally, Jay M. Feinman, Liability of Accountants for Negligent Auditing: Doctrine, Policy, and Ideology, 31 FLA. ST. U.L.REV. 17 (2003); Jodi B. Scherl, Comment, Evolution of Auditor Liability to Noncontractual Third Parties: Balancing the Equities and Weighing the Consequences, 44 AM. U.L.REV. 255 (1994). For the first half of the twentieth century, the seminal case on auditor liability was Justice Cardozo's New York Court of Appeals opinion, Ultramares Corp. v. Touche, 255 N.Y. 170, 174 N.E. 441 (1931). In Ultramares, the court discussed what it termed the assault upon the citadel of privity. Ultramares, 174 N.E. at 445. The court refused to extend negligence's foreseeability principle to economic losses caused by an auditor's lapse, absent a bond so close as to approach that of privity. Id. at 446. The court coined a phrase that would echo through succeeding opinions nationwide: If liability for negligence exists, a thoughtless slip or blunder, the failure to detect a theft or forgery beneath the cover of deceptive entries, may expose accountants to a liability in an indeterminate amount for an indeterminate time to an indeterminate class. Id. at 444. Over the ensuing decades, however, courts began to stray from Ultramares and expand auditors' scope of liability. These cases fall along a spectrum, with Ultramares on one end (requiring privity, or near-privity), and a handful of cases on the other (holding that mere foreseeability suffices to establish liability). The leading case in the latter camp is from New Jersey, H. Rosenblum, Inc. v. Adler, 93 N.J. 324, 461 A.2d 138 (1983). Likening a negligent audit to a defective product, the court held that the reasonably foreseeable consequences of the negligent act define the duty and should be actionable. Rosenblum, 461 A.2d at 145. Few states have adopted this approach, and Rosenblum itself was superseded by a 1994 statute replacing it with a near-privity standard, N.J. STAT. ANN. § 2A:53A-25. See, e.g., Touche Ross & Co. v. Commercial Union Ins. Co., 514 So.2d 315, 322 (Miss. 1987); Citizens State Bank v. Timm, Schmidt & Co., 113 Wis.2d 376, 335 N.W.2d 361, 366 (1983). New York and other states have drifted only cautiously from Ultramares's strict standard, adopting a near-privity predicate to auditor liability. The leading case behind this model is Credit Alliance Corp. v. Arthur Andersen & Co., 65 N.Y.2d 536, 493 N.Y.S.2d 435, 483 N.E.2d 110 (1985). Credit Alliance applied a three-part inquiry to determine whether an auditor and a third party have sufficient privity to implicate liability, namely: a particular purpose for the accountants' report, a known relying party, and some conduct on the part of the accountants linking them to that party. Id., 493 N.Y.S.2d 435, 483 N.E.2d at 119. In applying this test, the court held that even though the auditor was aware that the third party would receive the report, it was not liable because there was no allegation that [the auditor] had any direct dealings with plaintiffs, had specifically agreed ... to prepare the report for plaintiffs' use or according to plaintiffs' requirements, or had specifically agreed ... to provide plaintiffs with a copy or actually did so. Id. The high courts in Maryland, Montana, and Idaho have explicitly adopted Credit Alliance's reasoning. See Idaho Bank & Trust Co. v. First Bancorp of Idaho, 115 Idaho 1082, 772 P.2d 720, 722 (1989); Walpert, Smullian & Blumenthal, P.A. v. Katz, 361 Md. 645, 762 A.2d 582, 607 (2000); Thayer v. Hicks, 243 Mont. 138, 793 P.2d 784, 789 (1990). The American Law Institute's 1977 Restatement (Second) of Torts included a section on Information Negligently Supplied for the Guidance of Others. RESTATEMENT (SECOND) OF TORTS § 552. Section 552 offers a middle-ground approach to third-party auditor liability, providing that: [o]ne who, in the course of his business, profession or employment, or in any other transaction in which he has a pecuniary interest, supplies false information for the guidance of others in their business transactions, is subject to liability for pecuniary loss caused to them by their justifiable reliance upon the information, if he fails to exercise reasonable care or competence in obtaining or communicating the information. ... [T]he liability stated ... is limited to loss suffered (a) by the person or one of a limited group of persons for whose benefit and guidance he intends to supply the information or knows that the recipient intends to supply it; and (b) through reliance upon it in a transaction that he intends the information to influence or knows that the recipient so intends or in a substantially similar transaction. Id. Of the various approaches taken by states, most have embraced the Restatement's formulation. See Feinman, 31 FLA. ST. U.L.REV. at 41 n. 165. Although the Restatement has been criticized, [10] it provides a window through which direct victims of auditor negligence can demand accountability without unleashing potentially unlimited auditor liability. The most thorough exponent of the Restatement's construct can be found in a 1992 case from the Supreme Court of California, Bily v. Arthur Young & Co., 3 Cal.4th 370, 11 Cal. Rptr.2d 51, 834 P.2d 745 (1992). After surveying the waterfront of auditor liability to third persons, the Bily court concluded that the Restatement approach: is most consistent with the elements and policy foundations of the tort of negligent misrepresentation. The rule expressed there attempts to define a narrow and circumscribed class of persons to whom or for whom representations are made. In this way, it recognizes commercial realities by avoiding both unlimited and uncertain liability for economic losses in cases of professional mistake and exoneration of the auditor in situations where it clearly intended to undertake the responsibility of influencing particular business transactions involving third persons. Id., 11 Cal.Rptr.2d 51, 834 P.2d at 769. For nearly two decades, we have similarly embraced the Restatement approach. See McCamish, Martin, Brown & Loeffler v. F.E. Appling Interests, 991 S.W.2d 787, 791 (Tex.1999); see also Fed. Land Bank Ass'n v. Sloane, 825 S.W.2d 439, 442 (Tex. 1991). In McCamish, we examined whether the absence of an attorney-client relationship precluded a third party from suing an attorney for negligent misrepresentation under Restatement section 552. McCamish, 991 S.W.2d at 788. We held that, under certain circumstances, section 552 causes of action can be brought by third parties against attorneys, just as they have been legitimately brought against auditors, accountants, and other professionals. Id. at 791. We explained that a section 552 cause of action is available only when information is transferred by an attorney to a known party for a known purpose. Id. at 794 (emphasis added). Under section 552, a known party is one who falls in a limited class of potential claimants, `for whose benefit and guidance [one] intends to supply the information or knows that the recipient intends to supply it.' Id. (quoting RESTATEMENT (SECOND) OF TORTS § 552(2)(a)). This formulation limits liability to situations in which the professional who provides the information is aware of the nonclient and intends that the nonclient rely on the information. Id. Unless a plaintiff falls within this scope of liability, a defendant cannot be found liable for negligent misrepresentation. McCamish has served as a guidepost for our courts of appeals in analyzing the tort of negligent misrepresentation, [11] in contrast to earlier decisions applying a broader standard. [12] We reaffirm today that McCamish represents Texas law under section 552 of the Restatement.