Brief Fact Summary. The Appellate Division of the Supreme Court in the First Judicial Department (New York) modified and affirmed judgment in favor of the Defendants, George A. Touche and Touche, Niven & Co (Defendants), setting aside the Plaintiff, Ultramare Corp’s (Plaintiff) verdict and dismissing the complaint in the Plaintiff’s action for negligent and fraudulent misrepresentations respecting an audit.
Synopsis of Rule of Law. Accountants owe to their employer a duty imposed by law to make their certificate of audit without fraud and a duty growing out of contract to make it with the care and caution proper to their calling.
Facts. The Defendants, public accountants, had been employed by a third-party to prepare and certify a balance sheet exhibiting that party’s financial health. The Defendants certified capital and surplus to be in excess of $1 million. The business, however, was actually close to insolvency. Relying on the Defendant’s independent assessment of the third-party’s finances, the Plaintiff extended several loans and when the third-party’s business collapsed the Plaintiff was unable to secure repayment. The Plaintiff sued, alleging damages arising from the Defendants’ misrepresentations, negligence and fraud. The Defendants were aware third-party would use its certificate of audit to obtain credit for the operation of its business and in other financial dealings. Following judgment, the parties cross-appealed the appellate court’s dismissal of the Plaintiff’s complaint.
Issue. Do accountants owe a duty to submit audits in a thorough, accurate manner and in failing to do so face liability for fraud?
Held. Yes. The court concluded that the Defendants made a statement as true to their own knowledge when they had no knowledge on the subject and thus were liable.
Discussion. Writing for the New York Court of Appeals, Judge Cardozo examined the quality and degree of duty owed by accountants when certifying the financial health of business the records of which will be proffered to potential lenders.
As a threshold issue, Cardozo points out, “Accountants owe to their employer a duty imposed by law to make their certificate of audit without fraud, and a duty growing out of contract to make it with the care and caution proper to their calling.” He clarified further, “Fraud includes the pretense of knowledge when knowledge there is none.” Certitude with respect to auditing is critical, in that, as Cardozo explained, “To creditors and investors to whom the employer exhibits a certificate of audit, accountants owe a duty to make the certificate of audit without fraud, when there is notice in the circumstances of its making that the employer did not intend to keep the certificate of audit to himself.” In other words, investors and other figures place great reliance on the veracity of accounting firms’ analyses. Cardozo underscores the seriousness with which courts will regard such expectations of fiscal probity: “If liability for negligence exists, a thoughtless slip or blunder, the fai
lure 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. The hazards of a business conducted on these terms are so extreme as to enkindle doubt whether a flaw may not exist in the implication of a duty that exposes to these consequences.” The final responsibility, Cardozo asserts, will rest with the preparers of financial reports: “If the certificate of audit involves a representation of a fact as true to the knowledge of the auditors, and such a statement is made, whether believed to be true or not, the auditors are liable for deceit in the event that it is false.”
Liability may attach both with regard to certified documents and professional assessments. “Even an opinion, especially an opinion by an expert, may be found to be fraudulent if the grounds supporting it are so flimsy as to lead to the conclusion that there was no genuine belief back of it.” Further, Cardozo notes, “A representation even though knowingly false does not constitute ground for an action of deceit unless made with the intent to be communicated to the persons or class of persons who act upon it to their prejudice.” Specifically in regard to the case at hand, Cardozo observes, “Public accountants are public only in the sense that their services are offered to any one who chooses to employ them. This is far from saying that those who do not employ them are in the same position as those who do.” Even mistaken belief may not shield one from liability: “Where accountants certify as a fact, true to their own knowledge, that the balance sheet is in accordance with the books of ac
count, if their statement is false, they are not to be exonerated because they believed it to be true.” In essence, Cardozo states, the bottom line is the thoroughness and accuracy of the work in question: “How far books of account fair upon their face are to be probed by accountants in an effort to ascertain whether the transactions back of them are in accordance with the entries, involves to some extent the exercise of judgment and discretion. Not so, however, the inquiry whether the entries certified as there, are there in very truth, there in the form and in the places where men of business training would expect them to be.” Finally, the fiduciary duty owed by accounting firms cuts two ways, both to their clients and the general public: “Public accountants are public only in the sense that their services are offered to any one who chooses to employ them. This is far from saying that those who do not employ them are in the same position as those who do.”