Defending Accounting Malpractice Actions in Connecticut: an Increasingly Difficult Task
| Publication year | 2021 |
| Pages | 171 |
78 CBJ 171. DEFENDING ACCOUNTING MALPRACTICE ACTIONS IN CONNECTICUT: AN INCREASINGLY DIFFICULT TASK
VOLUME 78, NO. 3
I. INTRODUCTION
In today's social and political environment, accounting malpractice cases are becoming more and more difficult to defend. They are also becoming more and more frequent.(fn1) The significant number of accounting scandals that have gone public in recent years(fn2) has created an atmosphere in which courts and juries are increasingly willing to hold accountants liable for even discretionary acts that would have otherwise been thought of as standard practice several years ago. In addition, overzealous attorneys have been more and more willing to bring cases that have less and less merit. As a result, accountants are finding themselves defending more malpractice actions than at any other time in history.
The accounting standards to which your clients' work will be compared are also oftentimes vague, ambiguous and difficult to understand, at best. Because most of the standards leave so much discretion to the accountant to use his or her
* J.D., Seton Hall University School of Law, 1998, valedictorian; currently a Judicial Law Clerk to the Honorable Donna F. Martinez, United States District Court, District of Connecticut.
1 Between 1975 and 1985, the number of lawsuits filed annually in federal court against accountants increased from approximately 117,000 to 273,600. See Summer Bennett Joseph, Comment, Drowning Professionals in the Stream of Commerce: An Examination of Purposeful Availment in the Professional Liability Context, 53 EMORY L.J. 277, 277 (2004) (citing James L. Craig, Jr., The War on Accountants' Legal Liability, CPA J. Online (Mar. 1990) (interview with Robert Mednick, former partner, Arthur Andersen, LLP), at http://www.nysscpa.org/cpajournal/old/ 083 17026.htm)). These numbers continue to rise each year, "creating what has been called a 'litigation crisis' within the profession." Id. (citing Carl Pacini & David Sinason, Auditor Liability for Electronic Commerce Transaction Assurance: The CPA/CA Webtrust, 36 AM. BUS. L.J. 479, 481 (1999)).
2 See, e.g., Louis Grumet, No Time to Be Working Without a Net, 73 CPA J. 7 (Oct. 2003) ("The CPA profession has been on everyone's radar since late 2001 because accounting played a crucial role in the collapse of Enron and in serious problems at other corporations"); Ellen L. Rosen, Climate of Risk for Advisers Is Seen as Shifting after Enron, N.Y. TIMES, Apr. 30, 2002, at C2 (experts predicting that accounting malpractice claims will rise in the wake of Enron's collapse); Donna K.H. Walters, New Liability Twist Has Lawyers, Accountants Scurrying, L.A. TIMES, Mar. 29, 1992, at D1 ("Increasingly, lawyers and accountants are being blamed for the failures and frauds of their clients").
judgment, there is an equal amount of discretion left to a court or jury to find the accountant liable for his or her actions. This again increases the difficulty of defending an accounting malpractice case in this era of heightened skepticism.
There have also been significant increases in the number of third parties who have brought claims against accountants (arising out of the impact of the accountant's work). A shareholder of a corporation, for example, whose stock has been impacted by a decision made by an accountant, may seek to sue the accountant directly even though he or she was not a direct party to the accounting engagement. Most of these cases arise out of misdeeds or mistakes that simply were not detected by an accountant during the standard audit. Because accountants today face so many minefields, proper advice to your accountant client regarding the pitfalls inherent in the engagement (and also any potential contractual limitations on liability) is essential.
These factors combine to increase the importance of a number of different legal issues that can be raised by accountants in defense of a malpractice action. This article addresses a number of those defenses in the context of the two major claims made against accountants arising out of their work: professional malpractice (negligence) and breach of contract. Each of those causes of action is addressed separately below. Where appropriate, the author analyzes several of the unsettled areas of law in Connecticut as applied to accountants. Following that analysis is a separate section dealing with miscellaneous issues that should be considered when defending and/or advising your accountant client.
II. PROFESSIONAL MALPRACTICE(fn3)
A. Duty
1. The Legal Standard
The standard of care owed by any accountant to a client is determined by reference to standards prevailing in the
3 A cause of action for professional malpractice is based upon a negligence theory. Malpractice is commonly defined as "the failure of one rendering professional services to exercise that degree of skill and learning commonly applied under all the
accounting profession generally. Those prevailing standards are either Generally Accepted Accounting Principles ("GAAP") or Generally Accepted Auditing Standards ("GAAS"). These standards are applicable to every licensed public accountant in Connecticut(fn4) and indeed in the United States (hence the use of the term "generally accepted").(fn5) Indeed, GAAS itself requires that an accountant's audit report state that the audit was conducted in accordance with GAAS.
In spite of the public's recent attitude toward accountants, they should not be viewed as an insurance policy, which can be tapped in the event anything ever goes wrong. Audits are not foolproof, and the standards do not require the auditor to detect every underlying fraud or mistake.(fn6) Under GAAS,
3 (cont.) circumstances in the community by the average prudent reputable member of the profession with the result of injury, loss, or damage to the recipient of those services." Barnes v. Schlein, 192 Conn. 732, 735, 473 A.2d 1221 (1984). The four essential elements of an action for malpractice are that (1) the defendant must have a duty to conform to a particular standard of conduct for the plaintiff's protection; (2) the defendant must have failed to measure up to that standard; (3) the plaintiff must suffer actual injury; and (4) the defendant's conduct must be the cause of the plaintiff's injury. LaBieniec v. Baker, 11 Conn. App. 199, 202-03, 526 A.2d 1341 (1987).
4 Although Connecticut courts have not articulated the standard of care for accountants with any specificity, a recent Superior Court decision held that "[t]he standard of care for the accounting profession is GAAS, which is a product of the U.S. Auditing Standards Board and American Institute of Certified Public Accountants." Curtis Packaging Corp. v. KPMG, LLP, 2002 WL 31015828, *2 (Conn. Super. Ct. July 31, 2002) (McWeeny, J.).
5 See Hochfelder v. Ernst & Ernst, 503 F.2d 1100, 1108 (7th Cir. 1974) (finding that the standard of care for an auditor is "the standard of care which generally prevailed in the accounting profession during the years of [the relevant] audits"); rev'd on other grounds, 425 U.S. 185 (1976); Vosgerichian v. Commodore Int'l, 862 F. Supp. 1371, 1373 n.2 (E.D. Pa. 1994) ("In essence, GAAS and GAAP delineate due professional care owed by accountants to their clients as stated by the accounting community"); FDIC v. Schoenberger, 781 F. Supp. 1155, 1157 (E.D. La. 1992) ("Accountants . . . owe a duty to perform their services with that degree of skill and competence reasonably expected of persons in their profession in the community. By definition, an auditor owes a duty to conduct the audit in accordance with GAAS"); In re Worlds of Wonder Securities Litig., 147 F.R.D. 214, 216 (N.D. Cal. 1992) ("That standard [against which audit is to be measured] is established by GAAS and GAAP"); In re Conticommodity Servs., Inc. Sec. Litig., 1998 U.S. Dist. LEXIS 4812, *4-5 (N.D. Ill. 1988) ("accountants should not be held to a standard higher than that recognized in their profession"); Escott v. BarChris Constr. Corp., 283 F. Supp. 643, 703 (S.D.N.Y. 1968) (same).
6 See, e.g., Ahmed v. Trupin, 809 F. Supp. 1100, 1111 (S.D.N.Y. 1993) ("While accountants have a duty to investigate the obvious, they have no obligation to seek out fraud. If they do not know the data they audit is fraudulent, and the fraudulent nature of the data given them is not apparent, accountants are not liable if they audit in accordance with GAAP").
"the objective of the ordinary examination in most cases is not to disclose defalcations but to render an opinion on the financial statements as audited by the accountant through following accepted auditing procedures."(fn7) In other words, "[a]uditors are not detectives hired to ferret out fraud."(fn8) Instead, "[a]n accountant's good faith compliance with . . . GAAS discharges the accountant's professional obligation to act with reasonable care."(fn9)
GAAS also makes it very clear that the auditor is not responsible for guaranteeing the accuracy of the financial statements rendered by management of the company being audited. In fact, GAAS explicitly states that management is responsible for the entity's financial statements.(fn10)
With regard to an auditor's responsibility to conduct the audit in accordance with GAAS, "[t]hose standards require that the auditor obtain reasonable rather than absolute assurance about whether the financial statements are free of material misstatement, whether caused by error or fraud."(fn11) Accordingly, "a material misstatement may remain undetected."(fn12) Similarly, with regard to the auditor's understanding of the client's internal controls, "[a]n audit is not designed to provide assurance on internal control or to identify...
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