Lawyers say a recent Ontario Superior Court decision spells out auditors’ liability to their clients’ clients.
The plaintiff said the accounting firm, Miller Bernstein, was liable for negligently signing off on reports that falsely said the dealer was in compliance with the Ontario Securities Commission’s requirements on segregation and minimum capital requirements.
While the investors had never seen those reports, Belobaba ruled that the auditors had a duty of care to the investors.
Lawyers need to be aware of the decision if they represent investors or auditors, and the ruling demonstrates that there are circumstances in which auditors are going to owe a duty of care when the work they undertake is for the specific purpose of protecting a group of people.
“This decision helps clarify the situations in which an auditor is liable to people other than its clients,” says Daniel Bach, a partner with Siskinds LLP and one of the lawyers representing the plaintiff.
In 2001, the OSC put Buckingham Securities into receivership, but by that time, the securities dealer had already used the unsegregated assets and class members lost $10.6 million.
The dealer admitted that it had made false statements in Form 9 reports, which were audited by Miller Bernstein and filed to the OSC every year to prove the dealer was segregating assets and minimum capital.
The OSC brought proceedings against both the dealer and the auditor.
The plaintiff commenced the class action lawsuit in 2005 and it was certified in 2010.
The primary area of disagreement between the parties in the case was whether the accounting firm owed a duty of care to the investors.
The plaintiff argued that the auditor owed a duty of care causing foreseeable losses and the defendants contended that the plaintiff was trying to “dress up a negligent misrepresentation claim as something else” because no duty of care could be established.
Belobaba found that a negligence claim was appropriate as the OSC would have likely intervened before all the assets were lost if the auditor had filed accurate reports.
He determined that even though the class members had not seen the reports, the auditor “had an obligation to be mindful of the plaintiff’s interests” when filing the reports and that the defendant understood the consequences their actions would have on the investors.
He found that the closeness of the relationship between the auditor and investors created a duty of care.
Margaret Waddell, a class action lawyer who was not involved in the case, says that a claim in negligence makes good sense in this situation.
“You would expand out the duty of care to include liability to the clients of the brokerage because they’re the ones that are relying on the firm being properly policed,” she says.
“If the people that are tasked with doing that review are negligent, then the negligence isn’t just something that hurts the firm that they’re auditing but the clients who are fundamentally the people that they’re there to protect.”
The decision also dealt with the concern of whether the claim would open the defendant up to indeterminate liability.
Bach says that as a general proposition, courts don’t want to impose a duty of care in a situation where the defendant would owe a duty to an indeterminate number of people.
“In this case . . . the class of people affected was limited. It was not indeterminate and the amount was limited,” he says.
Belobaba found that the scope of liability would be limited in this case as the auditor knows the identity of the plaintiff and the defendant’s statements were used for the specific purpose for which they were made.
Joel Rochon, managing partner of Rochon Genova LLP, says the case is important as it confirms that auditors of a securities dealer can be held liable in negligence to their clients’ clients.
“Justice Belobaba’s ruling makes clear that reliance is not an essential ingredient of a claim in negligence,” says Rochon, who was not involved in the case.
“Nor can auditors in securities class actions escape liability for losses suffered by class members by arguing that a negligent misrepresentation claim has been pled as a negligence claim in order to circumvent the requirement to prove reliance.”
Rochon adds that the focus of the duty of care analysis is whether as a matter of simple justice the defendants had an obligation to be mindful of the investors’ interests when conducting the audits.
Robert Staley, one of the lawyers representing the defendants, did not respond to a request for comment.