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2nd Circuit Finds Primary Liability for Auditors Under Section 10(b)

The 2nd U.S. Circuit Court of Appeals held that an auditor may be primarily liable for violations of 10(b) and Rule 10b-5 "when the auditor makes a statement in its certified opinion that is false or misleading when made, subsequently learns or was reckless in not learning that the earlier statement was false or misleading, knows or should know that potential investors are relying on the opinion, yet fails to take reasonable steps to correct or withdraw its opinion." The holding stemmed from an appeal of a district court's (SD NY) order dismissing investors' securities fraud claims with prejudice for failure to plead a viable theory of primary liability against an accountant engaged in auditing a broker-dealer's financial statements.

The investors claimed that the auditor recklessly audited and evaluated the broker-dealers affairs by ignoring various "red flags" that cast doubt on the accuracy of its financial statements, and as a result, made significant errors which concealed the broker-dealer's tax liability. A review of the accountant's audits revealed that his audits were "deficient” and that if he had properly reviewed the payroll tax liability, he would have learned of the errors. The auditor never took steps to withdraw his certification or remedy the situation. The investors claimed that they relied on these financial statements when deciding whether or not to invest in the broker-dealer.

Vacating and remanding the district court's decision, the appellate panel acknowledged that although the court has recognized the existence of an accountant's duty to correct its certified opinion. However, the panel noted that the 2nd Circuit had never held that such a duty existed for the purposes of primary liability under Section 10(b). Relying on the existence of the "duty to correct" precedent, the court stated that when an accountant violates the duty, they become primarily liable under Section 10(b) in the circumstances "when the accountant 1) makes a statement in its certified opinion that is false or misleading when made, 2) subsequently learns or was reckless in not learning that the earlier statement was false or misleading, and 3) knows or should know that potential investors are relying on its opinion." Accordingly, concluded the appellate court, if an accountant failed to take reasonable steps to correct or withdraw its certified opinion and financial statements in these circumstances, he would be primarily liable for a misleading omission under Section 10(b).

The court was careful to point out the limited scope of the holding, and stated that an accountant need correct only those particular statements set forth in its opinion and certified financial statements. Additionally, the court stated that the accountant is not under a duty to disclose information collateral to the statements of accuracy and financial fact set forth in the opinion and certified statements. Additionally, the court noted that "the duty to correct requires that the accountant correct statements that were false when made," and that the accountant is not under a duty to update a statement that was true when made, but made misleading by intervening events.

Overton v. Todman & Co. (2ndCir) is reported at ¶94,160.