Recent Decisions Limit Accountants' Liability Under Both Federal and California Law

Date: May 1993

Two recent decisions -- one from the United States Supreme Court and the other from the California Supreme Court -- have limited potential liability of accountants in suits brought by injured investors or borrowers seeking to recoup business losses from accountants who audited the companies which caused their loss.

In Reves v. Ernst & Young, 61 U.S.L.W. 4207 (1993), a suit was filed under the federal Racketeer Influenced and Corrupt Organizations Act (RICO) against an independent accounting firm which certified financial statements concealing the audited company’s insolvency. The accountants were accused of violating the RICO provision forbidding the conduct of an enterprise’s activities through a pattern of racketeering activity. A “pattern of racketeering activity” can consist of two or more acts such as fraud or extortion.

The United States Supreme Court held that the independent accountant’s involvement in the enterprise’s activities was insufficient to support liability under RICO because only those who have “some part in directing the enterprise’s affairs” can be deemed to be involved in the “conduct” of the enterprise. Although the accountants were accused of preparing fraudulent financial statements, they were not involved in the “operation or management” of the company they were auditing. Consequently they were absolved from potential RICO liability for that company’s fraudulent activities constituting a pattern of racketeering activity.

Accountants’ potential exposure to claims under California state law was also recently limited in Bily v. Arthur Young & Co., 3 Cal.4th 370 (1992). The Supreme Court of California held that accountants have no liability to non-clients for negligent audits even if it was foreseeable that third parties would rely on the fairness and accuracy of the financial statements audited by the accountant. Accountants who negligently misrepresent facts regarding a company’s financial condition remain potentially liable to third parties whom, the auditor knows, the audited financial report is specifically intended to influence (such as a lender who has requested the audit). The Supreme Court made it clear in Bily that auditors still face liability to both clients and non-clients to whom the auditors have made deliberate misrepresentations with the intent to defraud.

For further information about these cases or other current issues in litigation, please contact our Litigation Department at (310) 858-7700.

Our Litigation Department specializes in civil litigation at all levels of the judiciary, and has wide-ranging experience in litigating business, commercial and entertainment-industry related matters. We have extensive experience in accounting and partnership, antitrust, and securities and corporate litigation. Additional areas of emphasis include copyright and intellectual property, real estate and products liability litigation as well as in the appellate practice.

Rosenfeld, Meyer & Susman was founded in 1957.  The Firm’s areas of expertise include: Labor and Employment Law, Litigation, Corporate, Entertainment, Trusts and Estates, Taxation, Family Law, Insurance Coverage and Defense, Real Estate and Employee Benefits.

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