CPAs’ Audit Report and Qualified Opinion Did Not Cause Company’s Or Investors’ Losses Where There Was No Evidence Of Reasonable Reliance

By: Kacey R. Riccomini
April 24, 2016

Accountants can breathe easier after Mosier v. Stonefield Josephson, Inc., CPAs (9th Cir., Feb. 23, 2016, No. 13-56453) 2016 WL 703104. Recently, the Ninth Circuit Court of Appeals, found that Stonefield, an accounting firm that was hired by PEMGroup and its related entities to audit financial statements, did not cause PEMGroup or its investors’ losses where there was no evidence the company or its investors actually or reasonably relied on the CPAs’ audit report, particularly when PEMGroup’s management defrauded investors and Stonefield issued qualified opinions of PEMGroup’s financial statements. Going forward, the Ninth Circuit’s decision will greatly impact professional liability suits against accountants, among others.

Before the suit, PEMGroup’s directors and managers used their companies to defraud investors of approximately $950 million via a Ponzi scheme. Unaware of this scheme, Stonefield audited the financial statements of six of PEMGroup’s offerings for the 2003 through 2007 fiscal years. Beginning in 2004, Stonfield also issued qualified opinions of PEMGroup’s operations, specifically its improper method of valuing its assets and the unknown effects of such valuation on its financial statements. In 2009, after learning that the SEC had filed a complaint against PEMGroup and the FBI had arrested one of PEMGroup’s managers, Stonefield resigned.

Thereafter, Receiver Robert Mosier sued Stonefield in place of the PEMGroup entities, asserting causes of action for professional negligence, aiding and abetting conversion of PEMGroup’s assets by its managers, and unjust enrichment in the form of professional fees the PEMGroup entities paid Stonefield. Mosier claimed that Stonefield’s audit reports fell below Generally Accepted Auditing Standards and that Stonefield failed to sufficiently warn investors that management had not accurately reported asset values in accordance with Generally Accepted Accounting Principles. Mosier also argued that Stonefield should have issued either an adverse opinion or refused to issue any opinion, and should have immediately terminated its relationship with the PEMGroup entities. Stonefield filed a motion for summary judgment and the district court ultimately dismissed each of Mosier’s causes of action, finding there was no showing that Stonefield caused PEMGroup harm because there was no evidence that PEMGroup or its investors relied on Stonefield’s audits.

Similarly, in affirming the district court’s ruling, the Ninth Circuit reasoned that, to prove the causation element of Mosier’s claims, he had to establish that PEMGroup and its investors reasonably relied on Stonefield’s audit reports. However, management of the PEMGroup entities, having engaged in the fraud, could not have relied on the audit reports. Additionally, there was no direct evidence that any of the defrauded investors were provided with or reasonably relied on Stonefield’s audit reports, particularly where the qualifications in the reports would be red flags to investors. Moreover, Mosier’s unjust enrichment claim, seeking return of the fees the PEMGroup entities paid Stonefield, could not succeed in the absence of Mosier’s other claims or where Stonefield’s engagement letter stated that Stonefield would not be responsible for any misrepresentations made by PEMGroup.

In conclusion, the implications of Mosier’s discussion on reasonable reliance are far-reaching as a substantial number of suits are filed against accountants based on an alleged failure to warn or properly disclose information. It also highlights the importance of accountants issuing well-crafted engagement letters. Additionally, Mosier is likely to affect suits against other professionals such as attorneys, who, like accountants, are retained to provide skilled analyses and opinions.

About the author

Kacey R. Riccomini

Ms. Riccomini is an Associate at Chapman Glucksman Dean Roeb & Barger.

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