Shareholder can sue accounting firm

A shareholder could sue a company’s outside accounting firm for alleged negligence in its preparation of the company’s financial statements, a Rhode Island Superior Court judge recently decided.
The accounting firm argued the suit should be dismissed because it had no duty of care to third parties like the shareholder, with whom it had never engaged in a direct financial transaction.
But Judge Michael A. Silverstein disagreed, saying an accountant owes a duty to any individual or group of people who are meant to benefit from or be influenced by the information the accountant provides.
Silverstein relied on the Second Restatement of Torts: “The Restatement approach strikes the appropriate balance between compensating victims of malpractice and limiting the scope of potential liability for those who certify financial statements. While it remains to be proved that [the firm] actually did foresee that their financial statements would be used by the shareholders [in the manner alleged], the absence of a particular financial transaction does not preclude the finding of a duty in this case.” (Anjoorian v. Arnold Kilberg & Co., et al., Docket No. PC 97-1013.)
The plaintiff, Paul V. Anjoorian, owned 50 percent of the shares of Fairway Capital Corp. (FCC), a Rhode Island company that extended and serviced equity loans to small businesses. The three children of FCC’s manager, defendant Arnold Kilberg, owned the other 50 percent of its shares. FCC’s capitalization included a $1.26 million investment by the plaintiff.
A defendant, Pascarella & Trench, a Providence accounting firm, began auditing FCC’s financial statements on a quarterly basis beginning in 1990. The firm’s responsibility was to perform the audit in accordance with accepted auditing standards and to “express an opinion on the financial statements” based on the audits.
On March 2, 1994, Anjoorian filed a complaint seeking dissolution of FCC on various grounds. The defendant accounting firm was not a party to that suit.
As a result of the suit, Kilberg’s children exercised their right under state statute to purchase the Anjoorian’s shares of the corporation.
At the time, FCC’s main asset was its right to receive payment for loans it had made. The court-appointed appraiser determined the value of the corporation was $2.4 million, plus a payroll adjustment of $102,000, minus a “loss reserve” adjustment to account for the fact that 10 of FCC’s 30 outstanding loans were delinquent.
The loss-reserve adjustment reduced the total appraised value of the corporation by $878,234. As a result, Anjoorian’s interest in the corporation was reduced by $439,117. He ultimately received a judgment for $809,382 in exchange for a buyout of his shares.
Anjoorian sued Pascarella & Trench claiming the firm was negligent in omitting the loan-loss reserve in its statements. He also claimed that had the accounting firm included a loan-loss reserve in the statements, he would have sought dissolution of FCC much earlier than 1994, when his shares would have been more valuable. As a result of the alleged negligence, Anjoorian claimed, he lost more than $300,000 in share value between 1990 and 1994.
Silverstein observed that while the question of accountant liability to third parties was unsettled in Rhode Island, the Rhode Island Supreme Court had identified three competing interpretations.
The first interpretation was the “foreseeability test,” under which an auditor has a duty to all foreseeable recipients of information he provides. “This rule gives little weight to the concern for limiting the potential liability for accountants and is not widely adopted,” Silverstein noted.
The second interpretation, the judge continued, was the “privity test,” requiring a contractual relationship to exist between an accountant or auditor and another party.
Finally, the Restatement test, found in §522 of the Restatement (Second) of Torts, states an accountant who does not exercise reasonable care “is only liable to intended persons or classes of persons, and only for intended transactions or substantially similar transactions,” said Silverstein. “[This approach] applies not only [to] specific persons and transactions contemplated by the accountant, but also specific classes of persons and transactions.”
Silverstein settled on the Restatement rule.
Applying the rule, Silverstein denied summary judgment for the accounting firm, concluding there was a genuine issue of material fact on whether the accounting firm could be liable.
“This court would have no difficulty finding a duty in this case, in the absence of a specific financial transaction, if it can be shown that [the defendant] intended the shareholders to rely on the financial statements for the purpose of evaluating the financial health of the company, and therefore, their investment in the company,” wrote Silverstein.