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Global Accounting Firms May Face Liability for Foreign Affiliates

By Karen L. Stevenson, Litigation News Associate Editor – May 5, 2009

Shockwaves were sent through the blogosphere earlier this year when the U.S. District Court for the Southern District of New York denied Deloitte Touche Tohmatsu (DTT) summary judgment, allowing trial to proceed on whether the firm could be held liable for an allegedly defective audit by its Italian affiliate, Deloitte & Touche, S.p.A. (Deloitte Italy). 2009 U.S. Dist. LEXIS 6329, In re Parmalat Sec. Litig. Defense counsel expressed concern and plaintiffs’ counsel expressed hope that the decision would clarify liability of global accounting firms and potentially other businesses that have affiliates in foreign countries.


So far, however, the reach of federal Judge Lewis Kaplan’s decision is not clear. “It is hard to say whether [the opinion] will have a monumental effect on international professional services firms,” says Paul M. Koning, Dallas, cochair of the Section of Litigation Professional Liability Litigation Committee.


“The opinion is very fact specific. I would be surprised, however, if similarly-situated firms were not actively reviewing their policies and procedures to identify, and eliminate if possible, general indicia of control over affiliates,” Koning says.


At issue in the ruling was whether DTT could be held vicariously liable for the alleged conduct of Deloitte Italy, and could turn on whether it had a “principal-agent” relationship with that Italian affiliate.


Underlying the action was the collapse of Parmalat Finanziaria, S.p.A. and its affiliates after the discovery of massive financial fraud. In the wake of the collapse, shareholders brought a federal securities class action in U.S. District Court against Parmalat’s accountants and others. Although starting in 1999, Deloitte Italy was responsible for conducting Parmalat’s audits, the plaintiffs’ complaint asserted that DTT should be held vicariously liable for the alleged violations of the U.S. securities laws by Deloitte Italy. DTT sought dismissal of the claims under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 on the grounds that DTT cannot be vicariously liable for audits conducted by its Italian affiliate because the firms were legally separate entities.


DTT is organized as a Swiss verein, a Swiss business form. The member firms, including Deloitte Italy, are organized as limited liability entities under the laws of their local jurisdictions. DTT’s website contains a disclaimer asserting the legal separateness of DTT and its members. Still, the court found that triable issues of fact exist regarding DTT’s control of its affiliates.


Judge Kaplan first addressed DTT’s argument that Stoneridge Investment Partners, LLC v. Scientific-Atlanta, Inc. [PDF] foreclosed liability under common law theories of secondary liability for securities claims. He found Stoneridge did not address the question of “whether a principal is liable vicariously for an Exchange Act violation committed by its agent acting within the agent’s scope of employment.” He also noted that almost every circuit to consider the issue has expressly permitted the application of the common law respondeat superior principle to hold principals liable for Section 10(b) violations by their agents.


Next, the court found that both the form and function of DTT’s relationship with Deloitte Italy and other member firms raised genuine issues of fact as to whether the affiliates were agents of DTT for purposes of vicarious liability.


Despite its website disclaimer, the court found that DTT held itself out as an integrated, cohesive, global entity, providing clients, in the words of CEO James Copeland, with “consistent seamless service across national boundaries.”


In reviewing the element of “function,” the court noted there was evidence that international members followed general professional standards and auditing procedures promulgated by DTT, that DTT set policies and dictated methodologies for conducting audits, that DTT controlled acceptance and rejection of engagement by member firms, that DTT prohibited member firms from suing each other and required member firms to accept client work referred from another member firm, and that member firms generally relied upon DTT’s legal staff.


The court further noted there was evidence that DTT required member firms to purchase specified levels of insurance coverage and that DTT’s professional practice manual provides that “differences of opinion between Member firms” should be resolved by referring such issues to DTT’s chairman and chief executive.


The court further found it significant that in a 2002 difference of opinion between Deloitte Brazil and Deloitte Italy about how to treat a transaction involving Parmalat Brazil, a DTT representative appointed by the CEO made the final decision in favor of disclosure to resolve the dispute.


In denying summary judgment, Judge Kaplan’s court acknowledged that a jury might conclude that the evidence cited by the plaintiffs was insufficient to establish vicarious liability. However, he found the evidence sufficient to create a triable question of fact of agency sufficient to deny the motion. The court also found triable issues of fact as to whether DTT was a “controlling person” within the meaning of Section 20(a) of the Securities Exchange Act based on evidence that DTT purportedly had the ability to influence the preparation of member firms’ audit reports generally, as exemplified by the Parmalat audit prepared by Deloitte Brazil.


After Judge Kaplan’s decision was issued, plaintiffs’ counsel, Stuart M. Grant, New York, told the Wall Street Journal, “This is huge.” Judge Kaplan has finally made the law reflect reality. These accounting firms sell themselves as worldwide, seamless organizations. Now they are going to be held responsible in the same fashion,” he noted.


However, Lamont Jefferson, San Antonio, cochair of the Section’s Commercial and Business Litigation Committee, cautions “Litigators and especially plaintiffs’ lawyers are constantly searching for ways to pierce organizational structures and there will be some who view Judge Kaplan’s ruling as beneficial in that search, but the decision seems very much grounded in the unique facts before the court.”


Keywords: Vicarious liability, summary judgment


 

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