Did high-flyer Winstar co-opt its auditing firm?
Defendants facing securities fraud claims have won more than their share of cases in the last half a decade or so. Decisions by the U.S. Supreme Court have helped.
In 2011, for instance, the Court ruled that you must have "ultimate authority" to make a false statement before a lie exposes you to liability under federal securities law. Janus Capital Group, Inc. v. First Derivative Traders, 131 S. Ct. 2296 (2011) (post). Few auditors, if any, will have such authority, other than with respect to their own (one-page) audit opinions.
The Court in Stoneridge Investment Partners LLC v. Scientific-Atlanta, Inc., 552 U.S. 148 (2008) (post), held that aiding and abetting securities fraud doesn't run afoul of the Securities Exchange Act of 1934, at least in private litigation. That eliminates most claims against auditing firms.
And in Tellabs, Inc. v. Makor Issues & Rights Ltd., 551 U.S. 308 (2007) (post), the Court set a tough test for judging whether a complaint alleges facts that raise a "strong inference" of the scienter element — whether the pleading as a whole gives "cogent" reasons for believing that the defendants meant to practice a fraud. The standard defeats a great many securities fraud cases, including those against auditors.
The plaintiffs' bar recognizes that courts tend to view fraud claims against auditors with a skeptical eye. Such claims rarely survive the long gauntlet they must run — from Twombly motions to dismiss, Dukes attacks on class certification, Daubert challenges to experts, and Celotex motions for summary judgment — even if claims do survive against the securities issuer itself or its insiders.
But one squeezed by last week. In Gould v. BIM Intermobiliare SGR, No. 10-4028-cv(L) (2d Cir. July 19, 2012), the court reversed summary judgment for an auditing and accounting firm, Grant Thornton, which issued a clean audit opinion for the (fraudulent) 1999 financial statements of broadband services provider Winstar Communications. Winstar filed for bankruptcy protection about a year after it published its 1999 financials, which inflated its revenues by more than $100 million. The panel reversed the district court's ruling, which held that the plaintiffs had failed to present evidence that raised an inference of scienter. The panel said:
Some evidence supports the Plaintiffs' contention that GT consciously ignored Winstar's fraud when it approved Winstar's recognition of revenue for the suspicious 1999 transactions. This evidence goes beyond a mere failure to uncover the accounting fraud and, in general, relates to (1) Winstar's recognition of revenue for the sale of equipment or services without sufficient indicia of delivery, (2) its reconition of all revenue associated with the incomplete sale of telecommunications systems, and (3) its recognition of revenue for sales of IRUs [indefeasible rights of use], equipment, and services to financially unstable companies to whom Winstar paid back large sums under separate contractual obligations.
Id. at 20.