On June 23, 2010, the Third District Court of Appeal for the State of Florida reversed entry of judgment on a $510 million jury verdict against BDO Seidman, LLP, and remanded the case for a new trial. BDO Seidman, LLP v. Banco Espirito Santo Int’l, __ So.3d __, 2010 WL 2507051 (Fla. 3d DCA June 23, 2010). In its opinion, the court reaffirmed a number of legal principles that are particularly relevant to public accounting firms.

First, the court reiterated that an auditor is not exposed to liability with respect to all transactions in which its client seeks to raise capital. BDO audited a factoring company, E. S. Bankest L.L.C. (Bankest), which issued $140 million in promissory notes to individual investors. Plaintiffs, as assignees of the noteholders, alleged that the noteholders had been duped into making their investments by Bankest’s materially misstated financial statements, and that BDO bore responsibility by failing, through simple or gross negligence, to detect and prevent those misstatements. 

Under Florida law, to make out such a claim, plaintiffs “had to comply with the test outlined in Restatement (Second) of Torts section 552,” a standard that has been endorsed by the courts of many other states. As the court explained, “[u]nder that test, BDO would have potential liability only if BDO knew, at the time it was hired for a particular audit, that the audit would be used as part of a private placement memorandum which was to be given to prospective purchasers of the notes” or, alternatively, if BDO “subsequently affirmatively consented” to the inclusion of its audit report in the placement memorandum.

That test could not be satisfied with respect to a number of the notes because it was undisputed that BDO’s audit reports were not attached to Bankest’s 1998 and 1999 private placement memoranda. Plaintiffs sought to evade this result by arguing that purchasers of the notes had nevertheless received BDO’s reports “for other reasons.” But that was “insufficient to impose liability.” There was no evidence that BDO knew that its reports—which were not attached to the 1998 and 1999 placement memoranda and were circulated “for other reasons”—would ever be used by investors for the specific purpose of assessing a potential investment in the 1998 and 1999 notes. 

Indeed, even if BDO had known that Bankest’s “financial statements, accompanied by an auditor’s opinion, are customarily used in a wide variety of financial transactions by the corporation and that they may be relied upon by lenders, investors, shareholders, creditors, purchasers and the like, in numerous possible kinds of transactions,” that still would not have sufficed. An auditor cannot be sued under Section 552 merely for issuing an audit opinion with knowledge that its audit client may thereafter engage in one or more capital-raising activities of some sort. Before liability can attach, the auditor must knowingly assume the risk that its report will be used in connection with the specific transaction on which the plaintiff sues.

Next, the court held that even if Bankest’s private placement memoranda “actually included BDO audit reports,” plaintiffs bore the additional burden of proving individual reliance. Plaintiffs maintained that they could “prove individual reliance by calling just one noteholder to testify that he or she relied on the BDO audits,” arguing that “because the private placement memoranda and audit for any particular note series were identical, it can be inferred that every nontestifying noteholder had the same reliance as the testifying noteholder.” The court disagreed, holding that “[w]hat one purchaser may rely upon in entering into a contract may not be material to another purchaser.” Plaintiffs must prove “individualized reliance by each noteholder.” 

Finally, the court rejected plaintiffs’ theory of indirect reliance. Plaintiffs argued that “the noteholders relied on [the plaintiff assignees], which in turn relied on BDO’s financial statements.” But the court found that this argument also ran counter to Section 552, as applied by the Florida courts. Under Section 552, auditors are liable to, at most, a “limited group” of potential investors. If liability extended instead to all who purportedly relied on members of that limited group, the express limitations of Section 552 would be rendered meaningless.

For more information about the BDO Seidman decision, or any other matter raised in this Legal Update, please contact Jonathan Medow at +1 312 701 7060, Brian Massengill at +1 312 701 7268 or David Pope at +1 312 701 8733.

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