Accountant Can Be Liable For Failing To Detect Fraud

An accounting firm hired to audit a corporation�s finances could be liable to shareholders for failing to detect high-level fraud that led to the corporation�s bankruptcy, a State Supreme Court has ruled. The Corporation retained a large accounting firm as its independent auditor. Two officers of the corporation, who were the primary contacts of the accounting firm, orchestrated a series of fraudulent transactions to inflate the company�s reported expenses. The accounting firm did not detect the fraud for several years. As a result of the fraud, the corporation went bankrupts and had its assets purchased by another company. Plaintiff, the shareholders of the corporation, sued the accounting firm for negligently failing to detect the fraud. As an initial defense, the accounting firm argued that the imputation doctrine, which holds that knowledge of an agent is imputable to its principal, barred the Plaintiff�s suit. But the Court disagreed. The Court stated that the matter does not present the typical circumstance for which the imputation defense was designed because the corporation�s agents did not directly defraud an innocent third party. They defrauded the corporation and its creditors instead. In that respect, the accounting firm is not a victim of the fraud in need of protection. Further, the accounting firm had an independent contractual obligation, at a level defined by its agreement with the corporation, to detect the fraud, which it allegedly failed to do. Allowing the accounting firm to avoid liability for its alleged negligent contact would not promote the purpose of the imputation doctrine, that is, to protect the innocent. Accordingly, the Court held that the lawsuit may continue.

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