In an opinion last week, Judge Scheindlin denied the plaintiffs in a securities class action leave to amend their complaint to assert securities fraud claims against the company’s auditors, PriceWaterhouseCoopers and Ernst & Young. The proposed amendment would have alleged that PwC and E&Y took at face value the erroneous opinion of a third party tax preparer (referred to as “Frankel”), which the plaintiffs argued is as reckless and fraudulent as simply taking management representations as true:
Plaintiffs have cited no case — nor have I been able to locate any — that supports the proposition that “a tax preparer’ s analysis, independently done … is no different [than] if it came from management itself.” . . . . The reason auditors are required to investigate in-house representations — indeed, the reason why 10(b)(5) violations occur — is that managers often have an incentive to distort. There is little reason to think that third-party tax preparers, operating at arm’s length from the company, share this propensity. If anything, they have the opposite incentive, because they owe their clients a duty of care, and they face potential liability (unconnected to securities fraud) for performing erroneous calculations. Furthermore, the specific issue addressed in the Frankel opinions — the meaning of section 956 — is notoriously esoteric, even among tax lawyers. It is one thing to say that PwC and E&Y should have done more to discover the misstatements of tax liability. That may be true. But it is quite another thing to say that PwC and E&Y, by relying on the representations of a third-party with (1) every incentive to be truthful and (2) expertise in an abstruse area of tax law, “egregious[ly] refus[ ed] to see the obvious” — much less that they acted with an intent that “approximates an actual intent to aid in the fraud being perpetrated.” That assertion strains credulity.
Our prior post on the case is here.