Auditors Cry Foul. The Audit Interference Rule. by Brian J. Hunt

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1 The Audit Interference Rule Auditors Cry Foul by Brian J. Hunt Suits by audit clients against their auditors, by their very nature, require an analysis of the manner in which the client and auditor interacted. Naturally, by the time suit is filed, the manner in which the client and auditor interacted and who was to blame for what can be a matter of great dispute. Furthermore, the potential disparity between the degree of auditor negligence and the ensuing damages was succinctly summarized by Cardozo in a well-known quote from the Ultramares decision: 2004 DRI. All rights reserved.

2 If liability for negligence exists, a thoughtless slip or blunder, the failure to detect a theft or forgery beneath the cover of deceptive entries, may expose accountants to liability in an indeterminate amount, for an indeterminate time to an indeterminate class. The hazards of a business conducted on these terms are so extreme as to enkindle doubt whether a flaw may not exist in the implication of a duty that exposes to these consequences. Ultramares Corp. v. Touche, 174 N.E. 441, 444 (N.Y. 1931). When faced with allegations of professional negligence, the auditor will likely want to assert the client s comparative fault. In response, the client will contend that any comparative fault on his part should be disregarded or limited. In contrast, the auditor will contend that the scope of the client s comparative fault ought to be broad and encompass, for instance, poor business decisions as well as conduct which may have interfered with the audit itself. This article will address the manner in which courts throughout the United States have analyzed the client s comparative fault in claims for professional negligence resulting from an audit. National Surety: Reports of its Death are Greatly Exaggerated New York had the first reported opportunity to address a client s negligence in the audit context and provided fodder for both sides. In Craig v. Anyon, 212 A.D. 55 (1925), the plaintiffs were securities and commodities brokers for whom the defendant accountant had conducted an audit, every three months, for several years. In fact, plaintiff s employee had embezzled substantial sums over a fiveyear period. In response to plaintiff s allegations of negligence and breach of contract, the defendants alleged the affirmative defenses of plaintiff s negligence which would have been a complete bar to recovery as well as the intervening criminal acts of the embezzling employee. The evidence at trial established that the thieving employee had been given absolute control over the commodities department, encompassing not only the manner in which the business was conducted but also the manner in which the accounting records were kept. Although the jury returned a verdict of over $1 million (the amount embezzled), the trial judge entered judgment against the defendants only in the amount of $2,000 (the amount of fees the defendants had charged). In affirming the trial court s judgment, the appellate court noted both that the plaintiffs had an obligation to supervise the embezzler and that the auditors relied on the embezzler. Id. at The appellate court held that: [T]he loss was not entirely the result of the negligence of the defendants, but also resulted from the careless and negligent manner in which the plaintiffs conducted their business. Id. at 267. The appellate court also held: Plaintiff should not be allowed to recover for losses which they could have avoided by the exercise of reasonable care. Id. at 268. Although Craig is sometimes cited by those who would deny application of the Audit Interference Rule (and its broad reference to plaintiff s negligence supports that end), it can also be read as consistent with the Rule as it developed in the subsequent case law insofar as the undetected fraud was perpetrated by the employee upon whom the auditor relied. When presented with the same issue not too much later, New York took an arguably more refined approach. In National Surety v. Lybrand, 256 A.D. 226 (1939), plaintiff surety company, as subrogee of the audit client, claimed breach of contract and professional Brian J. Hunt is a shareholder with Williams Montgomery & John Ltd. in Chicago where his practice focuses on the counseling and representation of CPAs and other business professionals and on the resolution of business disputes. He is a member of DRI s Professional Liability Committee. negligence against the CPA firms which performed its audits but failed to detect an employee s defalcations. Plaintiff asserted that, if the defendants had discerned and reported the misappropriation, the employer would not have continued to employ the worker in question and therefore would not have sustained the subsequent losses. As an affirmative defense, the defendants asserted the employer s contributory negligence which, again, would have been a complete bar to recovery by conducting their business so as to make the defalcations possible. Reversing the trial court s judgment, the appellate court rejected defendants contributory negligence defenses stating: We are, therefore, not prepared to admit that accountants are immune from the consequences of their negligence because those who employ them have conducted their own business negligently. The situation in this respect is not unlike that of a workman injured by a dangerous condition which he has been employed to rectify. [Citations omitted.] Accountants, as we know, are commonly employed for the very purpose of detecting defalcations which the employer s negligence has made possible. Negligence of the employer is a defense only when it has contributed to the accountant s failure to perform his contract and to report the truth. Id. at Thus, the Audit Interference Rule was born. Nebraska adopted the Audit Interference Rule in Lincoln Grain, Inc. v. Coopers & Lybrand, 345 N.W.2d 300 (Neb. 1984). In that suit, Lincoln Grain alleged that Coopers & Lybrand had negligently conducted its audit with respect to inventory valuation at one of its divisions. The division had no storage or shipping facilities, and its inventory consisted only of contracts to sell or purchase commodities. The audited financial statements, for which Coopers & Lybrand had issued a clean opinion, reflected the division s inventory at $2 million. A post-audit investigation conducted by Lincoln Grain led to an admission by the division s vice president that he had falsified the inventory valuations, and the inventory was accurately valued at $143,000. In response to the negligence allegations, Coopers & Lybrand as- September

3 serted Lincoln Grain s comparative negligence with respect to its failure to monitor and review the division s financial data; failure to properly supervise the division; failure to take notice of information in its possession; and failure to provide Coopers & Lybrand accurate data relating to the division. In reversing the jury s verdict in favor of Coopers & Lybrand, and remanding for a new trial, the Supreme Court of Nebraska explicitly adopted the National Surety holding that the contributory negligence of the client is a defense only where it has contributed to the accountant s failure to perform the contract and to report the truth. Id. at 442. The court stated that to allow accountants to assert as a defense that Lincoln Grain may have conducted its business negligently would render illusory the notion that an accountant is liable for the negligent performance of his duties. Id. Lincoln Grain stands as a close peer to National Surety as the seminal case establishing the Audit Interference Rule. Explicit Adoption Subsequent to the National Surety and Lincoln Grain decisions, the Audit Interference Rule has been explicitly adopted in four additional jurisdictions: Pennsylvania, Utah, Oklahoma, and, most recently, Illinois. In Jewelcor v. Corr, 542 A.2d 72 (Pa. 1988), Jewelcor alleged negligence and breach of contract in connection with Ernst & Whinney s audit of Granjewel, which was conducted for the fiscal year preceding Jewelcor s purchase of it. Jewelcor alleged that it relied on the audited financial statements which inaccurately reflected the inventory evaluation. In affirming the trial court s entry of judgment based on the jury s verdict in favor of Ernst & Whinney, the Superior Court of Pennsylvania adopted the Audit Interference Rule without discussion and noted that Ernst & Whinney presented evidence at trial which showed that Granjewel s employees had miscalculated the inventory evaluation and that Granjewel s officers had failed to timely inform Ernst & Whinney of those errors. Id. at 80. Thus, the court adopted the Audit Interference Rule while affirming a defense verdict. In Fullmer v. Wohlfeiler & Beck, 905 F.2d 1394 (10th Cir. 1990), the plaintiffs were shareholders, creditors and directors who alleged negligence, negligent misrepresentation and fraud against the auditor for large losses sustained from transactions between the plaintiffs and the audit client. The auditors asserted the plaintiff s comparative fault both with respect to their failure to give due attention to the business and their failure to properly conduct their transactions. The trial judge held that the plaintiffs comparative fault was only a defense where the The court adopted the Audit Interference Rule while affirming a defense verdict. plaintiff s conduct contributed to the accountant s failure to perform his work or his failure to furnish accurate accounting information. Although the plaintiffs were imprudent and negligent in the manner in which they handled a number of the subject transactions including obtaining no security and occasionally failing to even obtain notes none of that conduct was relevant to the defendant s responsibility to furnish accurate accounting information. Accordingly, the trial judge ruled in favor of the plaintiffs. The Tenth Circuit Court of Appeals stated that the trial court s holding: is not in conflict with Utah cases and is supported by reason and other authorities, citing National Surety and Lincoln Grain. Id. at The appellate court rejected defendant s argument that Lincoln Grain was decided under contributory fault principles which would have barred any recovery by plaintiffs in the event of their negligence and stated that allowing either a contributory negligence or unfettered comparative negligence defense would lead to the result rejected in Lincoln Grain. Id. at The Supreme Court of Oklahoma addressed the Audit Interference Rule in Stroud v. Arthur Andersen, 37 P.3d 783 (Ok. 2001). In Stroud, the plaintiffs were the corporation which was the general managing agent of a crop insurer and the individual who was the largest shareholder of both the general managing agent and the insurer. The plaintiffs alleged that Andersen s audits of the crop insurer were deficient because the audited financial statements reflected no liabilities (which was a substantial understatement) and because Andersen failed to communicate certain allegedly material internal control weaknesses to the insurer. In response, Andersen alleged that the insurer s losses resulted from bad management decisions and the insurer s flawed internal accounting procedures. On appeal from the jury s verdict against Andersen, Andersen asserted that the trial court s comparative negligence instruction that plaintiff s conduct must have been unreasonable under the circumstances and interfered with defendant s ability to perform its duty contravened Oklahoma s comparative negligence scheme. Id. at 787. In affirming the verdict, the Oklahoma Supreme Court noted the enhanced obligations and responsibilities owed to the public by a person who dons the mantle of a professional. Id. at 789. The court noted the auditor s obligation to discover the client s inadvertent errors in connection with an engagement to provide an opinion as to whether the client s financial statements fairly represent its financial position in conformity with generally accepted accounting principles (GAAP). Id. The court rejected Andersen s effort to have the jury instructed that its conduct as an auditor could be excused if the client s conduct (i.e., negligently keeping the books which Andersen was auditing) caused injury to itself, stating that this was akin to the doctor attempting to excuse the negligent provision of medical services in the emergency room to the accident victim by asserting that it was the plaintiff s own negligence that caused the accident in the first place. Id. at 789. The court noted that Andersen adduced trial evidence, including the purchase of a building and moving the corporate headquarters, from which the jury might have found plaintiff s business decisions negligent. Id. at 790. The court also noted that, in response, plaintiffs adduced evidence that those business decisions were made in reliance on the flawed financial statements ; and that the jury concluded that the plaintiffs did not interfere with the subject audits. Id. Lastly, the court noted that Andersen offered no instance 38 For The Defense

4 where it requested something of the plaintiffs which was not provided to the audit staff and that the individual auditors testified at trial that the plaintiff was very cooperative with all of Andersen s requests. Id. The court also pointed out that circumscribing the use of adduced evidence of plaintiffs own negligence in regard to duty and breach neither foreclosed Andersen from arguing that plaintiffs conduct broke the chain of causation as to the injuries which emanated from the defendant s proven negligence nor precluded Andersen from arguing that its acts did not directly cause the injury for which plaintiff sought compensation. Id. (The court did, however, note that Andersen requested no instruction concerning supervening or intervening causation. Id.) The court stated that it found the legal analysis of National Surety and Fullmer to be persuasive. Id. Recently, Illinois acknowledged that the Audit Interference Rule applies in that jurisdiction. In Board of Trustees of Community College, District No. 508 v. Coopers & Lybrand, 803 N.E.2d 460 (Ill. 2003), the Illinois Supreme Court rejected arguments that the Audit Interference Rule is inapplicable in a comparative fault regime and that the application of the doctrine creates perverse incentives for the audit client. Rejection of National Surety Despite the recent decision of the Illinois Supreme Court, the greater number of jurisdictions to explicitly consider the Audit Interference Rule have rejected the doctrine and even more jurisdictions appear to have implicitly rejected it. Explicit Rejection The Audit Interference Rule has been explicitly considered and rejected in: Florida, Michigan, Minnesota, Arkansas, Arizona, Colorado, and Ohio. In Devco Premium Fin. Co. v. North River Ins. Co., 450 So.2d 1216 (Fla. Dist. Ct. App. 1984). Devco operated a complicated insurance premium finance business for which the outstanding payments due Devco were reflected as accounts receivable in its financial statements. In the event that the insured failed to become current on its payments, Devco principally relied upon the prompt notification to the insured of the arrearage and prompt cancellation of the subject policy. Although Devco s president had available to him monthly accounts receivable agings during the period at issue, he never reviewed them. In addition, the auditor selected 240 receivables to test by confirmation, but tested only 100 after concluding that no problems existed with the tested accounts. In fact, of the 100 accounts tested, 80 were accounts with arrearages and 27 were accounts for which the security interest of the unearned premium had been lost. The auditor, however, ignored the results of the statistical sample testing and instead established a doubtful accounts receivable balance of one-half of one percent of the outstanding premium contracts receivable. The president first became aware that Devco was not a profitable operation nearly one year after the most recently audited period when an employee showed him an accounts receivable aging with approximately onehalf million dollars of accounts receivable more than 90 days delinquent. Thereafter, Devco lost its bank financing and collapsed. The trial judge concluded that both management and the auditor were aware, or should have been aware, that collection of the accounts receivable became highly unlikely if timely cancellation for the non-payment was not effected. The trial judge also concluded that, although generally accepted auditing standards (GAAS) require that the auditor communicate to senior management or the board of directors any material weaknesses in internal control, this obligation is only incidental to performance of an audit and, in any event, the evidence did not establish that any such weaknesses came to the auditor s attention. The trial judge further concluded that, if the auditor had properly tested the accounts receivable, the internal control weaknesses would have been revealed and management could have taken remedial action. Lastly, the trial judge concluded that, although the accounts receivable testing was negligently done, Devco relied upon the audits to an unwarranted degree. The trial judge apportioned fault 80 percent to Devco and 20 percent to the auditor and entered judgment thereon. In affirming the judgment, the appellate court declined to adopt the holding of National Surety, noting that it was decided in a contributory negligence scheme which had been rejected in Florida. Id. at Instead, the court adopted the holding of Craig that plaintiff should not be allowed to recover for losses which they could have avoided by the exercise of reasonable care. Id. In Capital Mortgage v. Coopers & Lybrand, 369 N.W.2d 922, (Mich. Ct. App. 1985), the plaintiff sought recovery from the auditor for the failure to detect a $1.5 million embezzlement. The trial court entered judgment based on the jury s verdict in favor of the plaintiff which apportioned fault percent to the plaintiff and percent to the auditor. On appeal, the plaintiff contended that the issue of comparative fault should not have been placed before the jury because the auditor did not establish a causal link between the plaintiff s poor practices and the auditor s negligence. In affirming the judgment, the appellate court stated that [M]ost cases that dealt with accountant s liability and the client s negligence involved contributory negligence which would have precluded any recovery on the part of the client, citing Lincoln Grain. Id. at 537. The appellate court noted that the adoption of a comparative fault scheme eliminates the harsh result of a bar to recovery and the allowance of the auditor to escape all liability. Id. The court stated that the application of comparative fault principles creates an incentive for both parties to use due care. Id. In Halla Nursery v. Baumann-Furrie, 454 N.W.2d 905 (Minn. 1990), the defendant CPAs had performed accounting services over a three-year interval during which Halla s bookkeeper had embezzled $135,000. Halla alleged the CPA s negligence and the defendants, in turn, alleged Halla s comparative fault for, among other things, failing to put in place internal financial controls to protect the company from embezzlement. The trial court denied Halla s motion in limine to exclude all evidence of Halla s negligence which did not directly affect the CPA s ability to perform the contract and report the truth. The trial court also rejected Halla s proposed jury instruction attempting to limit Halla s contributory negligence to any acts or conduct which prevented the defendants from September

5 detecting the embezzlement. The jury allocated fault 80 percent to Halla and 20 percent to the CPAs, and a judgment of no recovery was entered. As the Supreme Court of Minnesota framed the issue: [T]he issue is not whether comparative fault applies but whether, in the context of an accountant malpractice action, the scope of the principles of comparative fault should be limited in their application. Id. at 907. While acknowledging the decisions in Craig, National Surety and Lincoln Grain, the court noted that some courts had refused to follow National Surety and Lincoln Grain because they were decided under contributory negligence schemes, citing Devco. Id. at 909. In affirming the trial court s treatment, the Supreme Court of Minnesota noted that Minnesota had broadly construed the comparative fault applicable to professional malpractice actions. Id. The court also noted that the Audit Interference Rule had generally only been applied to auditing contracts between a client and an accountant, and that the record was unclear as to whether the subject accounting services did involve an audit. Id. However, the court also stated that there may be instances where a limited exception to its ruling might be necessary, for example, where the scope of employment is such that discovery of defalcation is clearly encompassed. Id. FDIC v. Deloitte & Touche, 834 F.Supp (E.D. Ark. 1992), decided under Arkansas law, involved allegations of professional negligence in connection with bank audits which allegedly resulted in damages in excess of $400 million. Ruling on motions to dismiss, the trial judge determined that Arkansas would not follow National Surety in light of its broad application of comparative fault principles and the absence of harsh results concomitant with a contributory negligence regime. Id. at The court stated its view that comparisons between a patient s fault in medical malpractice cases and client s fault in accountant s malpractice cases is not particularly useful. Id. at Similarly, in RTC v. Deloitte & Touche, 818 F.Supp (D. Colorado, 1993), decided under Colorado law, the court ruled that adoption of the Audit Interference Rule (citing Fullmer) would effectively abrogate the statutorily enacted modified comparative fault scheme under Colorado law. Therefore, the Audit Interference Rule was rejected. In Scioto Memorial Hosp. Ass n v. Price- Waterhouse, 659 N.E.2d 1268 (Ohio 1996), Scioto Memorial Hospital hired PriceWaterhouse to advise on the financial feasibility of constructing a residential retirement center; to review the work of the architect, underwriter and marketing consultant; and to recommend whether to proceed with the investment. When fire destroyed three-quarters of the project, Scioto decided to rebuild with insurance proceeds, allegedly based on the advice of PriceWaterhouse. Thereafter, the project tanked. Scioto alleged PriceWaterhouse s negligence and breach of contract for failing to adequately assess and disclose to Scioto the risks associated with the project and failing to accurately reflect in its report the financial forecast of the underwriter. At trial, PriceWaterhouse presented evidence that Scioto s damages resulted from: residents backing out after fire-related construction delays; and Scioto s lack of business interruption insurance to cover the construction delay. The trial court had granted Scioto s motion in limine with respect to PriceWaterhouse s defense of comparative negligence based on National Surety, and no instruction on comparative negligence was given to the jury. The jury returned a verdict of $15 million, which was reduced by remittitur to $8.8 million. In affirming the trial court s judgment, the Supreme Court of Ohio stated that the Audit Interference Rule was made to soften the harsh rule which barred recovery of damages in the event of plaintiff s contributory negligence. Id. at However, the court stated that, in light of Ohio s comparative negligence statute, there was no need for a special rule. Id. The court held that, any negligence by a client, whether or not it interferes with the accountant s performance of its duties, can reduce the client s recovery. Id. The court went on to state that, [W]hile accountants should exercise ordinary care in conducting their accounting activities, the persons who hire accountants, usually business persons, should also be required to conduct their business activities in a reasonable and prudent manner, citing Halle Nursery. Id. The court noted, however, that despite the trial court s error in granting the motion in limine, PriceWaterhouse was not precluded from presenting extensive evidence tending to show that Scioto s own conduct was a cause of its losses, in addition to the negligence of PriceWaterhouse. Id. at The court concluded, therefore, that the error was not prejudicial. In Standard Chartered v. PriceWaterhouse, 945 P.2d 317 (Ariz. 1997), Standard Chartered alleged that it was caused to buy another bank (United) that it would not have otherwise bought, by PriceWaterhouse s negligent audit of United and approval of misleadingly favorable financial statements that United had prepared. The jury returned a verdict in the amount of $338 million, and judgment was entered thereon. As the appellate court framed the issue as to the Audit Interference Rule, it was: When the negligence that a third party attributes to an auditor is the failure to detect and report the financial mismanagement and inaccurate reporting of the audit client, may the auditor attempt to reduce its share of liability by allocating fault to the negligent client? Id. at 324. The appellate court answered in the affirmative, noting that National Surety had been decided in a jurisdiction in which contributory negligence was a complete defense. Id. at 352. In contrast, contributory negligence had never been a complete defense under Arizona law, and Arizona was then a jurisdiction of several liability and comparative fault. Id. For the sake of completeness, it is worth noting that the Court of Appeals of Texas applied the Audit Interference Rule in a case where contributory negligence was still a complete defense. Greenstein, Logan & Co. v. Burgess Mktg., Inc., 744 S.W.2d 170, 190 (Tex.Ct.App. 1987). However, that same year, the Texas legislature amended the contributory fault scheme to adopt a modified comparative negligence regime. See, Tex. Civil Practice and Remedies Code Ann. Section et seq. (1987). The amendments, which expressly applied to negligence relating to any professional services rendered by [a] certified public accountant allowed a claimant to recover damages only if his percentage of responsibility is less than or equal to 50 percent. Id. Section The term percentage 40 For The Defense

6 of responsibility is defined to be the percentage attributed by the trier of fact to each claimant [and] each defendant with respect to causing or contributory to cause in any way harm for which recovery of damages is sought. Id. Section (emphasis added). Therefore, the Texas legislature has arguably rejected the Audit Interference Rule. Furthermore, in University National Bank v. Ernst & Whinney, 773 S.W.2d 707, 708 (Tex. Ct.App. 1999), the jury was allowed to consider management s negligent supervision as evidence of contributory fault which did not affect the audit, although the issue was waived on appeal and not addressed by the Appellate Court. Id. at 710. Implicit Rejection Although not expressly considered, the Audit Interference Rule appears implicitly to have been rejected in the following jurisdictions: Iowa (American Trust v. United States Fidelity & Guaranty Co., 439 N.W.2d 188 (Iowa 1989)); Kansas (Comeau v. Rupp, 810 F.Supp.1172, 1182 n.6 (D. Kan. 1992)); Louisiana (National Credit Union v. Aho, Henshue & Hall, 1991 WL (E.D.La. 1991)); Maryland (Wegad v. Howard Street Jewelers, Inc., 605 A.2d 123 (Ct. App. Md. 1991)); New Jersey (H. Rosenblum v. Adler, 461 A.2d 138 (N.J. 1983)); Oregon (Maduff Mortgage Corp. v. Deloitte, Haskins & Sells, 779 P.2d 1083 (Or. App. Ct. 1989)); Washington (Esca v. KPMG, 959 P.2d 651 (Wash. 1998)); and Wisconsin (Imark Industries v. Arthur Young, 436 N.W.2d 311 (Wis. 1989)). The Most Recent Jurisdiction Heard From In Board of Trustees of Community College District No. 508 v. Coopers & Lybrand, 803 N.E.2d 460 (Ill. 2003), the Board sought more than $50 million in compensatory damages for the auditor s failure to discover and report to the board inappropriate investments made by the treasurer and chief financial officer. Despite board resolutions that funds were to be invested only in securities guaranteed as to payment by the full faith and credit of the United States of America, and an investment policy that securities should be purchased with the intent of holding to maturity the latter so as to minimize interest rate risk the treasurer and CFO had invested in complicated derivative investments which he expected to sell for a profit before he had to pay for them. Effectively, the treasurer and CFO was making unauthorized bets on interest rate fluctuations. Although Coopers asserted the Board s comparative negligence, the trial court applied the Audit Interference Rule, and Coopers was precluded from arguing the extensive evidence of the Board s oversight of the CFO and its The court noted the auditor s obligation to discover the client s inadvertent errors. knowledge of possible investment policy violations. Coopers was, however, allowed to argue comparative negligence with respect to misrepresentations that the CFO had made as to the contents of the investment portfolio and changes thereto. Id. at 463. Coopers was also allowed to introduce a management representation letter, signed by the acting controller, which stated that the plaintiff was not aware of any violations or possible violations of law or regulations whose effects should be considered for disclosure in the financial statements or as a basis for recording a loss contingency and that no matters or occurrences have come to our attention to the date of this letter that would materially affect the financial statements and related disclosure for the year ended. Id. at 464. The jury determined gross damages of approximately $23 million and assessed comparative fault to the Board of 45 percent. Therefore, the judgment entered against Coopers was over $12 million. In affirming the application of the Audit Interference Rule, the Illinois Supreme Court noted the Rule s birth in National Surety and a prior Illinois decision also decided under contributory negligence principles which adopted National Surety. Id. at The court held that, despite the subsequent statutory adoption of a modified comparative fault scheme, and a Public Accounting Act which made the modified comparative fault scheme applicable to accountants, the Audit Interference Rule had not been rejected. Id. at 465. The court noted that other jurisdictions that had adopted a comparative fault scheme also retained the Audit Interference Rule, citing Stroud and Fullmer. Id. at 467. Analogizing to a prior Illinois decision relating to a dental malpractice action, the court stated: Just as the patient s poor dental hygiene could not be asserted as a defense to the negligent infliction of a surgical injury, a client s poor business practices cannot be asserted as a defense to the auditor s negligent failure to discover and report a client s non-compliance with investment policy and legal requirements. Id. at 467. Rejecting the argument that application of the Audit Interference Rule would relieve the client from responsibility for negligence not directly affecting the audit, the court noted the more immediate and powerful incentives to management such as reputation, income and other similar benefits. Id. at 468. The court also referred to other potential deterrents, such as internal inquiry, shareholder disapproval, civil lawsuits, state and federal regulations and investigations by independent agencies. Id. Lastly, the court stated that application of the Audit Interference Rule gives the auditor incentive to exercise more skepticism of the client s statements, resulting in greater care by the client. Id. Conclusion As the recent decision in Community College makes clear, the battle over application of the Audit Interference Rule continues to rage. While some courts and commentators have noted that in certain circumstances (e.g., fraud by the auditor s principal client contact), adoption of the Audit Interference Rule will make little difference, one can easily conceive of other instances where its effect can be dramatic. The foregoing discussion displays the arguments for and against application of the Audit Interference Rule. In those jurisdictions where it applies, the challenge to CPAs and those who represent them will be to carefully link the client s comparative fault to the auditor s ability to perform the contract and report the truth. September