Accounting and Auditing Liability Issues Connecticut

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1 2015 by the American Bar Association. Reprinted With permission. All rights reserved. This information or any or portion thereof may not be copied or disseminated in any form or by any means or stored in an electronic database or retrieval system without the express written consent of the American Bar Association. Accounting and Auditing Liability Issues Connecticut James Bicks and Robert Hoff 1 Wiggin and Dana LLP Two Stamford Plaza 281 Tresser Boulevard Stamford, CT Lexington Avenue New York, NY jbicks@wiggin.com rhoff@wiggin.com A. Nature of Malpractice Claim (Tort, Contract, etc.) Professional malpractice is the failure of one rendering professional services to exercise that degree of skill and learning commonly applied under all the circumstances in the community by a reasonable prudent member of the profession with the result of injury, loss or damage to the recipient of those services. 2 There are four essential elements to a malpractice claim: (1) the defendant must have a duty to conform to a particular standard of conduct for the plaintiff s protection; (2) the defendant must have failed to measure up to that standard; (3) the plaintiff must suffer actual injury; and (4) the defendant s conduct must be the cause of the plaintiff s injury. 3 A critical question in cases against accountants and auditors in Connecticut is whether the plaintiff s claim sounds in tort or contract. Several consequences flow from this distinction, including the applicable statute of limitations three years for negligence and six years for breach of contract and whether a comparative negligence defense is available a defendant cannot plead comparative negligence in response to a breach of contract claim. 1 The authors are partners at Wiggin and Dana LLP and represented defendants in two of the cases discussed in this article: Vigilant Ins. Co. v. PricewaterhouseCoopers, LLP, No. X07-CV S (Conn. Super. Ct.), and Retirement Programs for Employees of the Town of Fairfield v. NEPC, LLC and KPMG LLP, No. X08-CV S (Conn. Super. Ct.). 2 Mukon v. Gollnick, No. CV S, 2013 WL , at *2 (Conn. Super. Ct. Feb. 15, 2003) (citing Barnes v. Schlein, 192 Con. 732, 735, 473 A.3d 1221 (1984)), reversed on other grounds Mukon v. Gollnick, 151 Conn. App. 126, 92 A.2d 1052 (2014). 3 Stuart v. Freiberg, 142 Conn. App. 684, 703, 69 A.3d 320, 331 (2013) (citations and emphasis omitted).

2 A claim against an accountant or auditor, like a claim against any other professional, can sound in tort or contract. 4 But the actual nature of the claim not what the plaintiff calls it will determine the applicable cause of action. A claim that an auditor failed to do something required by law, including professional standards, would support a tort claim. A claim that an auditor failed to perform a specific task required only by virtue of a contractual promise would support a breach of contract claim. In Vigilant Insurance Co. v. PricewaterhouseCoopers, a case alleging the auditors failed to detect an audit client s controller s embezzlement, the court observed that a claim that a defendant promised to work diligently or in accordance with professional standards is not made a contract claim simply because it is couched in the contract language of promise and breach. 5 Rather, the courts will look beyond the language used in the complaint to determine what the plaintiff really seeks. Just as [p]utting a constitutional tag on a nonconstitutional claim will no more change its essential character than calling a bull a cow will change its gender... putting a contract tag on a tort claim will not change its essential character. An action in contract is for the breach of a duty arising out of a contract; action in tort is for a breach of duty imposed by law. 6 Several courts have explained in the context of claims against other professionals, that to survive as a contract claim, a claim must refer to specific actions required by the defendant or cite promises to achieve a specific result. 7 In the Vigilant case, the court framed the issue as whether the [auditor s] engagement letters require specific actions of the defendant within the context of the action complained of by the plaintiff. 8 In other words, the court looked not only to the specific promises in the engagement letters, but also, which promises the defendant allegedly breached. The court held on summary judgment that plaintiff s claim sounded in tort, 4 See Vigilant Ins. Co. v. Deloitte & Touche, LLP, No. X07-CV S, 2008 WL , at *2 (Conn. Super. Ct. Jun. 12, 2008) ( Vigilant 2008 Decision ) (stating, Vigilant properly argues that it may plead both in contract and tort ). See also Weiner v. Clinton, 106 Conn. App. 379, 383, 942 A.2d 469 (2008) ( Connecticut law recognizes that one may bring against an attorney an action sounding in both negligence and contract. ). 5 Vigilant Ins. Co. v. PricewaterhouseCoopers, LLP, No. X07-CV S, 2011 WL , at *2 (Conn. Super. Ct. Mar. 2, 2011) ( Vigilant 2011 Decision ) (quoting Connecticut Educ. Ass n, Inc. v. Milliman USA, Inc., 105 Conn. App. 446, A.2d 1249 (2008)). 6 Id. (quoting Gazo v. Stamford, 255 Conn. 245, 263, 765 A.2d 505 (2001)). 7 Weiner, 106 Conn. App. at 385; see also Caffery v. Stillman, 79 Conn. App. 192, 197 (2003) (explaining that a contract claim can stand where a defendant who is a professional breached an agreement to obtain a specific result ). 8 Vigilant 2011 Decision, 2011 WL , at *3. 2

3 not contract, where the applicable engagement letters did not contain any specific promises outside of the GAAS requirements that defendant allegedly breached. 9 Arguably, the only task that the auditor was bound to perform solely by virtue of promising to do so in the contract as opposed to being bound to do so by law was to complete the audit that the client paid for. But, as the court noted, [t]he plaintiff does not dispute that the defendant completed the work and issued an unqualified opinion for the subject years. 10 The engagement letters also stated that the auditor would perform certain audit steps that the plaintiff claimed the auditor did not perform such as considering internal controls over financial reporting for the purposes of determining the necessary audit procedures. The court compared the engagement letters to GAAS and reasoned that GAAS already required the auditor to perform those audit steps. Therefore, they were not separate and distinct contractual promises to perform that could give rise to a breach of contract claim. 11 In a related case, the same court held on a motion to strike the Connecticut procedural equivalent of a Federal Rule 12(b)(6) motion to dismiss that a claim against Deloitte & Touche sounded in contract, where the engagement letter contained promises to perform specific actions that plaintiff claimed Deloitte & Touche breached. 12 Some of those actions were the very same actions that GAAS required. But construing the complaint most favorably to plaintiff, as the court had to do at the motion to strike stage, the court held that promises in the engagement letter to perform such tasks as obtaining an understanding of internal controls sufficient to plan the audit, supported a breach of contract claim. 13 The court also cited in support of the breach of contract claim the engagement letter s promises to perform an examination in accordance with the attestation standards established by the American Institute of Certified Public Accountants (AICPA) and the issuance of an attestation report on management s written assertion regarding the effectiveness of internal control over financial reporting, to perform an examination of management s assertions regarding the Company s policies and procedures relating to information barrier controls, and to perform procedures required by SEC Rule 17a At the motion to strike stage, when the court was confined to the allegations of the complaint, the court could not consult GAAS and compare the engagement letter s promises to 9 Id. See also Arnold v. Weinstein, Schwartz & Pinkus, No. CV S, 1996 WL 93602, at *3 (Conn. Super. Ct. Feb. 13, 1996) (denying accountant s motion for summary judgment where there was an issue of fact as to whether accountant simply agreed to perform in accordance with the standard of care or to perform additional, specific actions such as advising plaintiff on how to invest to take advantage of tax laws). 10 Vigilant 2011 Decision, 2011 WL , at *3. 11 Id. at * Vigilant 2008 Decision, 2008 WL , at *3. 13 Id. 14 Id. 3

4 the professional standards. 15 But when the court revisited this issue on summary judgment, it reversed course in part. It recognized that, [l]ooking now at the evidence, as opposed to being confined to the four corners of the complaint, it is clear that merely stating that D & T will perform the audit pursuant to GAAS is no more than spelling out that D & T will follow the professional standards. 16 Nevertheless, the court denied Deloitte s motion for summary judgment because an issue of fact existed as to whether there were other actions Deloitte promised to perform that were not required by GAAS. 17 Other Connecticut Superior Courts have considered this tort/contract distinction in accountant or auditor malpractice cases. Some have concluded that an alleged breach of an accountant s or auditor s agreement to perform in accordance with the standard of care sounds in tort. 18 Others have allowed both contract and tort claims to proceed despite each being based on alleged breaches of the standard of care. However, it is not clear that defendants in those cases argued that the contract claims should be dismissed as being duplicative of the tort claims. 19 B. Standing/Existence of Duty 1. Clients Clients have standing to assert claims against accountants and auditors. We are not aware of any Connecticut case law contradicting this point. 15 Id. See also Aetna Cas. & Sur. Co. v. Price Waterhouse LLP, No. CV S, 1998 WL , at *3-4 (Conn. Super. Ct. June 23, 1998) (denying defendant s motion to strike breach of contract claim as duplicative of professional negligence claim and stating that the court could not refer to professional standards and compare them to the complaint s allegations on a motion to strike because professional standards were outside the scope of the allegations). 16 Vigilant Ins. Co. v. Deloitte & Touche LLP, Nos. X07-CV S and X07-CV S, 2009 WL , at *2 (Conn. Super. Ct. Oct. 27, 2009) ( Vigilant 2009 Decision ). 17 Id. 18 See Facchini v. Miller, No. CV S, 2000 WL at *3 (Conn. Super. Ct. Jan. 31, 2000) (striking breach of contract claim against auditor for failing to allege more than a failure to provide the requisite standard of care ); Conco Med. Co. v. Zimmer and Zimmer, PC, No. CV S, 1997 WL at *1 (Conn. Super. Ct. Feb. 6, 1997) (noting, in breach of contract claim against auditor, that [w]hile the defendants duty to follow the standard of care is based on a contractual relationship, the gravamen of the claim is negligence ). 19 In Curtis Packaging Corp. v. KPMG LLP, No. X06-CV S, 2002 WL (Conn. Super. Ct. July 31, 2002), both contract claims and tort claims against an auditor were pursued, but there is no suggestion that the defendant argued that the contract claims were duplicative of tort claims, and the court did not appear to address the issue. In Northeast Mortgage Corp. v. Robison, Hill & Co., Nos. CV S and CV S, 2013 WL (Conn. Super. Ct. Aug. 23, 2013), the court, without extensive discussion, allowed plaintiff to proceed with breach of contract claims against an auditor even though those claims were based on an alleged violation of GAAS and GAAP. Id. at *5-6. 4

5 2. Trustees and Receivers When a bankruptcy trustee or a receiver for a liquidated entity sues a professional that provided services to the debtor, including an accountant or auditor, the trustee generally may bring claims founded on the rights of the debtor, and not claims that belong uniquely to individual creditors. 20 Whether rights belong to the debtor or individual creditors is a question of state law. Connecticut law has recognized the standing of creditors to maintain causes of action for negligence, breach of fiduciary duty, and fraud against professionals who provided services to the debtor when such claims are particularized as to the creditors. 21 For example, a court held that a bankruptcy trustee had no standing to bring claims predicated on the distribution by an accounting firm of misleading investment documents to investors since the investors had the exclusive right to bring those claims. 22 But a liquidator had standing to pursue claims on behalf of an insolvent insurer where the allegations were that the defendant failed to report the true financial condition of the insurer to the State Insurance Department, thereby allowing the insurance company to continue into insolvency without the insurance commissioner s knowledge. This alleged conduct diminished the insurance company s estate, which injured the public and all creditors and policyholders equally Other Assignees of Clients We did not find any case law in Connecticut discussing this topic. We note that an insurance company that pays an insurance claim to an auditor s client for a loss allegedly caused by the auditor s negligence has standing to sue the auditor where the audit client assigns its rights and claims to the insurance company Third Parties a. Privity/Foreseeable Users/Restatement (2d) of Torts 552 Connecticut s Appellate Court recently observed that courts generally now permit actions for professional malpractice without reference to privity, so long as the plaintiff is the intended or foreseeable beneficiary of the professional s undertaking 25 However, the conclusion that a particular injury to a particular plaintiff or class of plaintiffs possibly is 20 Hirsch v. Arthur Andersen & Co., 72 F.3d 1085, 1093 (1995) (citing Connecticut law); Reider v. Arthur Andersen, LLP, 47 Conn. Supp. 202, (Conn. Super. Ct. 2001). 21 Hirsch, 72 F.3d at 1093 (citing Gengras v. Coopers & Lybrand, No. CV S, 1994 WL , at *5 (Conn. Super. Ct. Mar. 31, 1994), Tackling v. Shinerman, 42 Conn. Supp. 517, 630 A.2d 1381, 1384 & n.2 (1993); Twin Mfg. Co. v. Blum Shapiro & Co., P.C., No , 1992 WL (Conn. Super. Ct. Feb. 18, 1992)). 22 Id. at Reider, 47 Conn. Supp. at See, e.g., Vigilant 2008 Decision, 2008 WL , at *1; Aetna Cas. & Sur. Co., 1998 WL , at *1. 25 Stuart, 142 Conn. App. at 703 (quoting Mozzochi v. Beck, 204 Conn. 490, 499, 529 A.2d 171 (1987)). 5

6 foreseeable does not, in itself, create a duty of care. 26 The court concluded that the defendant accountant was not entitled to summary judgment because there was an issue of fact as to whether the plaintiffs were intended beneficiaries of the defendant accountant s reports. 27 While the Appellate Court seems to have set forth a standard by which to measure an accountant s duty to non-clients, it did not address a long line of Connecticut Superior Court cases that have split on how to address this issue some applying a near-privity test derived from New York law, and others applying the Restatement (2d) of Torts 552. The Appellate Court s approach sounds more like the Restatement, described below, but that conclusion is not clear given that the court did not cite the Restatement or other cases applying it. 28 Connecticut Superior Courts have split on whether to apply the near-privity rule or the Restatement to analyze the question of an accountant s duty to non-clients. 29 The near-privity rule provides that: [b]efore accountants may be held liable in negligence to noncontractual parties who rely to their detriment on inaccurate financial reports, certain prerequisites must be satisfied: (1) The accountants must have been aware that the financial reports were to be used for a particular purpose or purposes; (2) in the furtherance of which a known party or parties was intended to rely; and (3) there must have been some conduct on the part of the accountants linking them to that 26 Id. at 704 (quoting Waters v. Autuori, 236 Conn. 820, 827, 676 A.2d 357 (1996)). 27 Id. at On appeal, the Connecticut Supreme Court declined to address the duty issue because it dismissed plaintiff s claims on other grounds. See Stuart v. Freiberg, 316 Conn. 809, 820 n.12 (2015). The dissent argued that Connecticut should adopt an intended beneficiary rule, at least in cases where an accountant is hired by an executor of an estate. Relying on case law examining the scope of an attorney s duty, the dissent contended that an accountant owed a duty to her client and to an intended or foreseeable beneficiary of the accountant s services. Id. at 845 (citing Krawczyk v. Stingle, 208 Conn. 239, 543 A.2d 733 (1988)). In the context of an accountant providing services to the executor of an estate, the dissent would have held that plaintiffs who were the estate s only beneficiaries created a genuine issue of material fact as to whether they were the intended or foreseeable beneficiaries of the accountant s services because: the executor of the estate hired the accountant; the accountant was paid with estate funds; the accountant had at least one conversation with one of the plaintiffs about financial statements; and the accountant forwarded financial statements to the plaintiffs, knowing they were the only beneficiaries of the estate. Id. at See Retirement Programs for Employees of the Town of Fairfield v. NEPC, LLC and KPMG LLP, No. X08-CV S, 2011 WL (Conn. Super. Ct. Dec. 8, 2011) ( Town of Fairfield II ) (analyzing plaintiffs claims under both rules); Schwartz v. Blum, Shapiro & Co, P.C., No. X04-CV , 2006 WL (Conn. Super. Ct. April 17, 2006) (same); Dudrow v. Ernst & Young, LLP, No. X01-CV , 1998 WL , at *9 (Conn. Super. Ct., Nov. 4, 1998) ( Dudrow I ) (rejecting New York s near-privity rule); Shawmut Bank Conn. N.A. v. Deloitte & Touche, No. CV S, 1995 WL (Conn. Super. Ct. Apr. 25, 1995) (rejecting New York rule in connection with negligence claim, and applying Restatement rule in connection with negligent misrepresentation claim); Rogovan v. Coopers & Lybrand, No , 1992 WL (Conn. Super. Ct. Apr. 3, 1992) (following near-privity rule); Twin Mfg. Co. v. Blum, Shapiro & Co., 42 Conn. Supp. 119, 602 A.2d 1079 (Conn. Super. Ct. 1991) (same). 6

7 party or parties, which evinces the accountants understanding of that party or parties reliance. 30 The Restatement (2d) of Torts 552, on the other hand, provides in pertinent part: One who, in the course of his business, profession or employment... supplies false information for the guidance of others in their business transactions, is subject to liability for pecuniary loss caused to them by their justifiable reliance upon the information, if he fails to exercise reasonable care or competence in obtaining or communicating the information. 31 This liability is further subject to the restrictions of subsection (2), which limits liability to that suffered: (a) by the person or one of a limited group of persons for whose benefit and guidance he intends to supply the information or knows that the recipient intends to supply it; and (b) through reliance upon it in a transaction that he intends the information to influence or knows that the recipient so intends or in a substantially similar transaction. 32 Comment (a) further explains: one who relies on information in connection with a commercial transaction may reasonably expect to hold the maker to a duty of care only in circumstances in which the maker was manifestly aware of the use to which the information was to be put and intended to supply it for that purpose. 33 The Restatement rule has been described as more generous than the near-privity rule. 34 Unlike the near-privity rule, which requires that the accountant know the identity of the recipient of, and specific use of, its report before a duty of care will follow, the Restatement extends an accountant s duty to foreseeable persons or limited classes of persons for whom the information was intended, either directly or indirectly, even if the identity of the person or persons is unknown. But the Restatement still does not extend liability to all reasonably foreseeable recipients of information. As one Connecticut court observed: 30 Town of Fairfield II, 2011 WL , at *5 (quoting Credit Alliance Corp. v. Arthur Andersen & Co., 65 N.Y.2d 536, 551, 483 N.E.2d 110 (1985)) (emphasis added). 31 Restatement (2d) of Torts 552(1). 32 Id. 552(2). 33 Town of Fairfield II, 2011 WL , at *6 (quoting Restatement (2d) of Torts 552, comment a (emphasis in original)). 34 Id. at *9. 7

8 The better reasoned decisions interpret 552 as limiting the potential liability of an accountant to noncontractual third parties who can demonstrate actual knowledge on the part of accountants of the limited though unnamed group of potential [third parties] that will rely upon the [report], as well as actual knowledge of the particular financial transaction that such information is designed to influence... The accountant s knowledge is to be measured at the moment the audit [report] is published, not by the foreseeable path of harm envisioned by [litigants] years following an unfortunate business decision. 35 The case of Retirement Programs for Employees of the Town of Fairfield v. NEPC, LLC and KPMG LLP, is an example of a case where plaintiffs claims failed under both tests. The plaintiffs had invested as limited partners in the Broad Market Fund, which placed all of its investments under the management of Bernard Madoff. KPMG audited the financial statements of the Broad Market Fund while plaintiffs were limited partners in the fund. Sometime before Madoff s fraud was uncovered, plaintiffs withdrew their investment from the Broad Market Fund and invested with the Maxam Fund, which was not a KPMG client. The Maxam Fund also invested with Madoff, and it was while the plaintiffs money was with Maxam that they suffered losses from Madoff s fraud. Plaintiffs claimed that KPMG s professional negligence harmed them because they would have withdrawn their money from the Broad Market Fund and not invested with Maxam if KPMG had performed its audits in accordance with professional standards. Plaintiffs also claimed that KPMG had communicated its audit reports of the Broad Market Fund directly to plaintiffs. The court held that these allegations failed to establish a duty under the near-privity test because no allegations linked KPMG specifically to the plaintiffs or evidenced KPMG s understanding of how plaintiffs would rely on its audit reports. 36 Under the Restatement, plaintiffs claims also failed because, even though plaintiffs alleged they were part of a limited group of potential entities intended to receive KPMG s report, they did not allege specific facts showing that KPMG knew its audit report regarding the Broad Market Fund would induce the plaintiffs to invest in the Maxam fund. 37 This result can be contrasted with Schwartz v. Blum Shapiro, which also cited both rules. The court denied defendant s motion for summary judgment because there was evidence that the 35 Id. at *10 (quoting Nycal Corp. v. KPMG Peat Marwick, LLP, 426 Mass. 491, 498, 688 N.E.2d 1368 (1998)). 36 Id. at *8. See also Rogovan, 1992 WL at *2 (dismissing complaint under near-privity test where plaintiffs claimed to have relied on defendant s audit report of company to invest in that company but did not allege accounting firm knew plaintiffs would rely on their audit report, did not allege facts linking the accounting firm to the plaintiffs, and did not allege the accounting firm understood how plaintiffs would rely on the report); Twin Mfg., 42 Conn. Supp. at 121 (dismissing complaint under near-privity test where plaintiff claimed to have purchased company in reliance on financial statements of company prepared by defendant, but plaintiff failed to allege that defendant prepared financial statements for plaintiff, was retained to assist plaintiff with purchase, or had any direct contact with plaintiff). 37 Town of Fairfield II, 2011 WL , at *10. 8

9 accounting firm knew a specific plaintiff was provided with statements the firm prepared, knew that plaintiff relied on them, and knew the specific purpose for which plaintiff used them. 38 b. Derivative/Direct Claims [I]t is axiomatic that a claim of injury, the basis of which is a wrong to the corporation, must be brought in a derivative suit, with the plaintiff proceeding secondarily, deriving his rights from the corporation which is alleged to have been wronged. 39 In order for a shareholder to bring a direct or personal action against the corporation or other shareholders, that shareholder must show an injury that is separate and distinct from that suffered by any other shareholder or by the corporation. 40 In the Town of Fairfield case, discussed above, KPMG claimed plaintiffs lacked standing because plaintiffs injury, if any, was derivative of the injury to the general partner in the Broad Market Fund and all limited partners in that fund. 41 The court stated that there is no dispute that under most factual scenarios, a professional negligence claim is a derivative claim that falls under the general partner s ability to bring claims for the fund. 42 However, the court held that plaintiffs alleged sufficient facts to survive a motion to dismiss. Plaintiffs alleged that there was direct contact between KPMG and the limited partners in the Broad Market Fund. KPMG s reports were addressed to The Partners of the Fund, and plaintiffs alleged that KPMG sent its reports directly to the plaintiff plans a fact that KPMG disputed. Despite that factual dispute, the court held that a colorable claim could be made that any limited partner would be reasonably entitled to rely on the information and representations contained in KPMG s audit reports addressed to The Partners, and thus, plaintiffs could assert an individualized injury. 43 As discussed above, however, the court ultimately dismissed plaintiffs claims because KPMG did not owe a duty to plaintiffs. 38 Schwartz, 2006 WL at *4-5. See also Shawmut, 1995 WL at *3 (denying defendant s motion to strike plaintiff s negligent misrepresentation claim, relying on the Restatement approach, where accountant allegedly prepared a report for a company called SecurityLink that it knew would be provided to Shawmut as a condition of Shawmut s loan to SecurityLink). 39 Fink v. Golenbock, 238 Conn. 183, 200, 680 A.2d 1243 (1996) (citation omitted). 40 Id. at Retirement Programs for Employees of the Town of Fairfield v. NEPC, LLC and KPMG LLP, No. X05-CV S, 2011 WL (Conn. Super. Ct. Jan. 5, 2011) ( Town of Fairfield I ) (citation omitted). The court considered Delaware law for guidance given that KPMG audited a Delaware limited partnership, but noted that the ultimate question of whether the court had subject matter jurisdiction was a question of Connecticut law. Id. at *4. 42 Id. at *6. See also Isakov v. Ernst & Young, Ltd., No. 3:10CV1517 (MRK), 2012 WL , at *9-10 (D. Conn. Mar. 19, 2012) (holding that plaintiff s malpractice claim against Ernst & Young was derivative where his injury, if any, was the diminution in value of shares, which all shareholders suffered equally). 43 Town of Fairfield I, 2011 WL , at *7. 9

10 C. Liability/Breach of Duty 1. General Standard of Care a. Role of GAAS (and whether incorporated into state law) Connecticut courts will rely on professional standards to identify the standard of care by which the performance of an accountant or auditor will be measured. 44 i. Reliance on internal controls It is important to educate the court on the standards applicable at the time of the audit and the auditor s responsibilities regarding internal controls under those standards. In Vigilant, the court held that an issue of fact precluded plaintiff s motion for summary judgment on whether Deloitte obtained a sufficient understanding of its client s internal controls. 45 Plaintiff s expert claimed that Deloitte failed to obtain a sufficient understanding of internal controls, and to document and report deficiencies in those controls. Deloitte s expert refuted that claim, and noted that, under the standards applicable at the time of the audit, Deloitte was required to obtain an understanding of the controls, but not to provide assurances on internal controls. 46 The court also denied plaintiff s motion for summary judgment on PricewaterhouseCoopers comparative negligence defense relating to internal controls. Defendant claimed its audit client was to blame for its controller s embezzlement because the client failed to follow the appropriate internal controls in place. Plaintiff moved for summary judgment seeking to dismiss the defense. In denying plaintiff s motion, the court noted, among other things, the embezzler admitted that, if he had followed the internal controls that Conning had adopted, the embezzlement would have been difficult, if not impossible to carry out. 47 Therefore, an issue of fact regarding who was at fault for not detecting the theft, and whether defendant should have found deficiencies in internal controls, precluded summary judgment. In Curtis Packaging, the court held that KPMG was negligent where it did not obtain a sufficient understanding of its client s internal controls to perform the audit. 48 Likewise, in Northeast Mortgage, the court held that the auditor failed to recognize deficiencies in the internal 44 See Vigilant 2011 Decision, 2011 WL , at *3, n.9. See also Curtis Packaging, 2002 WL at *2 ( The standard of care for the accounting profession is GAAS, which is a product of the U.S. Auditing Standards Board and American Institute of Certified Public Accountants. GAAS and statements of auditing standards (SAS) delineated the standard of care for accountants performing audits. ). 45 Vigilant 2009 Decision, 2009 WL , at * Id. 47 Id. at *6. 48 Curtis Packaging, 2002 WL , at *5. 10

11 controls, and that its failure to recognize a lack of segregation of duties allowed a theft at the company to go unnoticed. 49 ii. Auditors not guarantors Connecticut courts have recognized that it is not the auditor s responsibility under GAAS to detect theft, and that [a]uditors are not required to be detectives hired to ferret out fraud. 50 Notably, in the cases that have recognized this principle, the courts nevertheless found the auditors liable for malpractice under the facts of those cases. b. Internal firm guidance (extent to which it may or may not set a standard or be admissible as evidence of GAAS) Internal firm guidance and audit manuals may constitute trade secrets. 51 But the confidential or trade secret nature of such materials is not necessarily a sufficient reason to prevent their production. Courts maintain discretion to decide whether internal firm guidance should be produced because it is relevant to a particular case, balancing the need for the information against the injury that could result from its disclosure. 52 In Curtis Packaging, plaintiffs sought KPMG s internal audit services manual and internal audit checklist. The parties agreed that KPMG s performance should be measured by GAAS and GAAP, which described the appropriate standard of care. KPMG therefore argued that its internal policies were proprietary and irrelevant to determining whether it complied with the standard of care. The court held that [t]he criteria of necessity [for production] is met if the request for materials could show the accounting firm s interpretation and application of the standard of care. 53 But to protect against the production of more proprietary information than necessary, the court ordered KPMG to produce only those sections of its manuals that were directly relevant to plaintiff s claims Northeast Mortgage, 2013 WL , at *5. 50 Curtis Packaging, 2002 WL , at *3 (citation omitted). Accord Northeast Mortgage, 2013 WL , at * Curtis Packaging Corp. v. KPMG LLP, No. X06CV S, 2001 WL , at *1 (Conn. Super. Ct. Mar. 23, 2001). 52 Id. 53 Id. at *2. 54 Id. at *3. 11

12 c. Other standards (statutory, GAGAS, etc.) Connecticut courts have relied on different professional standards, as relevant, to identify the standard of care applicable to a malpractice claim. 55 In addition, Connecticut s State Board of Accountancy oversees the conduct of accountants in Connecticut. The Board has the power to, among other things, investigate violations of applicable statutes and regulations, conduct formal hearings, and impose substantial penalties. 56 D. Causation Causation is proven in two parts: cause-in-fact and legal cause. [A] plaintiff must establish that the defendant s conduct legally caused the injuries, that is, that the conduct both caused the injury in fact and proximately caused the injury But For /Reliance Cause-in-fact is but for causation, which considers whether the injury would have occurred were it not for the professional s conduct Legal/Proximate Causation Proving legal cause means proving proximate cause. Because actual causation, in theory, is virtually limitless, the legal construct of proximate cause serves to establish how far down the causal continuum tortfeasors will be held liable for the consequences of their actions. The existence of the proximate cause of an injury is determined by looking from the injury to the negligent act complained of for the necessary causal connection... This causal connection must be based upon more than conjecture and surmise. The test of proximate cause is whether the defendant s conduct is a substantial factor in producing the plaintiff's injury. The substantial factor test asks... whether the harm which occurred was of the same general nature as the foreseeable risk created by the defendant's negligence See, e.g., Northeast Mortgage, 2013 WL , at *8 (considering claims for violations of GAAP, GAAS, GAGAS and SAS 99); Calibre Fund, LLC v. BDO Seidman, LLP, No. X05CV S, 2010 WL , at *4 (Conn. Super. Ct., Oct. 20, 2010) (GAAS and GAAP). 56 See generally Conn. Gen. Stat. Ann et seq. 57 Northeast Mortgage, 2013 WL , at *10 (quoting Mulcahy v. Hartell, 140 Conn. App. 444, , 59 A.3d 313 (2013)). 58 Vona v. Lerner, 72 Conn. App. 179, 189 (2002). 59 Northeast Mortgage, 2013 WL , at *10 (internal citations and quotation marks omitted). 12

13 The inquiry is necessarily fact-specific. Connecticut courts have not had many occasions to discuss causation in accountant malpractice cases. In one case to address the issue the court held that [r]eliance on misleading financial information [prepared by accountants] in entering into a contract could fairly be held to be a substantial fact in causing damages if the entity with whom the contract was entered proceeds into financial failure. 60 E. Damages 1. Actual Damages A plaintiff who prevails is to receive fair, just and reasonable compensation for all injuries and losses which are proximately caused by the defendant s proven negligence. The purpose of an award of damages is not to punish or penalize the defendant, but to compensate the plaintiff for resulting injuries and losses. The plaintiff should be put in the same position that it would have been in had the defendant not been negligent. Damages should not be speculative. 61 Only a handful of Connecticut courts have addressed damages in accountant or audit malpractice cases. In Curtis Packaging, the court denied plaintiff s request for damages in the full amount of money stolen by an employee of plaintiff s payroll company, finding that such damages were not appropriate under a breach of contract theory or negligence claim. 62 The court ordered KPMG to compensate plaintiff for consequential damages in amounts paid to the IRS for underpayment of payroll taxes caused by the payroll employee s theft. The court also ordered consequential damages for amounts paid to professionals to assist in investigating the theft. 63 In Northeast Mortgage, the court ordered defendants to compensate plaintiff for actual damages in the amount of the deductible it paid on its fidelity insurance, for audit fees it paid, and for consequential damages in the amount of fees it paid an attorney to resolve a tax issue with the IRS Punitive Damages In order to award punitive or exemplary damages, evidence must reveal a reckless indifference to the rights of others or an intentional and wanton violation of those rights. 65 We 60 See Dudrow v. Ernst & Young, No. X01CV , 1999 WL , at *9 (Conn. Super. Ct. Sept. 14, 1999) ( Dudrow II ) (holding that [r]eliance on misleading financial information [prepared by accountants] in entering into a contract could fairly be held to be a substantial fact in causing damages if the entity with whom the contract was entered proceeds into financial failure ). 61 Northeast Mortgage, 2013 WL , at * Curtis Packaging, 2002 WL , at *6. 63 Id. at * Northeast Mortgage, 2013 WL at * Venturi v. Savitt, Inc., 191 Conn. 588, 592, 468 A.2d 933, 935 (1983). 13

14 have not located a case against an accountant or auditor in which punitive damages were awarded for malpractice Attorneys Fees Absent a contractual provision or statute to the contrary, a plaintiff is not entitled to recover its attorneys fees for pursuing a malpractice case. But as discussed above, fees paid to a professional as a consequence of defendant s negligence may be recovered in some cases. F. Defenses 1. Statutes of Limitations Professional negligence claims are governed by a three-year statute of repose. 67 of contract claims are governed by a six-year statute of limitations. 68 Breach a. Accrual In the case of an allegedly negligent audit, the delivery date to the client [of the final audit opinion] is the operative date for accrual of the limitations period. 69 We did not find cases deciding the accrual date of other claims, for example, against an accountant in non-audit cases. 70 i. Continuous representation Connecticut courts have considered a number of bases to toll accrual of the limitations period. As discussed below, however, they have sometimes conflated different doctrines. 66 E.g., Curtis Packaging, 2002 WL , at *6 (rejecting request for punitive damages). Note that punitive damages may be available under some statutory causes of action, such as Connecticut s Unfair Trade Practices Act. 67 Conn. Gen. Stat ( No action founded upon a tort shall be brought but within three years from the date of the act or omission complained of. ). 68 Conn. Gen. Stat (a) ( No action for an account, or on any simple or implied contract, or on any contract in writing, shall be brought but within six years after the right of action accrues... ). 69 Vigilant 2009 Decision, 2009 WL , at *6 (citing Auto Services Co., Inc. v. KPMG, LLP, 537 F.3d 853, 858 (8th Cir.2008); Arnold v. KPMG, LLP, 543 F.Sup.2d 230, 236 (S.D.N.Y. 2008)). See also Northeast Mortgage, 2013 WL , at *3-4 (holding that limitations period began to run on date auditors completed audit). But see Curtis Packaging, 2002 WL at *6 (holding that, under the continuing course of conduct doctrine, the statute of limitations began to run upon discovery of fraud). 70 But see Iacurci v. Sax, 139 Conn. App. 386, 392 (2012) (assuming, without deciding, that plaintiff s claim for negligent tax preparation work accrued on the last date on which the accountant provided professional services); Hnath v. Vecchitto, No. X03CV , 2003 WL at *4-5 (Conn. Super. Ct. Feb. 20, 2003) (assuming, without deciding, that plaintiff s claim commenced on the day it made investments in reliance on accountant s reports). 14

15 One tolling doctrine in Connecticut is the continuous representation doctrine. As adopted, the continuous representation doctrine does not apply to accountants or auditors. The Connecticut Supreme Court adopted the continuous representation doctrine as a basis to toll the statute of repose in the narrow setting of attorney malpractice claims. 71 The doctrine applies only when (1) the defendant attorney continued to represent the plaintiff with regard to the same underlying litigation; and (2) either the client did not know of the alleged malpractice, or the attorney could still mitigate the harm allegedly caused by that malpractice during the continued representation period. 72 The Court was driven by considerations unique to the attorney-client relationship. 73 The doctrine has not been extended by Connecticut s appellate courts beyond its original context of attorney malpractice committed during the course of litigation. 74 In Vigilant, the court held that the continuous representation doctrine does not apply in accounting malpractice cases. 75 Some Connecticut trial courts have applied the doctrine to accountants. 76 But they may no longer be good law as they were decided before appellate authority clarifying that the doctrine is limited to the attorney-client relationship. ii. Other (Continuing Course of Conduct) The continuing course of conduct doctrine is another basis for tolling the statute of limitations. It applies when the defendant: (1) committed an initial wrong upon the plaintiff; (2) 71 See DeLeo v. Nusbaum, 263 Conn. 588, 597 (2003). 72 Id. at For example, the Court was concerned about forcing a client to defend its attorney s conduct in the context of the ongoing litigation, while concurrently requiring the client to challenge the attorney s alleged malpractice in a separate case. Id. at 595; see also id. at 597 n.4 (explaining that our holding today is limited to cases in which an attorney is alleged to have committed malpractice during the course of litigation ). 74 In Piteo v. Gottier, 112 Conn. App. 441, 963 A.2d 83 (2009), the Court made clear that the continuous representation doctrine applies only within the attorney-client relationship and does not apply to claims against other professionals, such as accountants: The plaintiff argues that the continuous representation doctrine should be applied equally to all professionals, including accountants and financial investment professionals, who owe fiduciary obligations to their clients. We disagree. We do not believe that our Supreme Court intended the continuous representation doctrine to apply a priori to all professionals owing a fiduciary duty to their clients. Id. at See also Sean O'Kane A.I.A. Architect, P.C. v. Puljic, 148 Conn. App. 728, 734, 87 A.3d 1124, 1128 (2014) ( The plaintiff argues that this case is appropriately subject to the continuous representation doctrine. That doctrine, however, has been applied thus far only to contexts involving attorneys, where ethical considerations inform the preference to delay accrual, from the time of the act or omission complained of until the attorney's representation has ended. ). 75 Vigilant 2009 Decision, 2009 WL , at *6 n.16 (citing Piteo, 112 Conn. App. at 447). 76 E.g., Schwartz, 2006 WL , at *2 (Conn. Super. Ct. Apr. 17, 2006) (finding that continuous representation doctrine might apply to claim against an accountant where there was a longstanding relationship); Curtis Packaging, 2002 WL , at *6 (referring to continuous course of conduct doctrine, but tolling limitations period on sole basis that [a] review of the engagement letters confirms the continuing relationship between the client and auditor ); Hnath, 2003 WL , at *8 (declining to grant summary judgment based on statute of limitations because law was unclear and there was a question as to whether or not the continuous representation doctrine applies to the accountant-client relationship in this case ). 15

16 owed a continuing duty to the plaintiff that was related to the alleged original wrong; and (3) continually breached that duty. 77 To satisfy the second prong, the plaintiff must demonstrate that the defendant owed plaintiff a duty that remained in existence after commission of the original wrong related thereto. 78 As the Connecticut Supreme Court has explained, the doctrine focuses on the defendant s duty to the plaintiff arising from his knowledge of the plaintiff s condition. 79 [I]f the defendant had reason to know that the plaintiff required ongoing treatment or monitoring for a particular condition, then the defendant may have had a continuing duty to warn the plaintiff or to monitor the condition and the continuing breach of that duty tolls the statute of limitations. 80 Where courts have upheld a finding that a duty continued to exist after the cessation of the act or omission relied upon, there has been evidence of either a special relationship between the parties giving rise to such a continuing duty or some later wrongful conduct of a defendant related to the prior act. 81 A special relationship is not just an ongoing relationship or a fiduciary relationship, but a relationship in which the standard of care places on the defendant a continuing duty, based on the information in his possession, to monitor or warn the plaintiff. 82 [T]he imposition of an ongoing duty under such circumstances must rest on the factual bedrock of actual knowledge. 83 Connecticut courts have considered the continuing course of conduct doctrine in malpractice cases against accountants and auditors with mixed results. In Northeast Mortgage, the court rejected application of the continuing course of conduct doctrine. 84 Although the court did not say so explicitly, its ruling implies that no continuing duty existed after the auditor issued its audit report. Several Connecticut Superior Court cases have suggested that tolling under the continuing course of conduct doctrine might apply to accountants. In two cases, Curtis Packaging and Schwartz, the courts did not carefully delineate between continuous representation and continuing course of conduct, and therefore, the import of those cases is not entirely clear. 85 In Hnath v. Vecchitto, the court applied the doctrine to an accountant where it 77 Witt v. St. Vincent s Medical Center, 252 Conn. 363, 370 (2000). 78 Martinelli v. Fusi, 290 Conn. 347, 359 (2009). 79 Grey v. Stamford Health Sys., 282 Conn. 745, 755 (2007). 80 Id. at Martinelli, 290 Conn. at 359 (citing Witt, 252 Conn. at ). 82 See Hnath, 2003 WL at *6 (finding that it was possible that an accountant and investment adviser s continued relationship with the plaintiffs coupled with his knowledge in 1990 of Colonial s problems served to extend the date on which the statute started running ) (emphasis added). 83 Martinelli, 290 Conn. at 359 (internal quotations marks omitted). 84 Northeast Mortgage, 2013 WL at * In Curtis Packaging, the court applied a tolling doctrine, which it labeled the continuing course of conduct doctrine, even though its sole basis for tolling was that there was a continuing relationship between the client and ( continued) 16

17 was undisputed that plaintiffs and their accountant learned that a company in which plaintiffs invested had massive financial problems, and the accountant continued to represent the plaintiffs for two years following the date on which they learned of the financial problems. 86 In Dudrow v. Ernst & Young, the court relied on continuing course of conduct to deny summary judgment to the accountants on their limitations defense where plaintiff demonstrated that on some occasions, the accountants were engaged to perform services that related to prior audits. The accountants failed to rebut that showing, other than through conclusory statements that each audit was a separate engagement. 87 b. Tolling i. Fraudulent concealment By statute, fraudulent concealment tolls the statute of limitations in Connecticut. 88 To prove fraudulent concealment, a plaintiff must prove that the person concealing an action (1) had actual awareness, rather than imputed knowledge, of the facts necessary to establish the plaintiff[ s] cause of action; (2) intentionally concealed these facts from the [plaintiff]; and (3) concealed the facts for the purpose of obtaining delay on the plaintiff[ s] part in filing a complaint on [the] cause of action. 89 In Iacurci v. Sax, plaintiff argued that it did not have to prove all three elements of the fraudulent concealment statute because it established that defendant, who was plaintiff s tax accountant for many years, owed it a fiduciary duty, which shifted the burden to the defendant to disprove that all the elements of the statute were satisfied. The court held that defendant did not owe plaintiff a fiduciary duty (see discussion of breach of fiduciary duty claims, infra), and (continued ) auditor. Curtis Packaging, 2002 WL , at *6. In Schwartz, the Court denied the defendant auditor summary judgment on its statute of limitations defense because of a factual dispute regarding the nature of the relationship of the parties. Without considering the three prongs of the test described above, the court opined: I think it is appropriate to extend to accountants the considerations regarding tolling, at least in the circumstances of this case, where there is evidence that the relationship was in depth and of long standing. Schwartz, 2006 WL , at *2. 86 Hnath, 2003 WL , at *6. 87 Dudrow II, 1999 WL , at *4. 88 Conn. Gen. Stat ( If any person, liable to an action by another, fraudulently conceals from him the existence of the cause of such action, such cause of action shall be deemed to accrue against such person so liable therefor at the time when the person entitled to sue thereon first discovers its existence. ). 89 Iacurci, 139 Conn. App. at 392 (quoting Falls Church Group, Ltd. v. Tyler, Cooper & Alcorn, LLP, 281 Conn. 84, 105, 912 A.2d 1019 (2007)). 17