Ontario Court says auditor is liable to “its client’s clients” for investment losses
In the recent decision of Lavender v. Miller Bernstein, Justice Belobaba writing for the Ontario Superior Court found an auditor liable for the financial losses of a now-insolvent securities dealer’s clients. This case confirms that a defendant can be liable for a negligent misstatement in situations where the plaintiffs may not have been aware of the defendant’s role at the time of the loss and may not have read the untrue statements. It also highlights the circumstances under which an auditor may owe a duty of care to persons other than its clients.
Background
On July 6, 2001, the Ontario Securities Commission (“OSC”) placed Buckingham Securities (“Buckingham”) into receivership for contravening several securities requirements. However, due to the delay in discovering the contraventions, Buckingham’s investors lost approximately $10.6 million. The OSC initiated proceedings against Buckingham and several of its principals for making materially untrue statements in its 1999 and 2000 Form 9 reports filed with the OSC. The Form 9 reports for the years 1998, 1999 and 2000 were audited and filed by Buckingham’s auditor, Miller Bernstein. The OSC and the Institute of Chartered Accountants brought disciplinary proceedings against Miller Bernstein and the partner who audited the Form 9 reports.
The plaintiff commenced a class action in November 2005 on behalf of every person who had an investment account with Buckingham on July 6, 2001. The plaintiff claimed that Miller Bernstein had breached a duty of care owed to class members (as clients of Buckingham), which caused foreseeable losses for those class members. Specifically, the plaintiff claimed that if Miller Bernstein had correctly audited and filed the Form 9 reports, the OSC would have intervened before class members’ assets were lost. Miller Bernstein denied liability and claimed that the plaintiff was attempting to “dress up” a negligent misrepresentation claim because they were unable to establish reliance.
The class action was certified in 2010 and the plaintiff moved for summary judgment on five of the six common issues. There was no serious dispute between the parties on the availability or appropriateness of summary judgment.
Negligent misrepresentation or negligence?
In his judgment, Justice Belobaba confirmed that this was not a standard negligent misrepresentation case, noting that Canadian courts have previously held that it is possible for a plaintiff in a negligent misstatement case to proceed against the defendant on the basis of a simple negligence claim. In this case, the plaintiff was not claiming that the class members relied or even saw the Form 9 reports. Instead, the plaintiff claimed that Miller Bernstein, as an auditor, owed and breached a duty of care causing foreseeable losses for which it should be found liable. This was an important distinction insofar as the imposition of class-wide liability was concerned, as it allowed the plaintiff to circumvent the issues of “individual reliance” that often preclude certification of common law misrepresentation claims.
An auditor’s duty of care
While going through the two-step Anns-Cooper analysis, Justice Belobaba determined that there was a sufficient level of foreseeability and proximity required to establish a prima facie duty of care by the auditor to the investor class members. He stated that although the class members never saw or knew about the Form 9 reports, “the defendant auditor as a matter of simple justice had an obligation to be mindful of the plaintiff’s interest when auditing and filing the Form 9 reports with the OSC.” Justice Belobaba explained that Miller Bernstein understood that the Form 9 reports were used by the OSC to police securities dealers and protect investors. Miller Bernstein therefore understood the consequences to “its client’s clients” if there was a misstatement in the Form 9s – that a negligent audit “could expose the class members to the very loss that they incurred.”
Justice Belobaba noted that Miller Bernstein had access to the names and investor accounts of every class member and knew the exact amounts involved. Miller Bernstein even corresponded with some of the class members to verify that Buckingham’s internal client account records were complete and accurate. Some of the class members responded and alerted the auditor to serious discrepancies between Buckingham’s internal account records and the actual holdings and activity within their accounts.
Justice Belobaba also considered the second stage of the Anns-Cooper test and noted that “[t]he court’s primary concern when imposing a duty of care in cases of pure economic loss is the spectre of indeterminate or unlimited liability.” He concluded that indeterminate liability would not be a factor in cases where the auditor knows the identity of the plaintiff (or a class of plaintiffs) and where the defendant’s statements are used for the specific purpose for which they were made. In this case, because Miller Bernstein knew the names and addresses of each of Buckingham’s clients, it knew the of the narrowly circumscribed class of people to whom it could be liable for a negligent audit. In addition, the Form 9 reports were used for the very purpose for which they were prepared – they relied on by the OSC to protect investor (class member) assets.
No damages on a class wide basis
After determining that Miller Bernstein owed a duty of care to the class to conduct an audit of Buckingham’s Form 9 reports with the skill and care of a competent practitioner, Justice Belobaba determined that Miller Bernstein breached its duty of care in filing the Form 9 audits. He also determined that the filing of false Form 9s was at least a cause of the losses sustained by class members. The common issues, with the exception of damages, were therefore answered in favour of the plaintiff.
However, Justice Belobaba held that damages could not be determined on a class-wide basis. There was no evidence of the class members’ actual losses, whether on an individual or class-wide basis, and no proposed methodology for making this determination. Justice Belobaba noted that the expert reports purporting to estimate aggregate losses were not helpful since actual loss is needed to establish liability in a tort claim. The plaintiff indicated that he may bring a follow-up motion so that losses may be determined.
Key take-aways
Justice Belobaba’s ruling confirms that auditors of a securities dealer can be held liable in negligence to their “client’s clients”, such that auditors cannot necessarily avoid liability in the context of securities class actions by arguing that the plaintiff investors failed to prove individual class member reliance on the negligent misstatement. However, the decision turns on a number of fact-specific determinations, most notably the fact that the auditors were specifically aware of the identity of the class members and the scope of their investments. Moreover, the statements at issue (i.e., the Form 9 reports) were prepared for a specific purpose, which similarly obviated the concerns of indeterminate liability that otherwise arise in the context of auditor liability. Accordingly, the nature and extent of an auditor’s exposure to liability will turn on the particular facts of the case.