Lavender v Miller Bernstein: An Auditor’s Duty to Non-Clients

Written by on July 14, 2017.

Introduction

The Ontario Superior Court of Justice in Lavender v Miller Bernstein [1] recently added to the jurisprudence regarding a defendant’s liability for a negligent misstatement in a situation where the plaintiff did not personally read or rely on the misstatement.  Siskinds LLP is counsel to the class members.

The decision clarifies the circumstances under which an auditor may owe a duty of care to persons other than its clients.

Background

This was a motion for summary judgment on common issues in an auditor’s negligence class action.

The defendant Miller Bernstein LLP was an accounting firm appointed to audit the annual registration and renewal filings of a securities dealer called Buckingham Securities Corporation, which held the investment and savings accounts of 1002 retail clients (the class members).

The laws and regulations governing securities dealers required Buckingham to segregate its clients’ cash and securities from its own, and to maintain minimum levels of free capital. The purpose of these requirements was to protect investors’ assets from being commingled with Buckingham’s own assets and thereby being put at risk by being used as collateral for Buckingham’s own liabilities.

The Ontario Securities Commission (OSC) monitored securities dealers’ compliance with these investor protection requirements by relying on the audited information in Buckingham’s annual registration renewal document called a Form 9 Report. Among other things, the Form 9 Report indicated whether the securities dealer complied with the segregation and capital requirements.  The Form 9 was required to be audited by an auditor in accordance with generally accepted auditing standards and the OSC’s audit requirements.

Miller Bernstein audited Buckingham’s Form 9 Reports for the fiscal years 1998, 1999, and 2000. Each year, the Form 9 Reports falsely stated that Buckingham was in compliance with the segregation and capital requirements, and each year, Miller Bernstein gave an unqualified audit opinion on the Form 9 Reports.  Each year, the OSC allowed Buckingham to continue to operate and have access to client assets.

In fact, Buckingham never segregated its clients’ assets and had serious capital deficiencies. It had been using its clients assets as collateral for its own liabilities for years—they very thing the segregation and capital requirements were designed to protect against.

In 2001, the OSC discovered the segregation and capital deficiencies and immediately intervened to protect clients’ assets and put Buckingham into receivership. However, it was too late—the clients lost their savings, worth over $10 million.

An Auditor’s Duty of Care

The court identified the core dispute as whether Miller Bernstein owed a duty of care to Buckingham’s clients.

The court rejected the defendant’s argument that the plaintiff’s action was a disguised misrepresentation claim that attempted to circumvent the reliance requirement, and that no duty of care (“to the defendant auditor’s client’s clients”) can be imposed on the facts of the case.

Negligence or Negligent Misrepresentation?

The court held that the plaintiff was not asserting a disguised negligent misrepresentation claim. The plaintiff was “not saying that the class members relied on or even saw the Form 9s—they did not. The plaintiff’s claim is in negligence simpliciter—that the defendant owed and breached a duty of care causing foreseeable losses for which it should now be found liable.”[2]

The court relied on decisions from then-Justice McLachlan in Yorkshire Trust Co. and the Ontario Court of Appeal in Lipson, which held that there is a “cause of action in negligence which arises from making a negligent misrepresentation in a situation in which a duty of care exists,” and that “in some of these situations there will be found to be a duty of care owed by the representor not only to the representee, but also to third parties . . . even in a case where he never had notice of the representation at all.”[3]  In such instances, “the claim in simple negligence is distinct from [the plaintiff’s] claim in negligent misrepresentation, which required proof of reliance. . . by individual class members” and “[f]ramed in this way, the cause of action in simple negligence does not require a showing of reliance by . . . individual class members.”[4]

The court held that in this case, the plaintiff’s negligence claim was appropriate because the allegation was that if the defendant had conducted a proper audit, the OSC would have intervened before the assets and money were lost.[5]

Anns-Cooper Analysis

The court noted that this was “obviously not a conventional negligence case,” as it was “about an auditor’s misstatement that was filed with the OSC, was never seen by the class members, and arguably caused pure economic loss to the auditor’s client’s clients.”[6]  A first principles analysis was therefore required under the Anns-Cooper test.

Stage One – prima facie duty

The court found a prima facie duty of care at the first stage of the test.  The foreseeability and proximity requirements were satisfied: “Even though the class members never saw or even knew, at the time, about the Form 9s, the defendant auditor as a matter of simple justice had an obligation to be mindful of the plaintiff’s interests when auditing and filing the Form 9 reports with the OSC.”[7]  This is because “[t]he defendant understood that the Form 9s were used by the OSC to police the securities dealers and protect their investors” and that “[i]f the Forms 9s indicated a breach of the segregation or minimum capital requirements, the OSC would intervene.”  The court held that “[i]n short, the defendant. . . well understood the consequences to ‘its client’s clients’ if the segregation or capital deficiency information was misstated in the Form 9s—that a negligent audit of these Form 9s could expose the class members to the very loss that they incurred.”[8]

This foreseeability was also buttressed by a finding of proximity: a “relationship of sufficient closeness has been established” because the defendant had access to the names and account balances of each class members, knew the exact amounts in the accounts, and even corresponded with some of the class members to verify their account records. In addition, “the defendant also knew, without being told, that even if the class members knew nothing about the Form 9s, they would reasonably expect Buckingham and its auditor to provide information required under provincial law accurately and honestly, particularly if that information could affect their financial interests.”[9]

The court had “no difficulty concluding on the particular facts of this case, that it is just and reasonable to impose a prima facie duty of care on the defendant auditor.”[10]

Stage two – indeterminate liability.

There was no reason to negate the prima facie duty of care at stage two of the Anns-Cooper test.

The court noted that “the reason for stage two is especially important in cases such as this where the plaintiff’s claim is for pure economic loss. The court’s primary concern when imposing a duty of care in pure economic loss is the spectre of indeterminate or unlimited liability.”[11]  Where “indeterminate liability cannot be established on the facts of the particular case, then a duty of care will be found to exist.”[12]  There will be no indeterminate liability concerns “where the auditor knows the identity of the plaintiff (or class of plaintiffs) and where the defendant’s statements are used for the specific purpose for which they were made…because the defendant’s scope of liability can be circumscribed.  If the plaintiff-identity and specific-purpose conditions are satisfied the prima facie duty of care established at the first stage of the Anns-Cooper analysis will not be negated and a duty of care may properly be found to exist.”[13]

The uncontroverted evidence before the court was that both the plaintiff-identity and specific purpose conditions were satisfied: (i) Miller Bernstein “knew the names and addresses of each of Buckingham’s clients at the time of its audits” and “was also required, between audits, to stay informed of any major changes to Buckingham’s business, such as a significant change in customers, or the value of their accounts. The defendant knew of the narrowly circumscribed class of people to whom it could be liable for a negligent audit” and (ii) “the Form 9s on the facts herein were used for the very purpose for which they were prepared—to be relied on by the OSC in protecting investor (class member) assets.”[14]

Negligence, Causation and Damages

Having found that the defendant owed a duty of care to the class members, the court answered the remaining common issues (other than damages) in favour of the plaintiff: Miller Bernstein breached the duty of care for each of its 1998, 1999 and 2000 Form 9 audits, and that breach was a cause of damages to the class members.[15]

The court indicated that additional evidence was required in order to determine the damages common issue, and indicated that the plaintiff may bring an additional motion for damages after filing such evidence.[16]

[1] 2017 ONSC 3958

[2] Para 12

[3] Yorkshire Trust Co. v Empire Acceptance Corp., [1986] BCJ No 3254 (BCSC) at para 15

[4] Lipson v Cassels Brock, 2013 ONCA 165 at para 98

[5] Para 15

[6] Para 16

[7] Para 20

[8] Para 21

[9] Para 23

[10] Para 24

[11] Para 26

[12] Para 27

[13] Para 28

[14] Para 29

[15] Paras 35-44

[16] Paras 45-47

Posted in Class Actions, Securities