Accounting Firms’ Foreign Subsidiaries in For the Long Haul

In the Parmalat securities litigation, Judge Lewis A. Kaplan (S.D.N.Y.) has ruled that the Italian subsidiaries of Deloitte and Grant Thornton will not be dismissed from the action, despite their argument that they “each are factually and legally separate from their Italian affiliates and therefore cannot be liable for the affiliates' alleged fraud.” Although the court rejected Plaintiffs' alter ego argument, it did find that “an agency relationship existed between [Deloitte, Grant Thornton,] and its member firms that conducted the Parmalat audit. As principals, they would be responsible for the actions of their agents and the knowledge and, consequently scienter, of their agents is imputed to them.”

In addressing the causation elements of Dura, Judge Kaplan found it “difficult to imagine that the markets would not have moved on the basis of reports by Parmalat's independent auditors,” and therefore held that Plaintiffs “have pleaded transaction causation sufficiently.” As for loss causation, the court found Plaintiffs met that hurdle too, holding that “an allegation that a corrective disclosure caused the plaintiff's loss may be sufficient to satisfy the loss causation requirement, [but] it is not, however, necessary.” The court went on to observe the fact “that the true extent the fraud was not revealed to the public until February - after Parmalat shares were worthless and after the close of the Class Period - is immaterial where, as here, the risk allegedly concealed by defendants materialized during that time and arguably caused the decline in shareholder and bondholder value.”

Last, but certainly not least, Judge Kaplan confessed he “is in substantial sympathy with defendants” with respect to their motion “to dismiss the complaint under Rules 8(a)(2) and (e)(1), [because] at 368 pages and 1,249 paragraphs, it is too long and confusing.” He remarked that “the requirement of pleading fraud with particularity does not justify a complaint longer than some of the greatest works of literature. A complaint of this length, indeed, is an undue imposition on all who are obliged to read it. Nevertheless, a dismissal under Rule 8 is usually reserved for those cases in which the complaint is so confused, ambiguous, vague, or otherwise unintelligible that its true substance, if any, is well disguised. Although plaintiffs' submission is lengthy, it does not overwhelm the defendants' ability to understand or to mount a defense, [and therefore] it will not be dismissed under Rule 8."

You can read the decision, issued June 28, 2005, at 2005 U.S. Dist. LEXIS 12553.

Nugget: "The significance of the corporate form to the development of capital markets and economic progress in general cannot be denied. Nevertheless, the limited liability entity is not an unmitigated blessing. The limitation of liability that encourages capital formation in some circumstances may eliminate disincentives to fraudulent behavior."

Nugget: "Independent auditors serve a crucial role in the functioning of world capital markets because they are reputational intermediaries. In certifying a company's financial statements, their reputations for independence and probity signal the accuracy of the information disclosed by the company, the managers of which typically are unknown to most of the investing public."

Nugget: "Certification by an entity named Deloitte & Touche, Grant Thornton, or one of the small handful of other major firms is incalculably more valuable than that of a less known firm because the auditor "is in effect pledging a reputational capital that it has built up over many years of performing similar services for numerous clients."

Nugget: "In consequence, allowing those organizations to avoid liability for the misdeeds and omissions of their constituent parts arguably could diminish the organizations' incentives to police their constituent entities, with adverse consequence for participants in capital markets."