Judge Harold Baer, Jr. (S.D.N.Y.) has denied PwC’s (You simply must click this link – why in the world does PwC have this lady staring at us like this? Make her stop, we beg you!) motion to dismiss in the securities class action against Hibernia Foods "an Irish public company that exported beef until the ‘mad cow’ episode in 1997 when it switched to the sale of frozen desserts and ready-made meals." Wow, talk about an overreaction, huh? Plaintiffs said "PwC knew or recklessly disregarded risk factors e.g., Hibernia's repeated default on payments to lenders and suppliers and the sale of inventory at a loss to generate cash flow." PwC balked, saying Plaintiffs were not "specific enough to show how and when PwC acquired knowledge of an alleged fraud." Well, unfortunately for PwC, Judge Baer said "to plead with particularity does not require at this stage that Plaintiff spell out the very moment PwC should have known about the alleged fraud or that PwC had actual knowledge of the scope or particulars of the scheme."
Judge Baer also recognized that "Plaintiffs allege that PwC wanted to keep Hibernia as a client so that PwC could continue to derive a financial benefit from its client." Sounds reasonable, right? Perhaps a bit frustrated with those who might disagree, the judge offered the observation that "while not so far fetched to me, the current state of the case law holds otherwise and concludes that no independent auditor would risk ruination of its reputation for the fees it would collect in order to suppress fraud."
But, as it turns out, the red flags were waving too high and too fast. The court found that "the ‘red flags’ include, inter alia, allegations that Hibernia (1) repeatedly defaulted on payments to lenders and suppliers, (2) sold its products at a loss, (3) recognized revenue on products that had not been shipped, and (4) failed to write off valueless inventory or write down long-lived assets." Although "PwC argues that these ‘red flags’ offer only conclusory allegations that PwC should have known this behavior was tantamount to fraud," "these facts, which must at this stage of the litigation be taken as true, illustrate at the very least behavior that could not conceivably escape a rational auditor's critical eye, if his eyes were open."
You can read Whalen v. Hibernia, issued 2005 U.S. Dist. LEXIS 15489.
Nugget: "When all the ‘flags’ are run up the same poll [surely it said "pole," right?], it seems inescapable that a reasonable auditor was on notice, and acted recklessly when it disregarded all the ‘flags.’"