Accountants Facing More Tort Actions in Malpractice Cases

The balance is tipping against accountants on the "judicial ledger" as they face tougher consequences for professional malpractice.

No longer do accountants serve merely one master - the client. As in so many other areas of professionalism, liability is expanding as courts allow actions based in tort as well as contract on several fronts.

Take the case of Jerry Clark Equipment, one that will surely cause accountants and tax attorneys to sit up and take notice this tax season.

For years, AAA Bookkeeping Service performed accounting and tax services for Jerry Clark and his company in downstate Illinois. AAA's owner was a certified public accountant and a tax attorney.

The accounting firm failed to prepare corporate income tax returns for three years, yet never told plaintiff. The Clark company had to go so far as to institute a lawsuit to retrieve its own financial records.

A jury found AAA negligent and awarded actual damages just over $18,000 as well as $18,000 in punitive damages for the accounting firm's gross negligence. The court on appeal affirmed, never even considering a contract theory. Jerry Clark Equipment, Inc. v. Hibbits, 245 Ill.App.3d 230, 612 N.E.2d 858(5th Dist.1993).

Generally, the accountant-client relationship is a matter of contract, and an accountant's malpractice liability is determined by reference to this contract. The law implies in these contracts that such professionals will render their services with a degree of skill, care, knowledge and judgment usually possessed and exercised by members of that profession in that locality.

But courts in at least 11 states have gone beyond the relationship established by the contract and are recognizing accountants' liability in tort. 92 ALR3d 396. Illinois is among these states to take this innovative, yet realistic, approach to accountant malpractice.

In a case of apparent first impression, the Illinois Supreme Court decided in Congregation of the Passion, Holy Cross Province v. Touche Ross & Company, 159 Ill.2d 137, 636 N.E.2d 503 (1994), that accountants may be held liable in tort, thereby creating an exception to the economic loss doctrine.

This doctrine was established in Moorman Manufacturing Co. v. National Tank Co., 91 Ill.2d 69, 435 N.E.2d 443 (1982), which stated that purely economic losses are not recoverable in a negligence action. But the Moorman court itself set out an exception, finding that economic loss is recoverable where "one who is in the business of supplying information for the guidance of others in their business transactions makes negligent misrepresentations." 91 Ill.2d at 89, 435 N.E.2d at 452.

In the Congregation case against Touche Ross, the accounting firm was accused of misstating to the priests the market value of certain of its investments. There, the court found application of the economic loss doctrine inappropriate where the relationship resulted in something intangible, as is the case in attorney-client relationships, as well. Collins v. Reynard, 154 Ill.2d 48, 607 N.E.2d 1185 (1992).

"[T]he value of the services rendered lies in the ideas behind the documents, not in the documents themselves," the Congregation court wrote. 159 Ill.2d at 163, 636 N.E.2d at 515. The court further found that it is not possible to memorialize in a contract all of the elements of "competent representation," such as knowledge and expertise which are independent of the contractual obligation.

And more and more courts are using a negligence standard in determining an accountant's liability to third parties as well, turning Chief Justice Cardozo's seminal case of Ultramares Corp. v. Touche, 255 N.Y. 170, 174 N.E. 441 (1931), on its ear. For instance, a North Carolina district court even went so far as to recently hold that a negligence claim could be made against an accounting firm by public-market investors who had no relationship to the auditor but merely had purchased securities of the audited client in the open market. Simpson v. Speciality Retail Concepts, Inc., 908 F.Supp. 323 (M.D.N.C.1995).

And take the recent verdict against Coopers & Lybrand, which still sends shivers up and down the spines of accountants everywhere. A Pittsburgh jury in February found the Big Six accounting firm recklessly conducted certain audits in failing to uncover a $500 million fraud of the Phar-Mor discount drugstore chain, on which some Chicago-based investors relied.

Accountants in Illinois, however, can take solace in that such a verdict for a third party investor would be unlikely under Illinois law, given the 1986 amendment to the Illinois Public Accounting Act (225 ILCS 450/30.1) which requires privity between the investor and the accountant.

And late last year, Congress passed the Private Securities Litigation Reform Act (104 P.L. 67) over President Clinton's veto. Although the Big Six accounting firms long lobbied for many of its provisions, the new law also requires auditors to employ adequate procedures in their audits to detect illegal acts of public companies and be whistleblowers upon discovery of deception, which may open up yet other areas of liability. Despite the accounting profession's qualifications to carry out these tasks, it has vigorously fought being fraud sleuths against the client.

Yet, Illinois courts - and others - appear bent on sending a message to accountants to focus, not so much on the bottom line, but in-between the lines, in carrying out their professional service contracts with a high level of responsibility.

That message by now should be deafening.