Not My Brother's Keeper: Accounting Firms Face Increased Securities Claims for Audits Performed by Affiliates in Other Countries

Article excerpt


Call it "Enron" with an Italian accent. On Christmas Eve 2003, Parmalat, the world's largest dairy producer and Italy's eighth largest public company, declared bankruptcy in the wake of a massive corporate fraud.1 Parmalat's Chief Executive and Chief Financial Officer admitted to cooking the books, and investigators discovered that as much as $12 billion in assets, including a $4.9 billion bank account, simply did not exist.2 Parmalat's bankruptcy, coming just two years after the spectacular collapse of Enron3 and the bankruptcy of WorldCom,4 shattered the view that Europe might escape America's accounting scandals.5 As had happened in the wake of Enron and WorldCom, the focus in the Parmalat investigation turned immediately to its outside auditors, two of the biggest names in accounting, Deloitte & Touche and Grant Thornton.6 Local partners of Grant Thornton were arrested, and Deloitte-Italy was placed under investigation.7 Grant Thornton International expelled its Italian member firm.8 And investors filed a civil suit against the auditors, claiming billions of dollars in losses.9

The investors' lawsuit took a novel approach. They alleged that Parmalat's Italian auditors, Deloitte & Touche S.p.A. and Grant Thornton S.p.A., committed primary violations of section 10(b) of the Securities Exchange Act of 193410 by either participating in or acquiescing in Parmalat's fraud.11 Section 10(b), the antifraud provision of the Securities Exchange Act of 1934, prohibits the knowing use of a manipulative or deceptive document or other device in connection with the purchase or sale of securities.12 The investors sued not only Parmalat's Italian auditors but also the global accounting firms they belonged to and the U.S. member firms of each of these global accounting firms.13 In this way, the investors were able to reach the deeppocketed U.S. accounting firm by means of a "stepping stone" approach.14 The investors first alleged that the global accounting firms controlled the Italian auditors and were, therefore, vicariously liable for the Italians' bad acts.15 Next, the investors claimed that the U.S. accounting firms, by virtue of their size and financial resources, controlled the global firms and should be secondarily liable for the misdeeds of the Italian auditors.16

In early 2009, the U.S. district court in Parmalat ruled that the global accounting firms can be held vicariously liable for the Italian auditors' primary violations of section 10(b) under the common law theory of agency, which requires only a right to control, not actual control, of the alleged wrongdoer.17 The court also found that the investors could sue the global accounting firms under section 20(a) of the Securities Exchange Act of 1934,18 which imposes liability on a party that controls anyone who commits a primary violation of the Act.19 Section 20(a) is distinguishable from section 10(b) in that 20(a) provides an affirmative defense if the control defendant acted in good faith and did not directly or indirectly induce the violation.20 Turning to the U.S. accounting firms, the court found that they could be subject to secondary liability for controlling the global firms, which, in turn, controlled the Italian auditors.21

This Note argues that plaintiffs who sue a global accounting firm or a U.S. accounting firm for an audit performed by an affiliated accounting firm should be required to prove that the global or U.S. firm actually controlled the audit at issue in the litigation.22 Plaintiffs should not be permitted to bypass the express statutory limitations that Congress has placed on secondary liability in the Securities Exchange Act by applying broader common law principles of vicarious liability. The use of common law vicarious liability in section 10(b) litigation conflicts with Supreme Court precedent, which has taken a narrow view of liability under 10(b), particularly given that Congress has limited secondary liability by including a good faith defense in section 20(a). …