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Final Definitive Version Available At:

Leibman, J.H., & Kelly, A.S. (1992). Accountants’ Liability to Third Parties for Negligent Misrepresentation: The Search for a New Limiting Principle. American Business Law Journal, 30, 347-439.


In Ernst and Ernst v. Hochfelder,(n1) the Supreme Court held that section 10(b) of the Securities Exchange Act of 1934(n2) was inapplicable for holding accountants liable for mere negligence. Therefore, in the absence of scienter -- a provable "intent to deceive, manipulate, or defraud"(n3)

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    plaintiffs are required to look to state law for remedies when they have relied to their detriment

on negligently audited financial statements.(n4)

But in the state arena, injured investors, creditors, and other third party plaintiffs are confronted by several judicially adopted approaches that restrict in varying degrees parties not in contract privily with a company's auditors from recovering damages from those auditors caused at least in part by negligent auditing. In a number of jurisdictions injured parties have found that they generally have no standing to sue accountants they have not themselves engaged, except in those cases where the accountants had prior actual knowledge of the third parties' identity and their provable reliance(n5) on the financial information.(n6) This class of third parties -- generally made up of creditors,(n7) guarantors,(n8) and investors(n9) -- are subject to the famous rule from Ultramares v. Touche,(n10) in which Justice Cardozo expressed deep concern for the future of the developing public accounting profession,(n11) were he to rule, consistent with his opinion in McPherson v. Buick Motor Car Co.,(n12) that accountants must be prepared to compensate all foreseeable victims whose economic losses are proximately caused by the accountants' negligent statements.(n13) This privily/near privily rule is generally followed strictly in those jurisdictions that have adopted Ultramares.(n14)

Another group of states, however, follow the broader limitation of Section 552 of the Restatement (Second) of Torts,(n15) which does not require the members of the "limited group of persons for whose benefit and guidance"(n16) the accountant intends to supply the information to be individually identified.(n17) This "limited group" is sometimes referred to as a foreseen class of users.(n18)

An even more liberal approach follows Biakanja v. Irving,(n19) which provided several factors for determining whether a third party beneficiary under a will could maintain suit against a negligent notary in the absence of privily. Applied to auditors' liability the one court adopting this "balancing test" approach has held that the trier of fact is not precluded from finding liability in instances where the third parties are neither known to the auditor, as required by Ultramares, nor are in a class sufficiently foreseen to satisfy the Restatement.(n20) The operative balancing factors turn on both the foreseeability of the plaintiff and the closeness of the connection between the auditor's negligence and the harm to the plaintiff.(n21)

In the 1980s several state courts virtually eliminated the privily barrier in auditors' cases by judicially adopting some form of the general negligence foreseeability rule, holding that


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