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During the last few years there has been an increase in litigation
cases involving both commercial activities and personal disputes, such
as personal accident claims and matrimonial issues. Specialist
accounting and taxation knowledge is often required to support these
cases and to help ensure a successful outcome.
We have over a century's experience advising private clients on both
their business and private affairs. This covers the provision of advice
on a wide range of forensic and accounting support matters, including:
• personal injury and fatal accident
• matrimonial disputes
• medical negligence claims
• consequential loss of profits
• professional negligence claims relating to profit forecasts and audit opinions
• valuation of shares in privately owned companies and businesses
• fraud investigations
• Inland Revenue and HM Customs & Excise investigations
• security for costs
• investment business litigation
According to the 2003 PricewaterhouseCoopers Securities Litigation
Study and a preliminary analysis of the first six months of 2004, the
number of securities litigation cases with accounting allegations
remains well above historical averages. Mega- settlements continue to
drive average settlement values significantly higher than ever before.
The involvement of the Department of Justice (DOJ) and Securities and
Exchange Commission (SEC) adds additional potency to the nature of
securities litigation.
Accounting-Related Cases:
The number of accounting-related cases remains high, totaling more
than 60 percent of the 175 cases filed in 2003 and 57 percent of the
111 cases filed in the first seven months of 2004. The number one
allegation made in accounting-related cases continues to be revenue
recognition, alleged in over fifty percent of these cases in 2003. The
study also finds two other allegations that are emerging in
accounting-related cases: accounting estimates and internal controls.
In 2003 each of these allegations appeared in over 40 percent of the
accounting cases.
According to CPA Staff,, in 2004, PwC said, 14 settlements have been
announced for $30 million or greater, five of which settled for $100
million or more. The average accounting case, led by five case
settlements of over $100 million each, settled for over $38 million. In
addition, the median 2004 settlement is approximately $6.3 million and
the median accounting settlement is greater than $7 million, both up
from the 2003 numbers.
PwC noted that the dynamic of securities litigation has changed
dramatically in cases of what it calls "triple jeopardy" -- where
companies are subject to securities class actions along with Securities
and Exchange Commission and Department of Justice investigations. PwC
reported an all-time high of 40 such cases in 2002, with 2003 levels
dropping to only eight instances, marking a return closer to historic
norms. However, preliminary 2004 research indicates that at least 13
companies are facing “triple jeopardy” this year.
Case:
Abstract- A California jury recently found a leading accounting firm
liable for malpractice in its capacity as litigation support provider
and ordered it to pay $42 million in damages. 'Mattco Forge v. Ernst
& Young' is a landmark case for accountants because it has exposed
them to a new area of professional liability. It marks the first time
that an accounting firm was held liable and punished so severely for
litigation support negligence and fraud. In the past, large judgements
against accountants often involved auditor malpractice lawsuits. The
Mattco case is also significant to the accounting profession because it
may set a precedent for limits in the protection afforded to expert
witnesses under the common law doctrine of witness immunity. The case
calls the attention of accountants in public practice to liability
issues related to litigation advisory services.
A California jury recently awarded $42 million in damages against an
accounting firm for its work in litigation support. Although the facts
in this case may be unique, this and other court cases may erode the
protection of immunity normally granted to expert witnesses. Here is
the background and what accountants should know and do when practicing
in the area of litigation support. The Mattco Forge v. Ernst &
Young case has opened a potentially significant new area of
professional liability. Before this case, large judgments against the
accounting profession were primarily in auditor real-practice cases. In
June 1994, however, a Los Angeles jury awarded a $42 million judgment
against Ernst & Young for litigation support negligence and fraud.
This is the first successful case commenced against a major public
accounting firm for litigation support negligence and fraud; thus the
case is important. It is also a potential precedent for limits on
expert witness immunity. This case raises liability concerns for any
accountant who acts as an expert witness in a lawsuit.
Litigation Support
In an effort to diversify, expand services, and increase revenues,
public accounting firms have moved into a myriad of advisory services.
One of these rapidly growing services is litigation support. This
specialty can encompass a variety of services including investigation
of claims, calculation of damages, interpretation of financial
information, assistance in trial preparation, and expert witness
testimony in court. These support services have been offered by
accounting and consulting firms of all sizes, including many individual
practitioners. Common areas where attorneys seek litigation support
from accountants include marital dissolution, business valuation,
commercial damages, lawsuits against other accountants, bankruptcy
proceedings, forensic accounting cases, and tax-related litigation.
Professional standards offer limited guidance for CPAs engaged in
litigation support services. The basic principles of the AICPA Code of
Conduct including integrity, objectivity, due professional care, and
acting in the public interest apply to any professional service a CPA
offers and serve as guide for litigation support services. In addition,
litigation services are included in the broad definition of consulting
services under the AICPA Management Services Division's 1991 Statement
on Standards for Consulting Services. This Statement identifies
standards under Rule 201 of the Code of Conduct as applicable,
including professional competence, due professional care, planning and
supervision, and sufficient relevant data. Three additional standards
under Rule 202 identified specifically for consulting services are
client interest, understanding the client, and communication with the
client.
A client naturally expects effective advice and assistance when it
engages a CPA as an expert witness. Unsuccessful litigation may result
in the client questioning the effectiveness of the litigation support
services received. The Mattco Forge case is a stunning example of what
can go wrong when a CPA provides litigation support services.
Mattco Forge v. Arthur Young:
A California jury decision against the accounting firm of Ernst
& Young (formerly Arthur Young) held the accounting film liable on
two counts of fraud arising from litigation support rendered on behalf
of a manufacturing company. The jury awarded $14.2 million in
compensatory damages and $27.8 million in punitive damages in June
1994. The jury also found a former managing partner liable for $250,000
and a former employee liable for $5,000. The case is currently being
appealed by the accounting firm.
The size of this judgment and the serious implications of the
finding of fraud warrant a close look at the facts surrounding this
case. In the mid 1980s, Mattco Forge, a California small aircraft part
manufacturer, commenced a lawsuit against General Electric (GE)
alleging wrongful discrimination against the company in the awarding of
GE contracts. To prepare for trial and at the urging of one of the
accounting firm's managing partners, Mattco retained the public
accounting firm of Arthur Young for litigation support. Mattco alleged
that one of the reasons they retained the accounting firm was its
advertisement that stated the firm was an expert in litigation support
and could "assist attorneys and clients having a real or apparent lack
of data." In an engagement letter, the accounting firm agreed to assist
and supervise Mattco in analyzing financial data needed to calculate
Mattco's lost profit resulting from the loss of the GE contracts. The
firm was to act as a damage consultant and expert witness.
In attempting to calculate lost profits, the accounting firm had
difficulty locating essential information. Original estimate sheets
were not available for all contracts, so the accounting firm requested
that Mattco prepare noncontemporaneous estimated information for the
missing estimate sheets. These estimates were later turned over to GE,
but were never identified as being noncontemporaneous estimates. Mattco
contended they were never informed the sheets would be made available
to GE.
After receiving the information, GE attorneys sought a dismissal of
the lawsuit alleging Mattco had created and produced fraudulent
documents with an intent to deceive GE. In addition, GE contended
Mattco artificially inflated its claimed damages. The court found in
favor of GE and ordered Mattco to either pay GE $1.4 million in
compensatory damages to cover the costs of tracing the
noncontemporaneous estimates or dismiss its case. Mattco elected to
drop the case and did not appeal the decision. Mattco then filed a suit
against Arthur Young alleging professional malpractice, fraud,
negligent misrepresentation, breach of fiduciary duty, breach of
contract, tortious breach of implied covenant of good faith and fair
dealing, constructive fraud, and fraudulent concealment.
The trial court dismissed the Mattco suit on grounds that the
accounting firm was protected by a statutory litigation privilege that
protects witnesses from liability. The trial court also determined
Mattco had acted with unclean hands since the prior court had
determined Mattco acted fraudulently. The dismissal was appealed by
Mattco and in 1992 the California Court of Appeals reversed the
dismissal and ordered the case to trial. This successful appeal led to
the June 1994 jury trial.
In the trial, Mattco's attorneys alleged the Arthur Young employee
who handled the project was an auditor without previous litigation
support experience. One of Mattco's attorneys stated: "The initial
mistakes we allege were the result of lack of proper training and
supervision. The theory we pursued at trial was that he was ignorant of
consequences of his actions, and, since he didn't have training, he
didn't appreciate that litigation support was a totally different
animal than auditing." The finding of fraud in the Mattco case was
apparently a result of the advertisement of the accounting firm
claiming expertise the jury felt was not delivered. An apparent coverup
by the accounting firm was also alleged, resulting in a jury finding of
a fraudulent concealment.
From a legal standpoint, a significant aspect of the case is the
court's analysis of the litigation privilege protecting witnesses.
Witness Immunity:
Expert witnesses have historically assumed they could testify in
court without fear of legal retaliation from parties who may disagree
with their testimony. The common law doctrine of witness immunity has
been the basis for this legal protection and was, until recently,
followed in all states. In addition to this common law protection for
witnesses, California has adopted a statute creating a litigation
privilege that is designed to encourage witnesses at trial to feel free
to give information on the stand. By adopting this statute, California
has codified the common law approach used in other states.
Witness immunity first applied to general witnesses at trials and
was expanded to cover expert witnesses. The common law expert witness
immunity developed because the legal system recognized that the trier-
of-fact needed assistance in properly deciding technical problems.
Expert witnesses often provide judges or jurors with crucial
information needed to properly decide the outcome of a lawsuit.
Immunity is granted by common law under the logic that forcing expert
witnesses to face retaliatory lawsuits by those who disagree with the
expert's opinion may cause the expert to be reluctant, unwilling, or
overly cautious in participating in litigation. There is a further fear
that if expert witnesses could be held liable for their statements on
the stand that this could create a never-ending circle of litigation.
Common law witness immunity extends to all aspects of preparing for
litigation, including pre-trial proceedings as well as the trial
courtroom setting. This witness immunity privilege, as well as the
California litigation privilege is now being legally challenged.
The emergence of the legal question of whether witnesses should be
protected from liability for their testimony is not surprising given
the dramatic increase in the usage of expert witnesses over the past 30
years. There are numerous commercial services that advertise the
availability of literally thousands of potential expert witnesses who
will testify for a fee. Despite this proliferation of expert witnesses,
there has been a surprising lack of litigation brought against expert
witnesses.
Previous Witness Immunity Decisions:
As of 1993, only five states had decided cases involving lawsuits
against expert witnesses. Four of these five cases held expert
witnesses accountable for their actions and narrowly construed the
protection of witness immunity. Only Washington has held an expert
witness immune from liability. California, Missouri, New Jersey, and
Texas courts have held expert witnesses liable. In the Missouri case,
the court held that general witnesses are immune from liability, but
experts who are compensated for their testimony can be held liable for
negligent testimony. The New Jersey case found an accountant liable for
negligent valuation of a business in a divorce action.
The Washington court protected an expert witness from liability in a
case where two property owners sued their neighbor for the cost of
restoring lateral support for their land. The property owners hired an
expert to estimate the cost of restoration. The expert testified as to
his estimate and the court awarded the exact amount of the estimate.
The estimate turned out to be grossly underestimated. The property
owners unsuccessfully sued their expert for his alleged negligent
testimony. The court protected the witness from liability citing
several policy reasons. The court felt that without immunity, experts
would lose objectivity and experts would adopt the most extreme
position favorable to their client. The court also feared that the
imposition of liability would discourage anyone who is not full-time
professional expert witness from testifying. The court felt that
one-time or infrequent experts would not carry the necessary insurance
to cover the liability risk in testifying.
In the Mattco case the court noted the Washington case, but declined
to follow that court's rationale. The California court felt the
litigation privilege should not protect the accounting firm from
liability for several reasons. First of all, the court noted the
litigation privilege is generally designed to protect expert witnesses
from lawsuits by opponents who disagree with an expert's opinion.
Mattco was a friendly party, not a hostile opponent. Secondly, Mattco's
claim never reached trial and the claim against the accounting firm did
not involve the firm's expert testimony regarding the value of damages.
Because the accounting firm never made it to the witness stand, the
court felt it was inappropriate to protect the firm from liability
under California's litigation privilege.
Future decisions by other states will be crucial in developing the
responsibilities and liabilities of expert witnesses. Since 45 states
have not yet decided the extent of expert witness immunity, it is
difficult to predict what approach most states will take. Since four
out of five states have held experts liable, however, there obviously
appears to be a trend toward limitations on expert witness immunity. It
is possible that some states will follow the Washington approach to
protect witnesses from liability, but courts will no doubt note the
approaches taken by California, Missouri, New Jersey, and Texas.
Litigation Concerns for Accountants:
It is essential that accountants who work in the litigation support
area be equipped to properly perform their duties. CPA firms have a
responsibility to see that all accountants engaging in litigation
support are adequately trained and supervised. Accountants doing expert
witness work should be educated about how the legal system views
evidence, expert testimony, and negligence and should always adhere to
their professional responsibilities and ethical standards.
Rules of Evidence. Accountants engaged in litigation services must
become familiar with the rules of evidence that govern court
proceedings. All judges will follow the rules of evidence that apply to
their court in determining if evidence will be admissible. Federal
courts follow the Federal Rules of Evidence created in 1975. Most
states have patterned their state rules of evidence after the Federal
rules making this area of the law fairly uniform.
Expert Testimony. The rules of evidence permit the broad usage of
expert testimony. Under Federal Rule of Evidence 702, an expert is
allowed to testify when specialized knowledge will assist the trier of
fact. Rule 703 allows expert witnesses to form opinions based on three
sources of information: firsthand observations, presentations at trial,
and preparation of data outside the court. This allows broad leeway for
opinions. Finally, under Rule 705 an expert is allowed to give opinions
or inferences without disclosing underlying data or facts. The expert
can, however, be cross-examined by opposing attorneys regarding the
underlying data. The liberal admission of expert testimony makes the
role of an expert witness crucial to successful lawsuits.
Two areas of particular importance arising out of the rules of
evidence are discovery rules and rules on hearsay evidence. Discovery
Rules. Under the Federal and state rules of evidence there are pretrial
discovery rules that specify techniques that can be used by attorneys
to obtain information to prepare for trial or to attempt to obtain a
favorable settlement. Common discovery activities include depositions,
interrogatories, requests for the production of documents, and requests
for admissions by opponents. Litigation support in the discovery stage
can prove to be an invaluable service. Accounting expertise in
determining what type of financial information is needed can be crucial
in establishing lost profits as well as evaluating other types of data.
Litigation support accountants also can provide a valuable service in
responding to discovery requests from party opponents. Litigation
attorneys often find themselves inadequately trained in deciphering
financial information obtained from opponents or requested by
opponents.
Hearsay Evidence. Litigation support accountants must be somewhat
familiar with how rules of evidence apply to the admissibility of
evidence, especially the hearsay rule. The hearsay rule is designed to
prevent the introduction of unreliable second-hand testimony. Witnesses
are expected to testify only as to the validity of their statements.
The hearsay rule is very complex and is subject to over 20 exceptions.
These exceptions generally involve evidence that is inherently reliable
and thus deemed admissible.
One of the most important exceptions to the hearsay rule is the
"business records exception." Under this exception, business records
kept in the ordinary course of business are admissible. Computer-
generated information created in the ordinary course of business can be
admitted even if the person testifying did not enter the information or
accumulate the information. The business records exception can allow a
litigation support expert to effectively accumulate information and
testify as to its relevance and importance. The testimony can be
crucial to the success of litigation involving financial data. It is
not necessary that accountants become experts on the hearsay rule, but
litigation support accountants should be aware of the rule and its
affect on testimony and seek advice from an attorney when uncertainties
arise.
Negligence. In addition to the discovery rules, accountants must
understand negligence since it is the legal theory most likely used
against them in liability cases. Negligence is a common law theory that
creates liability if a party fails to use reasonable care resulting in
harm. To successfully sue an accounting firm for negligent litigation
support, the client will have to establish the four elements of a
negligence claim:
* Existence of a legal duty of care;
* Breach of the duty to act as a reasonable prudent professional under the circumstances;
* Causal connection between the actions of the defendant and damages suffered by the plaintiff; and
* Damages suffered by the plaintiff.
The first element of a negligence claim is easily established when a
client retains a litigation support accountant to prepare for a trial.
The existence of an express contractual relationship between the
parties creates a legal duty of care. Under the second element, the
accountant will be expected to use the same care, skill, and expertise
other members of the profession normally possess. Failure to meet this
standard will satisfy this element. Under the third element, the
plaintiff must show that proximate cause is present. Thus the plaintiff
must be able to establish that the negligent act of the defendant
foreseeably caused the harm suffered by the plaintiff. In litigation
support claims, the plaintiff will likely have to show that the
deficient service of the accountant caused the client to lose the
lawsuit. Finally, the plaintiff must establish the damages caused by
the deficient actions of the litigation support accountant.
Refernces:
1. Cpa Journal, 2000. 2. Litigation support liability - the Mattco decision, by Woodard, Robert L.
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