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Clean audit reports on financials that later prove inaccurate may serve as the basis for a Rule 10b5-1 securities fraud claim against a company’s independent auditor, according to an amended opinion issued last week by a Second Circuit panel. The amendment reversed course from the court’s 2023 decision to dismiss the claim. The WSJ reports:

After the [2023] ruling, a trio of former Securities and Exchange Commission officials filed a brief with the court asking it to reconsider the decision. The court then asked the SEC to submit a brief expressing its views on the subject. The SEC did so and it, too, asked the court to reconsider, writing in a brief last February that “audit certifications convey crucial information to the investing public” and “audit certifications are not too general to be material.”

The appeals court on Thursday reissued its decision with amendments and ruled the investors’ claims against BDO could proceed.

The investors had alleged that the audit report was uniquely problematic because the audit partners failed to complete the necessary checks and audit work papers before issuing the audit opinion; that they signed several audit work papers without reviewing them; and that they failed to verify that all the necessary audit work was performed before issuing the opinion. In addition, the plaintiffs alleged shortcomings under PCAOB standards that require appropriate supervision, testing of audit procedures, and quality review.

The court determined that the plaintiffs adequately alleged that the audit report contained potentially actionable misstatements, because it was plausible that the partner who signed the audit opinion disbelieved the statement that the audit was conducted in accordance with PCAOB standards. Moreover, the court found adequate allegations that the misstatements were material. Here’s an excerpt (citations omitted):

Although the challenged audit certification reflects standardized language, it is not “so general that a reasonable investor would not depend on it as a guarantee.” Instead, BDO’s certification that the audit was conducted in accordance with PCAOB standards succinctly conveyed to investors that AmTrust’s audited financial statements were reliable. The absence of BDO’s certification would have been significant, for without it, BDO could not 49 have issued an unqualified opinion, AU 508.07, which then would have alerted investors to potential problems in the company’s financial reports.

In other words, audit quality is important – and it’s been front & center in scandals & rules this year. We’ll be providing practical guidance on this topic in an upcoming webcast, “Audit Quality: Lessons from BF Borgers and Other Recent Developments.” Mark your calendars for Thursday, November 21st at 2:00 p.m. ET to hear Deloitte’s William Calder, Maynard Nexsen’s Bob Dow, and Nonlinear Analytics’ Olga Usvyatsky discuss what corporate attorneys need to know about the latest audit-quality developments to advise clients on financial reporting and corporate governance matters.

– Liz Dunshee