In 2009, the Securities and Exchange Commission sued Danny Pang and his two companies for allegedly defrauding investors of hundreds of millions of dollars by misrepresenting investments in the life insurance policies of senior citizens and in timeshare real estate. At the same time, the SEC obtained an emergency court order appointing a receiver over his companies ("PEMGroup"). Eventually, the receiver sued the accounting firm that had audited the financial statements for six of PEMGroup's offerings. The receiver sought $51 million in damages on claims of (1) professional negligence, (2) aiding and abetting the wrongful conversion of PEMGroup's assets, and (3) unjust enrichment. U.S. District Judge Philip S. Gutierrez granted summary judgment for the auditors on all three of these claims.
Yesterday, the Ninth Circuit Court of Appeals affirmed Judge Gutierrez' decision in Mosier v. Stonefield Josephson, 2016 U.S. App. LEXIS 3118 (9th Cir. 2016). In an opinion by Judge Stephen S. Trott, the Court of Appeals found that under both the professional negligence and the aiding and abetting claim, the receiver had to prove that the auditor's conduct was the proximate cause of the harm. To prove causation, the receiver had to prove reasonable reliance. PEMGroup could not prove reasonable reliance on the professional negligence claim because it knew about the fraudulent conduct that affected the accuracy of the financial statements. The Court found several problems with claims of reliance on the aiding and abetting claims. First, the receiver chose to rely on circumstantial, rather than direct evidence, that any investor actually relied on the audits. In this case, the investors were in Taiwan and there was no evidence that the financial statements and reports were translated or that the investors could read English. The receiver also was unable to overcome the effect of the qualifications that the auditor made to its reports:
The fatal problem for Mosier [the receiver] is that he has no evidence whatsoever demonstrating how these materials were used and, given Stonefield's [the auditor's] qualifications, what weight, if any, investors placed on them. Instead, he asks us to draw the inference from his circumstantial evidence that indeed investors did rely on them. This equivocal evidence does not warrant such an inference. First, because of the clear qualifications in Stonefield's audit reports, which amount to red flags, it is just as likely — without any evidence to the contrary — that PEMGroup did not show them to people it was attempting to deceive. It defies logic to assume that a crook would waive cautionary "buyer-beware" alerts in front of potential innocent victims of a Ponzi scheme. Stonefield's qualifications previously quoted amount to a warning that PEMGroup was using improper and unreliable valuation methods, methods that violated GAAP; and that PEMGroup's financial statements might not be reliable.
The Court of Appeals found that the auditor had forfeited his unjust enrichment claim by failing to respond to the auditor's challenge. Nonetheless, the Court of Appeals opined that "PEMGroup got what it deserved: qualified reports. This result was hardly unjust."
Meet me in San Diego
This Friday, Robert Copeland and I will be speaking at the San Diego County Bar Association's Annual Corporate and LLC Law Update. We will be covering a number of significant developments including recent amendments to the California Revised Uniform Limited Liability Company Act that took effect on January 1 of this year.