When Accounting Firms Speak, Plaintiffs Must Prove They Listened: Requiring Proof of Reliance in Securities Fraud Actions

Crowell & Moring LLP has achieved an important victory for the accounting industry in a decision issued by the United States Court of Appeals for the District of Columbia Circuit. The decision, In re: Interbank Funding Corp Securities Litigation, No. 09-7167 (D.C. Cir. Dec. 28, 2010), made clear that in securities fraud actions against accounting firms, courts may not presume that investors have relied on audited financial statements where the accounting firm has affirmatively certified the statements. Quite simply, the failure to disclose a fraud is not enough.

In order to establish a securities fraud cause of action, plaintiffs are ordinarily required to prove, among other elements, the existence of a causal link between a defendant's misconduct and the plaintiff's decision to purchase securities. Interbank, at 3. This is called reliance. Traditionally, however, securities fraud plaintiffs have avoided this requirement by taking refuge in the Supreme Court's decision in Affiliated Ute Citizens v. United States, 406 U.S. 128 (1972). The Court in Affiliated Ute held that where a fraud "involv[es] primarily a failure to disclose," plaintiffs are excused from their obligation to plead and prove reliance. Affiliated Ute, at 153. In those cases the court will simply presume reliance by plaintiffs in deciding to purchase securities.  This presumption of reliance was created by judicial fiat to alleviate the burden of requiring plaintiffs to prove that they relied on the unstated.

But in the face of an increasing number of district courts applying the Affiliated Ute presumption where plaintiffs alleged that defendants failed to disclose the existence of a Ponzi scheme, and without affirmatively pleading reliance, the D.C. Circuit held that the application of Affiliated Ute should be constrained and strictly construed. Accordingly, where an accounting firm has made affirmative, though boilerplate, statements of accuracy and compliance with Generally Accepted Accounting Principles - no presumption of reliance applies because the case does not primarily involve a failure to disclose. The Court reasoned that where an accounting firm has made such affirmative statements, the plaintiffs' burden of proving reliance is neither impossible, nor impractical. As a matter of law, the mere failure to disclose a fraud is insufficient to transform an affirmative misrepresentation case into an omissions case that qualifies for the presumption.

In rendering this decision the D.C. Circuit has now joined the Fourth, Fifth, Ninth and Eleventh Circuit Courts of Appeals in holding plaintiffs to their burden of proving reliance and in doing so has removed yet another tool from the arsenal of securities fraud plaintiffs.