Auditor Dismissed from $50 Million Securities Class Action Suit

In a decisive win for the malpractice community, an independent auditor achieved dismissal in a securities fraud class action lawsuit by way of a 12(b)(6) motion. The Middle District of PA dismissed some of the claims against a troubled bank and all claims against the bank’s public offering underwriter and its outside auditor. The court accepted the auditor’s arguments that the plaintiff had failed to establish the requisite element of scienter necessary to maintain a securities fraud claim and, moreover, had failed to properly plead that the auditor did not “honestly hold” its audit opinions with reference to the 2015 U.S. Supreme Court Decision in Omnicare. Given the stakes of this litigation, like many securities claims, the victory may serve as an important template for other auditors to follow when faced with similar claims.

In 2010, Orrstown Bank (“Bank”) raised nearly $40 million in a public offering of 1.4 million shares of common stock.  Following a series of revelations regarding its financial condition, the Bank reported losses for 2011 and disclosed in its Annual Report that it had a “material weakness” in its internal controls. Subsequently, the Bank revealed that it had entered into an agreement with various regulators requiring it to revise its underwriting and credit administration policies and strengthen its credit risk management practices.

On May 12, 2012, Lead Plaintiff Southeastern Pennsylvania Transportation Authority (“SEPTA”) filed a class action complaint against the Bank and several of its officers, its outside auditor and the underwriters of its common stock offering. As for its claims against the auditor, SEPTA asserted two theories of alleged liability: (i) the auditor violated Section 10(b) of the Exchange Act by “issuing unqualified or ‘clean’ audit reports” and (ii) the auditor violated Section 11 of the Securities Act by issuing “untrue statements of material fact” in the Bank’s registration statements.

All claims in SEPTA’s First Amended Complaint were dismissed, without prejudice, for failure to state a claim.  A Second Amended Complaint was filed, and the defendants again moved to dismiss. Again, the court dismissed all claims against the auditor. The decision is available HERE.

With respect to the Exchange Act claim, the court concluded that the plaintiff had failed to “allege material misrepresentations in [the audited financial statements] and further failed to plead facts supporting a strong inference of scienter.” The court held that “conclusory allegations” that the auditor violated accounting principles does not evidence that the auditor “intentionally issued false and misleading statements.”

With respect to the Securities Act claim, the court relied upon Omnicare, Inc. v. Laborers Dist. Council Constr. Indus. Pension Fund, in which the High Court defined the limited circumstances under which Section 11 liability may attach to sincerely held opinions that ultimately prove to be incorrect. The court concluded that the plaintiff had failed to properly plead that the auditor “did not honestly hold the challenged opinion” included with the “clean” audit reports. The court held that the allegations amount to “little more than a conclusory assertion that the [auditor’s] opinions … ‘lacked a reasonable basis’” which fell below the Omnicare standard. According to the court, allegations that the auditor missed “red flags” is irrelevant because the determinative factor is what was “known to” the auditor and what was the auditor’s intent when it reached its conclusions.

This decision could have widespread impact on the standard for pleading a securities violation against an independent auditor. Whether it be scienter under 10(b) or the Omnicare standard for 11, the bar remains high to assert such a claim particularly against auditors, and rightfully so. The auditor was represented by Professional Liability Matters’ own Jonathan Ziss and Seth Laver of Goldberg Segalla’s Philadelphia offices.