In a professional services setting, (in this case an accountant) when you can’t claim malpractice, you claim fraud.  Malpractice in this case was not possible to claim, because there was no privilty, and the paper documents ruled out “near privity.”

Israel Discount Bank of N.Y. v EisnerAmper LLP  2014 NY Slip Op 51620(U) [45 Misc 3d 1218(A)]  Decided on November 14, 2014  Supreme Court, New York County  Kornreich, J. demonstrates the importance of privity, and when a third-party may or may not rely on “near-privity.”

“Oak Rock, founded in 2001 by non-party John Murphy, is “a specialty asset-based lending company.” Complaint ¶¶ 12-13. Until the fraud at Oak Rock (discussed below) was discovered, Oak Rock was solely managed and controlled by Murphy. ¶ 12. Oak Rock makes “revolving asset-based loans” to installment financing dealers. ¶ 13. Simply put, Oak Rock [*2]funds the dealers’ financing and collateralizes that funding with the receivables in which the dealers have a security interest. Id. Oak Rock, in turn, finances its lending with credit facilities with a lower cost of debt than Oak Rock charges the dealers. ¶ 15. Thus, Oak Rock leverages its ability to obtain relatively low-cost debt and creates credit lines for merchants via the dealers, with the dealers doing the actual merchant lending. The merchant lending is secured by the merchants’ receivables, which is the collateral that flows upward to Oak Rock and its own financers, such as IDB, as the asset that backs this lending channel.

EisnerAmper issued unqualified Independent Auditors’ Reports on Oak Rock’s balance sheet and other financial statements for the years 2002 through 2011. ¶ 19. For 2002 through 2005, these audited reports were prepared by an EisnerAmper partner, Steve Singer. ¶ 20. Singer retired from EisnerAmper in 2006. ¶ 21. Thereafter, the audited repots were prepared by another partner, Steven Guzik. ¶ 22. Guzik, allegedly, “had virtually no experience in auditing asset based lenders.” ¶ 23. According to the complaint, at least four other EisnerAmper employees [see ¶¶ 24-27] also worked on Oak Rock audited reports, “[s]ome or all” of whom “lacked appropriate experience in auditing asset based lenders.” ¶ 28.

Each year, before EisnerAmper conducted its audit, Oak Rock signed substantially similar engagement letters. For instance, the engagement letter dated January 11, 2011 (for the 2010 audit) provided that “[t]he objective of [EisnerAmper’s] audit is to express an opinion about whether [Oak Rock’s] financial statements are fairly presented, in all material respects, in conformity with accounting principles generally accepted in the United States [GAAP].” The engagement letter then explained that the audit would be conducted in accordance with generally accepted auditing standards (GAAS), which required that EisnerAmper “plan and perform the audit to obtain reasonable, rather than absolute, assurance about whether the financial statements are free of material misstatement whether caused by error or fraud. Accordingly, a material misstatement may remain undetected.” The engagement letter further provided that “[t]he engagement is being undertaken solely for [Oak Rock’s] benefit and the parties do not intend to provide contractual rights to any other person” [emphasis added]. The engagement letter also noted that “the financial statements are the responsibility of the management of [Oak Rock]” and that “[m]anagement is responsible for designing and implementing programs and controls to prevent and detect fraud.””

“In this action, IDB seeks to hold EisnerAmper liable for the false information in Oak Rock’s financial statements that IDB allegedly relied on in lending money to Oak Rock. It is undisputed that, each year, Oak Rock’s financial statements contained myriad inaccuracies, which are set forth extensively in the complaint. See, e.g., ¶ 90 (false statements in 2010 financial statements). However, as noted earlier, in a highly unusual (and possibly intentional) decision, the complaint does not identify the cause or causes of action being asserted against EisnerAmper. Rather, a long, detailed narrative is presented, spanning 96 pages. When the court first read the complaint, it was unsure what claims were being asserted, and assumed that, based on the nature of the accusations, IDB was attempting to assert a malpractice claim against EisnerAmper. EisnerAmper’s counsel, understandably, thought so as well, and devoted a significant portion of its moving brief to explain, quite correctly, why such a claim fails as a matter of law. In opposition, IDB claimed its complaint was misunderstood, and, in reality, was only a claim for fraud. Specifically, IDB alleges that EisnerAmper’s false statements in its audit reports about Oak Rock’s financials, which IDB claims were the result of a grossly negligent audit process, amount to actionable fraud.”

“Finally, it should be noted that, while not a basis for this decision, the recently filed adversary proceeding (brought by the Official Committee of Oak Rock’s unsecured creditors) against IDB in Oak Rock’s bankruptcy proceeding suggests that, even if this case survived dismissal, its viability would be very much in question. The recently unsealed adversary complaint [see In re: Oak Rock Financial LLC, Case No. 8-14-08231, Dkt. 21 (Bankr EDNY Oct. 6, 2014)]^[FN5] alleges that IDB “had more contact, control and information about [Oak Rock] than any other lender and was responsible for managing [Oak Rock’s] collateral.” Id. ¶ 2 (emphasis added). The facts alleged in the adversary complaint, if true, would preclude an assertion of reasonable reliance and likely implicate the in pari delicto doctrine. See Kirschner v KPMG LLP, 15 NY3d 446, 464 (2010). Accordingly, it is

ORDERED that the motion to dismiss by defendant EisnerAmper LLP is granted, and the Clerk is directed to enter judgment dismissing the Complaint with prejudice.”