What happens when professionals take on a job, issue reports telling the client that all is well, only to have a governmental authority say that all is not well, and that the statutory reports understate a liability by $37 Million?

Leading Ins. Group Ins. Co., Ltd. v Friedman LLP 2016 NY Slip Op 30375(U) March 3, 2016
Supreme Court, New York County Docket Number: 651049/15 Judge: Saliann Scarpulla is one example.

“”LIGUSB is the U.S. Branch of a foreign insurance company and LIS is the United States Manager of LIGUSB pursuant to applicable New York law.” Licensed as an insurance company in New York, LIGUSB is monitored by the New York Department of Financial Services (“NYDFS”) and must submit annual financial statements (“Statutory Financial Statements”) that conform with New York’s Statutory Accounting Practices (“SAP”). The Statutory Financial Statements are required to be audited by an independent certified public accountant according to Generally Accepted Auditing Standards (“GAAS”) and SAP. The Statutory Financial Statements must be accompanied by the accountant’s opinion letter, “certifying, among other things, that the Statutory Financial Statements are fairly stated in all material respects in accordance with SAP.” The Statutory Financial Statements include a statement of the insurance company’s Joss reserves, which “include the estimated liability for investigating and settling unpaid insurance claims or losses, both known … and unknown.” LIG used an internal actuary to establish the loss reserves for LIGUSB ‘s 2012 Statutory Financial Statements. Pursuant to an engagement Jetter (“Engagement Letter”), dated October 24, 2012, Friedman agreed to perform an independent audit of LIGUSB ‘s Statutory Financial Statements for the year ending in December 21, 2012. In pertinent part, the Engagement Letter stated that: Friedman would “plan and perform the audit to obtain reasonable assurance about whether financial statements are free from material misstatement;” “[t]he objective of [the] audit is the expression of an opinion about whether [LIG’s] financial statements are fairly presented, in all material respects, in conformity with accounting practices prescribed or permitted by the [NYDFS];” and the “audit [would] be conducted in accordance with auditing standards generally accepted in the United States of America.” The Engagement Letter also contained the following qualifications, that: LIG “[was] responsible for establishing and maintaining internal controls, including monitoring ongoing activities;” “[b]ecause of the inherent limitations of an audit, combined with the inherent limitations of internal control, and because [Friedman would] not perform a detailed examination of all transactions, there [was] a risk that material misstatements may exist and not be detected by [Friedman], even though the audit is properly planned and performed in accordance with U.S. generally accepted auditing standards;” and the “audit is not designed to provide assurance on internal control or to identify deficiencies in internal control.” ”

“On or about May 3 I, 2013, Friedman delivered the final, audited Statutory Financial Statements and Schedules, provided an independent auditors’ report regarding these documents, and submitted its “Accountant’s Qualification an Internal Control letter to LIGUSB’s Board of Directors and Stockholders.” LIG alleges that it relied on Friedman’s representations to satisfy it “that (i) LIG’s internal controls and accounting policies, including its procedures and methods for establishing Joss reserves, were reasonable and appropriate and (ii) LIGUSB’s statutory financial statements were free of material misstatement and fairly presented LIGUSB ‘s statutory financial condition.” Subsequent to the 2012 audit, LIG avers that it used “Friedman to perform various other accounting, consulting, advisory and tax-related services, for which LIG paid Friedman substantial fees.” “On or around September 13, 2013, LIG again engaged Friedman to perform the independent audit of LIGUSB’s financial statements for the year end[ing] December 31, 2013.” In approximately October 2013, “NYDFS advised LIG that red flags existed in LIG’s loss reserve estimates in its recent financial statements and required that LIG engage an independent external actuary to conduct a peer review of LI G’s internal actuary’s findings at LIG’s own expense.” LIG complied and, in approximately February 2014, “LIG discovered that its carried loss reserves were inadequate, contrary to what Friedman had concluded and reported in connection with its audit.” According to LIG, because its prior loss reserves were considerably understated, it had “to take immediate action to increase its reserves by approximately $37,000,000” and to “take aggressive and immediate measures to increase and improve its related internal controls and procedures.”  ”

“LIG alleges that “[i]n or around April of 2014, LIG discontinued its use of Friedman’s services.” On approximately June 3, 2014, “Friedman announced to the NYDFS that it was withdrawing its 2012 audit opinion of LIGUSB.” LIG alleges that the withdrawal of Friedman’s opinion “was inconsistent with SAP and insurance industry standards concerning the correction of errors in financial statements previously filed with regulating authorities,” and that “Friedman also knew, or should have known, that its action to recall its audit opinion would be damaging to LIG.” ”

“Here, Friedman contends that the complaint fails to specify how Friedman allegedly deviated from acceptable standards of practice. In particular, it points to the allegation that a subsequent, independent actuary identified certain “red flags” that Friedman “inexplicably failed to identify,” without identifying those red flags or describing what Friedman should have done differently. However, the complaint contains numerous allegation detailing the ways in which LIG believes Friedman deviated from professional standards of care, including that it failed to comply with GAAS and SAP by, among other things, failing to implement appropriate and adequate audit procedure to verify the accuracy of the Statutory Financial Statements. See complaint, ilil 6, 37-41, 57, 59-63, 98-101. Moreover, this is a pre-answer motion to dismiss. Therefore, LIG need not “pro[ ve] that there was a departure from accepted standards of practice,” but rather, it need only make the necessary allegations. See D.D. Hamilton Textiles, 269 AD2d at 214- 215 (finding, in the context of a motion for summary judgment, that plaintiffs failed to prove defendant accountant’s work fell below applicable standards of care); see also EEC I, Inc., 5 NY3d at 19. Ultimately, LIG alleges that Friedman failed to identify deficiencies with LI G’s loss reserves; whether this failure “was [due to] a departure from professional accounting standards … is a question that requires expert evidence for its resolution.” Berg v Eisner LLP, 94 AD3d 496, 496 (1st Dept 2012) (reversing dismissal). “