Second Circuit and Eleventh Circuit Courts of Appeal
Order ID 53563633773 Type Essay Writer Level Masters Style APA Sources/References 4 Perfect Number of Pages to Order 5-10 Pages
Second Circuit and Eleventh Circuit Courts of Appeal
Auditors are not always found guilty of negligence, gross negligence, and fraud when lawsuits are filed against them. And they do not always settle lawsuits to avoid costly, protracted litigation. A good example is legal action
taken against three accounting firms in in re Advanced Battery Technologies, Incorporated and Ruble Sanderson v. Bagel, Josephs, Levine & Co., LLC, Friedman LLP, and EFP Rothenberg, LLP. For purposes of this case, Advanced
Battery is referred to as ABAT and the three accounting firms simply as “the auditors.”
On March 25, 2015, the Second Circuit and Eleventh Circuit Courts of Appeal affirmed dismissals of securities fraud claims filed against the auditors that audited Chinese reverse-merger companies because the plaintiffs did not
adequately plead scienter under the heightened pleading standard imposed by the Private Securities Litigation Reform Act of 1995.1 Under the PSLRA, plaintiffs must “state with particularity facts giving rise to a strong inference
that the defendant acted with the required state of mind” with respect to each act or omission of the defendant that is alleged to violate the securities laws.
The Second Circuit’s opinion in ABAT stated that to allege scienter on a recklessness theory against an independent audit firm under Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5, a plaintiff must allege
facts showing that the audit firm’s auditing practices were so deficient as to amount to “no audit at all” or that the audit firm disregarded signs of fraud that were “so obvious” that the audit firm must have been aware of them.
The ABAT ruling is significant because it is the first federal appellate case to expressly reject scienter arguments based on the alleged discrepancy between a company’s filings with the U.S. SEC and with China’s State
Administration of Industry and Commerce (SAIC), a regulatory agency to which Chinese companies must submit financial statements as part of an annual examination.
The decision reflects a growing trend of courts rejecting securities fraud claims filed against independent audit firms in the context of Chinese reverse-merger companies. In ABAT, the plaintiffs alleged that the auditors falsely
represented that they performed their audits in accordance with professional standards and that ABAT’s financial statements were fairly presented.
An amended complaint upon appeal of the lower court decision against ABAT alleged that the audit firms were reckless and committed an “extreme departure from the reasonable standards of care” by failing to identify several
purported “red flags,” including: (1) conflicts between ABAT’s financial statements filed with China’s SAIC and with the SEC; and (2) the unreasonably high profits that ABAT reported in its SEC filings, in contrast to the significant
losses that it reported in its SAIC filings. The district court denied leave to amend, and the Second Circuit affirmed
.2 The Second Circuit agreed with the district court that the proposed amended complaint, like the previous complaint, failed to adequately plead the audit firms’ scienter under the theory of recklessness and that amendment
would be futile. The appellate court explained that the plaintiff was required to allege conduct “that is highly unreasonable, representing an extreme departure from the standards of ordinary care,” such that the conduct “must, in
fact, approximate an actual intent to aid in the fraud being perpetrated by the audited company as, for example, when a defendant conducts an audit so deficient as to amount to no audit at all, or disregards signs of fraud so
obvious that the defendant must have been aware of them.”
3 Much of the Second Circuit’s analysis focused on the plaintiff’s argument that the audit firms acted recklessly by failing to inquire about or review ABAT’s financial filings with China’s SAIC.
In rejecting these arguments, the court noted that none of the “standards on which [the lead plaintiff] relies—the Generally Accepted Auditing Standards, Statements on Auditing Standards, or GAAP [generally accepted accounting
principles]—specifically requires an auditor to inquire about or review a company’s foreign regulatory filings.”
The court declined to adopt the general rule, urged by the plaintiff, that allegations of an audit firm’s failure to inquire about or review such foreign filings are adequate to plead recklessness under the PSLRA. Although the court
noted that “such a legal duty could arise under certain circumstances” (which it did not explain), it concluded that those circumstances were not pled here.
In addition, the Second Circuit held that ABAT’s report of high profit margins in its SEC filings triggered, at most, a duty to perform a more rigorous audit of those filings, not of the company’s SAIC-China filings. The court declined
to infer recklessness from the allegations that one of the audit firms had access to, and “presumably relied” on, the financial data underlying ABAT’s SAIC filings but failed to see that the data contradicted the company’s SEC
Instead, the court found another inference more compelling—that ABAT maintained different sets of data for its Chinese and U.S. regulators and provided the audit firm with false data. The ABAT opinion is significant because it
illustrates the high burden plaintiffs face in pleading recklessness in Section 10(b) cases against independent audit firms.
Notably, since under the PSLRA the plaintiffs filing suit must plead with particularity facts alleging that the audit firm’s work was so deficient as to amount to no audit at all, the historical legal standards for auditor liability seem to
have turned in favor of the auditors.
Also, the Second Circuit’s determination that allegations that an audit firm failed to review AIC filings is not sufficient to meet this high burden for pleading scienter is significant, as such allegations are frequently pled in matters
involving audits of the financial statements of Chinese companies listed on U.S. securities exchanges. ___________________ 1A reverse merger occurs when a privately-held Chinese company goes public in the U.S. by merging with
U.S. publicly-traded “shell companies.”
The reverse merger trend was initially fueled by the difficulties of going public in China. Reverse mergers are often described as an inexpensive “back-door” way of taking a company public, but they have a sketchy history in the
U.S. One reason is the publicly held shell company has virtually no assets or business of its own.
Many shell companies are the remnants of failed companies, though some are created from scratch for the single purpose of merging with an existing private company. 2 In re Advanced Battery Technologies, Incorporated and
Ruble Sanderson v. Bagel, Josephs, Levine & Co., LLC, Friedman LLP, and EFP Rothenberg, LLP, 14-1410-cv, March 25, 2015, Available at: http://caselaw.findlaw.com/us-2nd-circuit/1695335.html. 3“2 cases audit firm defendants
can rely on,” Law360, New York, April 9, 2015, Available at: http://www.law360.com/articles/640875/2-cases-audit-firm-defendants-can-rely-on.
The Second Circuit and Eleventh Circuit Courts of Appeal affirmed dismissal of securities fraud claims because the plaintiffs did not adequately plead scienter under the standard imposed by the Private Securities Litigation
Reform Act of 1995. Scienter is defined as which of the following?
(a)The standard of reasonableness required of a prudent person in the management of his affairs
(b)An untrue statement of a material fact
(c)The intent to deceive, manipulate, or defraud
(d)The failure to maintain due diligence during the issuance of new securities known as an IPO
The requirements of the Act of 1934 often center on the liability of auditors under Section 10 and rule 10b-5. The provisions make it unlawful for a CPA to:
(a)make an untrue statement of an immaterial fact.
(b)employ a device, scheme, or artifice to enhance the statements.
(c)engage in any act, practice, or course of business to commit fraud.
(d)make an immaterial false or misleading statement.
Second Circuit and Eleventh Circuit Courts of Appeal
QUALITY OF RESPONSE NO RESPONSE POOR / UNSATISFACTORY SATISFACTORY GOOD EXCELLENT Content (worth a maximum of 50% of the total points) Zero points: Student failed to submit the final paper. 20 points out of 50: The essay illustrates poor understanding of the relevant material by failing to address or incorrectly addressing the relevant content; failing to identify or inaccurately explaining/defining key concepts/ideas; ignoring or incorrectly explaining key points/claims and the reasoning behind them; and/or incorrectly or inappropriately using terminology; and elements of the response are lacking. 30 points out of 50: The essay illustrates a rudimentary understanding of the relevant material by mentioning but not full explaining the relevant content; identifying some of the key concepts/ideas though failing to fully or accurately explain many of them; using terminology, though sometimes inaccurately or inappropriately; and/or incorporating some key claims/points but failing to explain the reasoning behind them or doing so inaccurately. Elements of the required response may also be lacking. 40 points out of 50: The essay illustrates solid understanding of the relevant material by correctly addressing most of the relevant content; identifying and explaining most of the key concepts/ideas; using correct terminology; explaining the reasoning behind most of the key points/claims; and/or where necessary or useful, substantiating some points with accurate examples. The answer is complete. 50 points: The essay illustrates exemplary understanding of the relevant material by thoroughly and correctly addressing the relevant content; identifying and explaining all of the key concepts/ideas; using correct terminology explaining the reasoning behind key points/claims and substantiating, as necessary/useful, points with several accurate and illuminating examples. No aspects of the required answer are missing. Use of Sources (worth a maximum of 20% of the total points). Zero points: Student failed to include citations and/or references. Or the student failed to submit a final paper. 5 out 20 points: Sources are seldom cited to support statements and/or format of citations are not recognizable as APA 6th Edition format. There are major errors in the formation of the references and citations. And/or there is a major reliance on highly questionable. The Student fails to provide an adequate synthesis of research collected for the paper. 10 out 20 points: References to scholarly sources are occasionally given; many statements seem unsubstantiated. Frequent errors in APA 6th Edition format, leaving the reader confused about the source of the information. There are significant errors of the formation in the references and citations. And/or there is a significant use of highly questionable sources. 15 out 20 points: Credible Scholarly sources are used effectively support claims and are, for the most part, clear and fairly represented. APA 6th Edition is used with only a few minor errors. There are minor errors in reference and/or citations. And/or there is some use of questionable sources. 20 points: Credible scholarly sources are used to give compelling evidence to support claims and are clearly and fairly represented. APA 6th Edition format is used accurately and consistently. The student uses above the maximum required references in the development of the assignment. 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The paper has slight errors within the paper. This can include small errors or omissions with the cover page, abstract, page number, and headers. There could be also slight formatting issues with the document spacing or the font Additionally the paper might slightly exceed or undershoot the specific number of required written pages for the assignment. 10 points: Student provides a high-caliber, formatted paper. This includes an APA 6th edition cover page, abstract, page number, headers and is double spaced in 12’ Times Roman Font. Additionally, the paper conforms to the specific number of required written pages and neither goes over or under the specified length of the paper.
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