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Tricontinental Industries, Ltd. v. PricewaterhouseCoopers, LLP 475 F.3d 824 (7th Cir. 2007)

Anicom Inc. was a wire distribution company founded in the early 1990s. Its stock became publicly traded, and the company adopted a strategy to increase market share and to expand its operations. Between 1995 and 1997, Anicom acquired 12 companies. Each of these transactions involved some payment in the form of Anicom stock. During this time, PricewaterhouseCoopers LLP rendered accounting, audit, and various types of consulting services to Anicom.

In 1996, Anicom began engaging in improper accounting procedures to enable it to report that it had met sales and revenue goals. The procedures included the use of fictitious sales orders or prebills for goods that were not ordered. PwC became aware of these practices in July 1997 when it was asked to investigate Anicom's billing practices. After conducting its investigation, PwC reported to Donald C. Welchco, Anicom's vice president and CFO, that improper billing had occurred at Anicom branches and that, in the absence of controls, the practice might arise at other branches as well. No mention of these irregularities was made in PwC's audits of Anicom's 1998 and 1999 financial statements. Indeed, PwC issued opinions that Anicom's financial statements were accurate, complete, and conformed with GAAP and that its audits were performed according to GAAS.

In September 1998, Anicom made an asset purchase agreement to acquire the wire and cable distribution assets of three companies: Texcan Cables Ltd. (known now as Tricontinental Distribution Ltd.), Texcan Cables Inc., and Texcan Cables International Inc. Anicom acquired those assets in exchange for cash and Anicom stock. After the transaction, Tricontinental Distribution and Texcan Cables transferred their stock to Tricontinental Industries, Ltd.

On July 18, 2000, Anicom announced that it was investigating possible accounting irregularities that could result in revision of its 1998, 1999, and first-quarter 2000 financial statements by as much as $35 million. Accordingly, Anicom announced that its 1998 and 1999 financial statements should no longer be relied upon. After conducting an internal investigation, Anicom further announced that, subject to audit, it believed that, for the period from the first quarter of 1998 to the first quarter of 2000, the company had overstated revenue by approximately $39.6 million. None of the company's announcements or disclosures ever stated that full-year 1997 revenue or net income had been materially misstated or that any of Anicom's prior financial results were inaccurate in any way. On January 5, 2001, Anicom filed for bankruptcy protection.

In July 2001, Tricontinental filed an action against PwC for negligent misrepresentation. Tricontinental maintained that PwC knew that Tricontinental was relying on Anicom's audited financial statement for 1997 and, specifically, was relying on PwC's representation that the audit was performed in a manner consistent with GAAS and that Anicom's financial statements conformed with GAAP. These statements, Tricontinental alleged, were materially false, misleading, and without reasonable basis.

PwC moved to dismiss Tricontinental's complaint on the grounds that PwC owed no duty to Tricontinental because the Illinois Public Accounting Act (IPAA) limited PwC's liability to persons who were either in privity of contract with PwC or for whose primary intent Anicom had secured PwC's services. The district court granted PwC's motion. Tricontinental appealed.

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Ripple, Circuit Judge

In order to state a claim for negligent misrepresentation under Illinois law, a party must allege:

(1) a false statement of material fact; (2) carelessness or negligence in ascertaining the truth of the statement by the party making it; (3) an intention to induce the other party to act; (4) action by the other party in reliance on the truth of the statement; (5) damage to the other party resulting from such reliance; and (6) a duty on the party making the statement to communicate accurate information.

The Illinois courts have considered, on several occasions, the application of these requirements, specifically, the element of duty, as it applies to public accountants. The Illinois Appellate Court first spoke to this issue in Brumley v. Touche, Ross & Co., 463 N.E.2d 195 (Ill. App. Ct. 1984) (Brumley I). In that case, the court reviewed the various approaches that courts around the country had adopted for accountant liability to third parties: (1) the standard set forth in Ultramares Corp. v. Touche, 174 N.E. 441 (N.Y. 1931), which held that public accountants could not be liable in negligence to third parties absent privity; (2) a reasonable foreseeability standard; and (3) a more limited foreseeability rule that public accountants may be liable to plaintiffs, who are not exactly identifiable, but who belong to a limited class of persons whose reliance on the accountant's representations is specifically foreseen. The appellate court held that the plaintiff's complaint was insufficient to set forth a duty on the part of defendant to plaintiff because "the complaint did not allege Touche Ross knew of plaintiff or that the report was to be used by KPK to influence plaintiff's purchase decision nor does it allege that was the primary purpose and intent of the preparation of the report by Touche Ross for KPK." Id. (emphasis added).

In Brumley v. Touche, Ross & Company, 487 N.E.2d 641 (Ill. App. Ct. 1985) (Brumley II), the court revisited this standard. In Brumley II, the plaintiff had argued that the Supreme Court of Illinois had altered the standard for liability for attorneys, which necessitated a change by the appellate court with respect to accountant liability. The appellate court rejected this argument: it is apparent that to be sufficient plaintiff's complaint must allege facts showing that the purpose and intent of the accountant-client relationship was to benefit or influence the third-party plaintiff. 487 N.E.2d at 64445 (emphasis added).

Shortly after Brumley II, the Illinois legislature enacted the Illinois Public Accounting Act, 225 ILCS 450/30.1, which provides:

No person, partnership, corporation, or other entity licensed or authorized to practice under this Act . . . shall be liable to persons not in privity of contract with such person, partnership, corporation, or other entity for civil damages resulting from acts, omissions, decisions or other conduct in connection with professional services performed by such person, partnership, corporation, or other entity, except for:

(1) such acts, omissions, decisions or conduct that constitute fraud or intentional misrepresentations, or

(2) such other acts, omissions, decisions or conduct, if such person, partnership or corporation was aware that a primary intent of the client was for the professional services to benefit or influence the particular person bringing the action; provided, however, for the purposes of this subparagraph (2), if such person, partnership, corporation, or other entity (i) identifies in writing to the client those persons who are intended to rely on the services, and (ii) sends a copy of such writing or similar statement to those persons identified in the writing or statement, then such person, partnership, corporation, or other entity or any of its employees, partners, members, officers or shareholders may be held liable only to such persons intended to so rely, in addition to those persons in privity of contract with such person, partnership, corporation, or other entity.

Following IPAA's passage, there was some question regarding the effect of the IPAA on accountant liability. We are obliged, however, to follow the interpretation given the language by the state appellate court in Chestnut Corp. v. Pestine, Brinati, Gamer, Ltd., 667 N.E.2d 543, 54647 (Ill. App. Ct. 1996). The Illinois court took the view that the first clause of subparagraph (2) states the general rule of accountant liability as set out in Brumley while the second clause creates a legislative exception to the general rule. Continued the court:

[T]o adopt the defendants' interpretation of the statute would require us to hold, as a matter of law, that accountants are never liable to third parties, absent fraud or intentional misrepresentation, unless they agree in writing to expose themselves to liability. The law in Illinois would have come full circle then and returned to the rationale of Ultramares in 1931. Absent a clear signal from the legislature or the supreme court that such a return is intended, we believe the observation of the trial court and the evolution of the law since Ultramares provides a useful background as one measures the statute's meaning.

Id. at 547.

Although the Supreme Court of Illinois has not spoken to the issue, Illinois Appellate Courts seem to agree that the IPAA embodies the rule applied to accountants in Brumley II: The plaintiff must show that a primary purpose and intent of the accountant-client relationship was to benefit or influence the third-party plaintiff.

The primary intent rule, however, has proven to be somewhat difficult to define in practical terms. For instance, disputes have arisen regarding whether the "primary intent" of the client must be contemporaneous with the accountant's work product on which the third party relies. With respect to this issue, the Illinois Appellate Court has stated:

In terms of timing, we do not read the statute to strictly require that an accountant be made aware of his client's intention to influence or benefit a third party only at the time the work product was created as defendant contends. The standard requires that a plaintiff prove that the primary purpose and intent of the client was to benefit or influence the third party. In Brumley II, we held that the plaintiff in that case met the standard because he alleged that the defendant knew of the plaintiff's reliance on the defendant's reports and that the defendant had subsequently verified its accuracy. We do not, however, read Brumley II as per se requiring independent verification in order to meet the standard in Pelham. Other conduct may be sufficient to satisfy Pelham.

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Builders Bank v. Barry Finkel & Assocs., 790 N.E.2d 30, 37 (Ill. App. Ct. 2003) (emphasis added).

Further, although Illinois case law has established that "independent verification" is not a per se requirement, Illinois courts have not set forth in detail what "other conduct" may satisfy the "primary intent" standard. The cases, however, do establish that some affirmative action on behalf of the defendant-accountant is necessary. For instance, in Builders Bank, the record indicated that Finkel, the accountant, was told by Urkov, the company owner, that UMC was applying for a loan and requested that financial statements be furnished to UMC. The record further establishes that Finkel personally met with UMC on two occasions to discuss issues related to the loan. In at least one meeting, UMC was seeking an increase of $200,000 on a loan that had already been approved. In our view, it is reasonable to infer that Finkel played an active role in securing the loan or increasing the loan amount for UMC. From this evidence, a finder of fact could conclude, pursuant to the statute, that Finkel knew its work was being used to influence UMC at least at the time of the second meeting and that defendant, at minimum, presented its work as accurate. Id.

Similarly, in Freeman, Freeman & Salzman, P.C. v. Lipper, 812 N.E.2d 562 (Ill. App. Ct. 2004), the court held that the standard had been met by the allegation that the accountant to an investment fund had "issued clean audit opinions on each investment partner's capital accounts for those years"; had "addressed and sent its clean audit opinions to the partners who invested in those funds, including plaintiffs"; and had "prepared federal income tax Schedules K-l for plaintiffs and the limited partners each year." Id. at 56667. Furthermore, "each Schedule K-1 purported to reflect each partner's proportionate share of the partnership's net income for the year, as well as each partner's capital account balance at the beginning and end of each year." Id. at 567.

Finally, in Chestnut Corp., the court held that the plaintiffs had stated a claim for negligent misrepresentation by alleging that the plaintiff's representatives had gone to the offices of the defendant-accountants to discuss their possible investment in the client company and to review its financial condition. In response to specific inquiries by the plaintiff's representatives, the defendants "stated that the audit was accurately performed according to generally accepted auditing standards." Chestnut Corp., 667 N.E.2d at 545.

In sum, the duty owed by a professional accountant to non-client third-parties is the standard articulated in Brumley II and codified in the IPAA. The IPAA provides that an individual accountant, partnership or firm will be liable to a third party for negligence only "if such person, partnership or corporation was aware that a primary intent of the client was for the professional services to benefit or influence the particular person." This "primary intent" may be demonstrated by "independent verification" or by other affirmative actions taken by the accountant and directed to the third party.

With this standard in mind, we turn to the allegations set forth in the Amended Complaint to determine whether they state a claim for relief.

With respect to the negligent misrepresentation claim, Tricontinental alleged as follows:

163. Prior to the time that PwC conducted its 1997 audit, PwC had assisted Anicom in raising money for acquisitions and finding acquisition candidates. PwC most certainly knew that acquisition candidates, such as Plaintiffs, would rely on the 1997 Form 10-K in making their decisions on whether to invest in Anicom's securities.

164. PwC knew prior to the closing of the Texcan transaction that Plaintiffs were negotiating to sell significant assets to Anicom in exchange in part for Anicom securities. PwC was on the circulation lists for drafts of the Asset Purchase Agreement and PwC conducted due diligence of Texcan for Anicom. PwC knew that Plaintiffs had received and were relying on Anicom's Form 10-K for 1997 and, in particular, PwC's unqualified audit report, and that Anicom intended that Plaintiffs rely on the 10-K and PwC's audit report in assessing an investment in Anicom. Despite its awareness of these facts, and despite its knowledge from its own investigation and its involvement in the business of Anicom that Anicom was engaged in improper accounting practices and lacked adequate controls to prevent these irregular practices, PwC intentionally or recklessly failed to withdraw its audit opinion on the 1997 financial statements. Instead, PwC allowed Plaintiffs to rely on the false and misleading information contained in Anicom's Form 10-K for 1997.

As noted by the district court, these allegations do not demonstrate any "independent verification" provided by PwC to Tricontinental. However, such verification to the third party is not a per se requirement. "Other conduct" by PwC directed to Tricontinental also may satisfy the "primary intent" requirement of the IPAA. Tricontinental alleges that PwC knew of its reliance on the 1997 audit opinion, knew of the misrepresentation contained in the statement and "allowed plaintiffs to rely on the false and misleading information." However, Illinois cases, fairly read, make clear that the IPAA requires more. In order to state a claim under the IPAA, Tricontinental must allege that it was a primary purpose "of the accountant-client relationship . . . to benefit or influence" Tricontinental. None of the allegations contained in