On May 20, 2016, the US Court of Appeals for the Second Circuit affirmed the dismissal of federal securities claims, under § 10(b) and § 11, against Moore Stephens, a Hong Kong accounting firm. The court held in a summary order that Plaintiffs failed to establish scienter under § 10(b) and failed to establish subjective falsity under § 11. Significantly, the court held that auditors’ reports are “statements of opinion subject to the … standard” established by the Supreme Court for § 11 claims in Omnicare, Inc. v. Laborers Dist. Council.

Plaintiffs brought claims in the Southern District of New York alleging that Moore Stephens should have uncovered fraud at Puda Coal, a US holding company, involving the transfer of its main operating subsidiary, a Chinese coal mining company, to a company executive. On summary judgment, Judge Forrest excluded Plaintiffs’ expert witness as unqualified to testify on the relevant Public Company Accounting Oversight Board (PCAOB) standards, while refusing to exclude Moore Stephens’ PCAOB expert. Accordingly, the district court ruled that there was no material issue of fact on § 10(b) scienter and that there was no evidence of and no triable issue on § 11 subjective falsity.

On appeal, the Second Circuit affirmed Judge Forrest’s decision on both claims. First, the court affirmed the exclusion of Plaintiffs’ expert because she lacked the requisite experience and expertise to opine on PCAOB auditing standards given her concession, among others, that she had never conducted an audit under the PCAOB standards. The Second Circuit agreed that allowing opinions on other purportedly similar auditing standards—as Plaintiffs’ purported expert had offered—“would not be helpful to the jury on any relevant issue,” “would risk muddling the issue of the applicable standard of care” and would be “speculative” because Plaintiffs’ expert “had no basis for comparing” PCAOB standards with other standards.

The Second Circuit then affirmed summary judgment on Plaintiffs’ § 10(b) claim because there was no triable issue of fact as to whether Moore Stephens’ audit was reckless. This was true, the court held, regardless of whether expert testimony on the auditor’s standard of care was required. If expert testimony was required, Plaintiffs’ claim failed because they had “no factual basis for alleging that the … audits were ‘extreme departure[s]’ from PCAOB standards ‘amounting to no audit at all.’” But even if expert testimony was not required, summary judgment was proper because Plaintiffs’ alleged “red flags” were “not obvious signs of fraud,” holding that Plaintiffs alleged, at most, “fraud by hindsight,” which is not sufficient to meet the heightened scienter standard for auditors.

Finally, and most importantly, on § 11 the court held that Moore Stephens’ “[a]udit reports, labeled ‘opinions’ and involving considerable subjective judgment, are statements of opinion subject to the Omnicare standard for Section 11 claims.” Applying Omnicare, the Second Circuit concluded that there was “no evidence that Moore Stephens did not believe its ‘clean audit opinions’” or that “Moore Stephens omitted material facts about the basis for its audit reports.” Accordingly, the court affirmed summary judgment for Moore Stephens on Plaintiffs’ § 11 claim.

The Second Circuit’s decision is of particular import to accounting firms facing § 11 claims because it clarifies that auditors’ reports, which are styled as opinions and not certifications of the company’s financial statements, are opinions. As such, to plead a successful case, plaintiffs must comply with the standards set forth in Omnicare by showing either subjective falsity—that the auditor did not believe its report when issued—or that the auditor omitted material facts from its report.