CANADA – In Lavender v. Miller Bernstein, 2017 ONSC 3958, a recent class action decision of the Ontario Superior Court, the auditor of a now-insolvent securities dealer was found liable for financial losses sustained by the dealer’s clients. The decision of Justice Belobaba focuses on the question: does an auditor have a duty of care to its client’s clients, including where there is no direct relationship with or reliance by these third party clients?
The dealer, Buckingham Securities (the “Dealer”), held the investments of roughly 1000 retail customers (the “Class Members”). The defendant auditors, Miller Bernstein LLP (the “Auditor”), was found to have negligently signed-off on Form 9 reports, which are filed annually with the Ontario Securities Commission (the “OSC”), the provincial securities regulator, to ensure compliance with segregation of assets and minimum free capital requirements. The Dealer had not segregated the Class Members’ funds, which it later misappropriated causing an alleged loss of $10.6 million. These facts were later admitted by the Auditor in disciplinary proceedings against the Auditor.
The Plaintiff launched class proceedings against the Auditor claiming in negligence simpliciter – that the Auditor owed and breached a duty of care causing foreseeable losses. This cause of action was later certified. The Plaintiff did not claim in negligent misrepresentation, which would require the Class Members to have read and relied upon the Form 9 reports.
The Auditor was found to owe a duty of care to the Class Members because their relationship was sufficiently foreseeable and proximate. The Court held that, “[e]ven though the class members never saw or even knew, at the time, about the Form 9s, the defendant Auditor as a matter of simple justice had an obligation to be mindful of the Plaintiff’s interests when auditing and filing the Form 9 reports with the OSC.” In essence, the Auditor knew, or ought to have known, that, if it filed truthful reports, the provincial regulator would have intervened and prevented the Class Members’ losses.
Negligence claims are not usually available for pure economic loss because the Courts are reticent to impose indeterminate liability on the tortfeasor. However the Court applied an exception because damages in this case were circumscribed to losses sustained by the Class Members whose identities were known to the Auditor, and to losses arising from the intended use of the Form 9 reports. The Auditor had been retained to perform an “assurance audit” and was specifically aware of the Class Members’ names and the exact amounts involved, and even corresponded with certain Class Members to verify account records. The Auditor also understood the consequences of misstatements in the Form 9 reports, namely that a negligent audit “could expose the Class Members to the very loss that they incurred.” The Auditor “knew its precise potential liability at the time of its audits,” and could therefore be held liable in that amount.
This decision confirms that auditors of securities dealers can be liable in negligence simpliciter to their client’s clients, and may not avoid liability by demonstrating a lack of individual reliance. Future cases may turn on the extent to which auditors were specifically aware of the identity and accounts of class members, and whether the misstatements at issue were prepared for the specific purpose which gave rise to the losses.
Despite the highly fact specific nature of this decision, we can expect an increase in Canadian claims brought against auditors, even where there is little connection between the services provided by the auditor and the end investors.