Defense Digest

New Jersey Recognizes Tort Of Aiding And Abetting Fraud Against Accountants

On August 18, 2006, New Jersey's Appellate Division held that aiding and abetting fraud is a cognizable civil cause of action under New Jersey law. In State of New Jersey Department of Treasury v. Quest Communications International and Arthur Anderson, LLP, A-2503-04T1 (App. Div. August 18, 2006), the New Jersey Department of Treasury (NJT) filed suit seeking damages for alleged securities fraud against Quest Communications International and the former accountants and auditors for Quest, Arthur Anderson, LLP. The trial court dismissed the complaint. However, the Appellate Division reversed and reinstated the complaint, holding that the claims were not barred under the New Jersey Accountant Liability Act, N.J.S.A. 2A:53A-25.

The NJT sought damages and alleged that the defendants caused Quest stock to trade at artificially inflated prices by employing improper accounting practices and by issuing false and misleading statements about Quest's business, revenues and profits. The plaintiff alleged that Anderson participated in and blessed Quest's illicit swap transactions and that improper accounting practices were designed to inflate Quest's reported revenues and earnings, and then turn its stock price, at a time when NJT purchased the stock. The plaintiff alleged that Anderson aided and abetted Quest's fraud by intentionally advising Quest on how to structure the illicit swap transactions, and other accounting practices, to artificially inflate Quest's revenues because Anderson possessed unique and superior knowledge of Quest's accounting and business practices and was informed of the specific fraudulent actions used in various acquisition transactions, including the swap agreements. NJT maintained that Anderson participated in, knew of, or recklessly disregarded the facts and circumstances of the fraudulent acts when issuing numerous public documents regarding Quest's financial status and participated in Quest's manipulation of the fraudulent public financial disclosures by advising the corporation on how to accomplish its fraud. The complaint also contained a claim of civil conspiracy.

The representatives of Quest testified before the House of Representatives that Anderson played a critical role in advising Quest on financial reporting and accounting, provided audits and pre-issuance reviews, and made presentations to the Board of Directors. In a press release, Quest reported that Anderson had full knowledge and approved of Quest's method of accounting for the swap transactions. It also stated in the press release that, with the guidance of Arthur Anderson, Quest improperly recognized and reported $1.48 billion of revenue from the swap transactions following the merger of Quest and U.S. West, Inc.

Anderson filed a Motion to Dismiss arguing that the complaint failed to state a claim under N.J.S.A. 2A:53A-25(b)2. The Appellate Division noted that the Accountant Liability Act does provide greater protections for accountants by limiting their exposure for liability for damages for negligence to third parties. See, CP Litigation Trust v. KPMG, LLP, __ NJ __, (2006). Thus, generally, the negligent performance of audit services for a client does not give rise to third party liability under the Act. However, the Act exempts from its immunity provisions negligence occurring where the accountant and the third party are in privity, Finderne Management Co. v. Barrett, 355 N.J. Super. 197 (App. Div. 2002), certif. den., 177 N.J. 219 (2003), so that negligent conduct is actionable when the accountant knows the third party will rely upon his audit and the accountant agreed his work would be released to and relied upon by the third party.

In NJT, the complaint sounded in fraud, which is not barred by the Act. N.J.S.A. 2A:53A-25(b) does not shield accountants from intentional acts of fraud or from intentional acts that assist a client in committing a fraud or conspiratorial cooperation aimed at perpetration of a fraud.

Significantly, while Anderson argued that New Jersey does not recognize aiding and abetting fraud, the Appellate Division held that aiding and abetting fraud is a cognizable civil cause of action under New Jersey law. The Appellate Division relied upon Section 876(b) of the Restatement (2nd) of Torts (1979), which defines the tort of aiding and abetting. New Jersey has adopted the Restatement's definition of aiding and abetting liability. Therefore, the Appellate Division held that an action against a defendant for the tort of aiding and abetting is cognizable. The plaintiff must show that: (1) the party whom the defendant aids has performed a wrongful act that causes an injury; (2) the defendant must be generally aware of his role as part of an overall illegal or tortious activity at the time that he provides the assistance; and (3) the defendant must knowingly and substantially assist the principal violation. Tar v. Ciasulli, 181 N.J. 70 (2004).

NJT alleged Anderson aided and advised Quest in performing its fraudulent reporting of earnings to inflate its stock price, which caused NJT injury in the form of multi-million dollar losses when the fraud was disclosed. NJT did allege that Anderson was generally aware of its role as part of the overall illegal activity because it was an active participant and helped perpetrate the fraud and that Anderson knowingly and substantially assisted Quest with the creation and implementation of fraudulent accounting schemes to implement the fraud. Therefore, the court found that NJT pled the fundamental requisites of aiding and abetting fraud.

Of course, a claim for aiding and abetting fraud also requires proof of the underlying tort, that is, the fraud committed by Quest. The plaintiff's complaint did plead facts asserting Anderson's actions in presenting and propagating the fraudulent accounting reporting to advance Quest's objective of increasing its stock value so an investor like NJT would increase its investment to its detriment. The allegations were not merely that Anderson failed to detect Quest's alleged fraudulent reporting of revenue and expenses, but that it actually facilitated the known fraud. NJT argued that further discovery would provide the specificity of Anderson's acts. The court accepted the plaintiff's position and found that NJT's complaint was properly pled. Therefore, the Appellate Division reversed the Trial court's order and reinstated this complaint.

Should you have any questions regarding this decision, please contact Jack Slimm of the firm's Cherry Hill, New Jersey office.

* Jack is a shareholder in the firm's Cherry Hill, New Jersey office, and he can be reached at jlslimm@mdwcg.com or (856) 414-6021.