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NCP Litigation Trust v. KPMG, LLP

A-2344-02T5 (N.J. Super. App. Div. 2004) (Unpublished)

FRAUD; MISREPRESENTATION—Equitable fraud or negligent misrepresentation requires proof of a material misrepresentation of a material existing or past fact, reasonable reliance on that representation, and damages flowing from that misrepresentation.

A medical practice’s independent auditor issued audit opinions on the practice’s Fiscal Year (FY) 1995 and FY 1996 financial statements. The opinions stated that the auditor had conducted its audits in accordance with Generally Accepted Auditing Standards (GAAS) and Generally Accepted Accounting Principles (GAAP). In 1998, the auditor reported some accounting irregularities in the company’s FY 1997 financial results. Following this discovery, the auditor withdrew its report on the company’s FY 1995 and 1996 statements and resigned. As a result, the practice’s commercial bankers deemed the company in default of credit agreements, leading to various negative outcomes, including a cash shortfall and layoffs. The company’s new auditor discovered that the company’s FY 1995 financial records were in disarray, that the company’s FY 1995 results had been overstated by more than $41 million, and that the company’s FY 1996 reported$16.1 million of profit where there had actually been a $15.2 million loss. The auditor concluded that these irregularities were due to the fraud by the practice’s president and vice-president of finance.

The practice sued its previous auditor, alleging negligent misrepresentation. Specifically, it alleged that it suffered damages by reason of false and misleading audit opinions which allegedly resulted from the auditor’s failure to perform its audits in conformity with GAAS and GAAP and its failure to uncover the misconduct. The auditor moved to dismiss the complaint on the ground that the practice lacked standing to assert those claims because the fraudulent conduct of the employees was attributed to the company itself. The lower court dismissed the practice’s complaint, holding that the auditor was entitled to a complete defense against all counts of the complaint unless the practice could prove that the auditor had participated in the employees’ misconduct in a “material” way. The lower court also held that only a similarly fraudulent intent on the part of the auditor would preclude its reliance on the imputation defense.

The Appellate Division reversed that decision, and reinstated the suits. It held that equitable fraud or negligent misrepresentation requires proof of a material misrepresentation of a presently existing or past fact; reasonable reliance on that representation by another; and resulting damages. To support a claim of negligent misrepresentation, what needs to be proven is the existence of an incorrect statement, negligently made and justifiably relied upon, resulting in damages for economic loss. Since this was not a claim of legal fraud, the practice did not have to prove that the auditor had actual knowledge of the employee’s fraud. Therefore, the Appellate Division reversed the dismissal of the motion and remanded for further proceedings.


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