Negligent Audit Suit In California

In Arthur Andersen v. Superior Court (1998), we noted that AA performed an audit of the 1991 financial statements of Cal-American. As required by section 900.2, AA's audit report was filed with the Commissioner. The Commissioner's staff allegedly relied on AA's unqualified audit opinion to accept that Cal-American's financial statements fairly represented its financial position in accordance with generally accepted accounting principles. Since the financial statements showed Cal-American to be solvent, no regulatory action was taken. In actual fact, Cal-American was insolvent. Its financial statements materially misrepresented its true financial condition by failing to disclose that a significant portion of Cal-American's assets were encumbered as a result of related party transactions. (Andersen, supra, 67 Cal. App. 4th at pp. 1483-1484.) By the time the Commissioner discovered Cal-American's true insolvent condition, Cal-American had allegedly descended deeper into insolvency, and had become unable to pay an increased amount of insurance claims. The Commissioner instituted conservation proceedings that were later converted into liquidation proceedings. The Commissioner then filed suit for professional negligence and negligent misrepresentation against AA, claiming that he would have acted sooner and would have reduced the losses caused by Cal-American's deepening insolvency if AA's audit report had been accurate. (Id. at pp. 1484-1485.) AA moved for summary judgment and summary adjudication, contending that AA owed no duty to the interests represented by the Commissioner. The trial court denied AA's motion. AA then petitioned for a writ of mandate. (Andersen, supra, 67 Cal. App. 4th at p. 1485.) the primary issue was whether AA was entitled to summary judgment on the authority of Bily. We summarized Bily as follows: "The universe of persons to whom an auditor can be liable for a negligent audit is determined according to section 552 of the Restatement Second of Torts (Restatement 552). According to Restatement 552, as interpreted in Bily, an auditor may be liable for negligence to the audit client, and for negligent misrepresentation to 'those persons who act in reliance upon those misrepresentations in a transaction which the auditor intended to influence.' (Bily, supra, 3 Cal. 4th at p. 376.) On the other hand, audit reports are often widely disseminated, and the auditor's potential liability does not extend to the entire universe of third persons who might possibly read an audit report. This limitation on the universe of potential plaintiffs was deemed necessary to avoid liability out of proportion to the auditor's degree of fault and unrelated to the degree of connection between an auditor's report and a third party's injuries. (Id. at pp. 401-402.)" (Andersen, supra, 67 Cal. App. 4th at p. 1485.) We concluded, "An issue is thus posed as to whether the Insurance Commissioner, with whom an audit report must be filed by statute, is within the universe of permissible plaintiffs defined in Bily." (Ibid.) We held that "the Insurance Commissioner, in his capacity as liquidator of Cal-American's estate, may recover from AA on behalf of the liquidation estate (for the benefit of policyholders and others having claims against the liquidation estate) for damage caused to the liquidation estate by negligent misrepresentations in AA's audit report." (Andersen, supra, 67 Cal. App. 4th at p. 1486, italics added.) As to the professional negligence cause of action, we stated: "Although (as held in Bily) the Insurance Commissioner can recover from AA for professional negligence only if the Insurance Commissioner was AA's audit client, the issue of who was the audit client was not fully developed in the trial court." (Id. at pp. 1486-1487, 79 Cal. Rptr. 2d 879.) "For example, the record does not contain AA's audit engagement letter. In addition, AA's separate statement says nothing about how AA was retained for this audit. It implicitly appears to be the case that AA's engagement was solely with Cal-American, and that the Insurance Commissioner was at most an expected beneficiary by reason of Insurance Code Section 900.2. If this is correct, AA will be entitled to judgment on the Insurance Commissioner's negligence (as opposed to the negligent misrepresentation) claim." (Id. at p. 1487, fn. 2.)