[IMGCAP(1)]The Nevada Supreme Court issued a little-noticed decision in late May that could have significant implications for disputes between auditors and their clients.

The case, Cucinotta v. Deloitte & Touche LLP, held that Deloitte was absolutely privileged against civil liability for disclosing allegedly defamatory information to its client’s audit committee pursuant to the express requirements of the federal securities laws.

While the decision is narrowly drawn, it implies a broad defense for auditors who do what they are required to do—whether by federal statutes, state law, regulators or professional standards—and a valuable tool for managing disputes with audit clients.

The Nevada Case
In the course of audit work for an unrelated client, Deloitte obtained a copy of an FBI intelligence bulletin containing allegations of serious criminal activity by two executives of another audit client, Global Cash Access Holdings Inc. Because the intelligence bulletin contained “information indicating that an illegal act . . . may have occurred,” Deloitte concluded that it had a duty under Section 10A of the Securities Exchange Act of 1934 to disclose the allegations to the GCA audit committee.

An investigation conducted by an independent law firm ultimately identified no evidence of misconduct by the company or either of the two executives named in the FBI bulletin.

Nevertheless, the two executives were forced to resign. Although not discussed in the court’s opinion, the pleadings reveal that the executives threatened to sue Deloitte. As required by professional standards, Deloitte informed the audit committee that the threat of litigation undermined its independence and would require Deloitte to withdraw as the company’s auditor.

The company thereafter requested the executives to withdraw the threat and, when they refused, requested their resignations.

The two executives filed suit against Deloitte alleging defamation, tortious interference with their contracts with GSC, and tortious interference with prospective business advantage. Following limited discovery, the lower court granted summary judgment in favor of Deloitte, and the executives appealed.

The Nevada Supreme Court’s decision is straightforward. The court adopted Section 592A of the Restatement (Second) of Torts, which provides that “[o]ne who is required by law to publish defamatory matter is absolutely privileged to publish it.”

The court noted several decisions of other courts applying Section 592A in a variety of contexts. Although neither the court nor the parties’ briefs identified any precedent for applying Section 592A to communications by an auditor, the court readily found that the section accorded Deloitte’s communications an absolute privilege as a matter of law. Summary judgment, therefore, was affirmed.

Implications as Precedent
The Nevada court was careful to limit the scope its decision. The court emphasized that the “class of absolutely privileged communications . . . remains narrow and is limited to those communications made in judicial or quasi-judicial proceedings and communications made in the discharge of a duty under express authority of law.” On the facts, the decision addressed only the narrow situation of an auditor disclosing information specifically required to be disclosed to the specific audience identified in a federal securities statute that specifically regulates the audit relationship. Nevertheless, this decision should have broad implications in several respects.

First, although Section 592A on its face provides a defense only to an action for defamation, the Nevada court applied it to the executives’ claims for tortuous interference as well. As the court notes, the underlying rational for Section 592A is that “one who is required by law to do an act does not incur liability for doing it.” This common-sense principle implies not only immunity from suit on defamation grounds, but on any grounds. The court’s affirmation of summary judgment on the tortious interference claims further supports this construction.

Second, the executives’ claims against Deloitte arose from more than just disclosure of the defamatory allegations contained in the FBI bulletin. The executives lost their jobs only after Deloitte additionally advised the board of directors that the executives’ threat of litigation would require it to resign as the company’s auditor. Although the opinion does not discuss the point, the court’s disposition effectively extended the absolute privilege to Deloitte’s communication that it would resign if the threat of litigation was not resolved.

Third, there is no principled reason to limit this immunity to communications required under the federal securities laws. Auditors regularly are required to make various disclosures and communications under many other statutes, regulations and professional standards. The court’s reasoning, the result in the case, and the underlying rationale set forth in the restatement itself apply equally to any situation in which an auditor acts as required by law, regardless of the specific source of the legal obligation.

Most significantly, the auditors’ immunity should apply when they act pursuant to the extensive requirements of Generally Accepted Auditing Standards. GAAS applies to auditors with the force of law for several reasons. Most and perhaps all state licensing regimes require public accountants to comply with GAAS. Auditors also enter into contracts with their clients (i.e., engagement letters) that typically include a legal obligation to comply with GAAS. And GAAS is enforced by state tort law as well, because failure to comply with GAAS generally is recognized as proper grounds for a professional malpractice action.

In sum, the Nevada decision is a solid and well-reasoned precedent that implies a broad immunity for any actions by an auditor, whether communications or otherwise, that are required by any source of law, whether statutory or otherwise.

Managing Client Disputes
The specific facts of the Deloitte case were highly unusual. But auditors frequently have disagreements with management or other client personnel about how information identified in an audit should be interpreted, whether that information is material, or what should be reported to an audit committee, to a regulator or in the client’s financial statements. Occasionally, these disputes boil over into litigation.

In one widely publicized recent case, a relatively large regional accounting firm suffered a $50 million adverse jury verdict in a lawsuit arising from a dispute with notable similarities to the case in Nevada. Many of the key facts were hotly disputed, but the basic outline involved a disagreement with management over accounting estimates, the auditors’ reporting that disagreement to the board, a threat of litigation against the audit firm, and the firm thereafter resigning from the engagement pursuant to independence requirements.

The Nevada decision suggests that auditors can best manage this sort of client dispute by careful adherence to applicable legal requirements and professional standards. If an auditor concludes that it is required to act in a manner that might precipitate such a dispute, the auditor should take care to document that conclusion and the basis for it. The relevant communications should be made in writing, or promptly memorialized in writing, so that there is a clear record of what was said.

When client relationships or communications become contentious, auditors may have opportunities to protect themselves by carefully structuring their responses within the framework of applicable legal and professional standards.

Bennett W. Lasko is a partner at the law firm Drinker Biddle & Reath LLP in Chicago who focuses on complex business and financial litigation. His clients range from international accounting firms and Fortune 100 companies to closely held businesses and high net worth individuals.

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