BDO faces investor lawsuit that could impact other firms

BDO USA has been involved in a yearslong lawsuit involving the investors in a defunct hedge fund who sued the auditing firm for negligence, breach of contract and breach of fiduciary duty, and a judge recently opened the door wider to future lawsuits against other firms.

The lawsuit involves a group of investors in Platinum Partners, a hedge fund manager that has faced charges from the Securities and Exchange Commission and the Department of Justice. The hedge fund collapsed in December 2016 when the DOJ arrested its top executives and charged them with a $1 billion investment fraud. BDO was one of the fund's auditors, along with CohnReznick, which was also sued but chose to settle with the investors. 

The investors alleged BDO negligently performed its audits, but they had relied on the BDO audit reports in making their investment decisions. The court directed the investor claims against BDO to an arbitration panel. In a July 29, 2024 decision, the arbitrators found BDO was negligent in its 2012 and 2013 audits for failing to uncover Platinum's overvaluation of its assets and awarded over $9 million to the investors.

BDO filed a motion before the New York State Supreme Court to vacate the arbitration award in favor of the investors. But then in January of this year, Justice Andrea Masley affirmed the arbitration panel's award in its entirety and went further on an issue that could affect the rights of hedge fund investors against accounting firms in the future. 

For decades, accounting firms have been given nearly total immunity from investor lawsuits in their audits of hedge funds, based on a legal doctrine derived from a 1985 case in a New York State appeals court involving Arthur Andersen & Co., which was sued by Credit Alliance Corp. after it lent money to a company whose financial statements were prepared by Andersen. It required investors to prove a "near-privity" (i.e., contractual) relationship with the accounting firms. To demonstrate "linking conduct," courts concluded that investors needed to have had direct communications with the fund manager's accounting firm, which rarely occurs. 

According to the judge's ruling, BDO had argued that the arbitration panel erred in finding near-privity between the investors and BDO sufficient to establish a third-party negligence claim. BDO also argued that the investors in the written interrogatories and the testimony admitted that they had never communicated with BDO other than the receipt of audit reports and routine audit confirmations, and thus receipt does not amount to linking conduct.

Justice Masley ruled that "linking conduct" to support near privity was demonstrated by the Platinum Partners investors, not with direct communications but by the fact that for 10 years BDO had issued its audited results in letters that were addressed to the investors, even though the letters were not sent by BDO to the investors, because BDO knew such reports would be provided to the investors by Platinum Partners and relied upon by investors.

A BDO spokesperson declined to comment on the matter. The decision opens the door for other claims by investors wronged by accounting firms that have performed shoddy, negligent audits or worse, with a potential long-term effect of forcing accounting firms to perform their audits with greater rigor and independence from the funds they're examining.

The negligence underlying the award was found by the arbitration panel to be egregious, saying BDO had overvalued the hedge fund's investments by hundreds of millions of dollars. The panel said the investors had no ability to evaluate these valuations, and were entirely dependent on the fund performing honest valuations, and BDO fairly auditing those valuations, neither of which happened. 

"These huge differences lead to the appearance that these analyses are just numbers on a page designed to bless the client's number rather than serious efforts to measure risk," the panel wrote. They said BDO selected risk factors because they supported Platinum's valuation of an asset. "What is wrong is to select risk factors because they support the client's mark rather than because they accurately measure risk," said the arbitrators.

"It is difficult to fathom BDO's thinking process on this sensitivity analysis," the arbitration panel wrote, referring to BDO's analysis of an asset called Black Elk. "The client's mark seemed to have served as an anchor to chase and caused the auditors to lose sight of the facts that nothing about the company or the market in which it was operating suggested that the value of the Funds' investment had increased at all, let alone by $92 million. At the very least, BDO's having done calculations producing a range of $29 million to $382 million for the same investment should have provoked a most searching analysis of all the assumptions producing these wildly disparate results. The panel concludes that BDO was negligent in performing its audit of the Funds' investment in Black Elk for 2012." 

Judge Masley agreed with many of the arbitration panel's findings. "The very fact that the Panel found BDO's audits problematic suggests that BDO was indeed the cause of the losses suffered by the Investors," she wrote. "It is irrelevant if the Panel specifically failed to use the term "loss causation. Therefore, the court rejects BDO's argument."

Platinum stopped working with BDO after the firm issued a 2013 audit and engaged CohnReznick to prepare the 2014 audit. It too was sued by the investors and chose to settle, according to David King, a partner in the litigation department at Herrick Feinstein in New York, which is representing some of the investors. The CohnReznick settlement is confidential, he told Accounting Today, but he estimates that BDO was the most culpable firm and could end up owing the investors and other claimants approximately $20 million, including interest accruing at New York's high rate, if the award is ultimately upheld. 

"We recovered roughly $9 to $10 million in an award representing the claims of, I believe, 13 out of the 90 or some investors who we represent," said King. "Each side picked a group of investors, and there was an arbitration just on the smaller group of claims. They're called bellwether claims, essentially to try to get a feel for what the arbitrators thought about the case generally, and hopefully enable some sort of a broader settlement for the entire group of investors. That hasn't happened at this point."

The award is now on appeal after BDO tried to vacate it. The investors also moved to have a portion of the award vacated because they wanted a larger damage award on some of the panel's rulings. Both sides' applications were denied and the matter is now before the First Department Appellate Division of the New York State Supreme Court. 

"We have to hear what the First Department thinks about Justice Masley's decision, who affirmed the arbitration award and refused to vacate any aspect of it," said King. "Now, the standard for overturning an arbitration award is pretty high, and the standard in reviewing Justice Masley's decision is going to rely in part on that standard. We'll see what the First Department does. That appeal could take most of 2026 to get resolved. Meanwhile, with respect to the other claims by the claimants who have not yet had their claims tried, their claims would basically stay while we find out what the court is going to do with the bellwether claims. Once the decision is in from the First Department, assuming it doesn't go to the Court of Appeals, we'll have a framework, essentially, for how to deal with the remaining claimants' claims against BDO."

He believes the case could have wider implications for accounting firms. Securities class-action lawsuits against auditing firms actually declined last year to a record low of 34, according to a report released Wednesday by Cornerstone Research.

"What's interesting about the case is it's extremely difficult to sue accounting firms for their audit work, particularly where you are an investor, as here in a hedge fund, because the argument is made that there's no privity between the investors and the accounting firm," said King. "The contract is between the accounting firm and the hedge fund, not the accounting firm and the investors. Now, before that, they compelled arbitration against our clients by arguing essentially that we were trying to sue under the contract and Justice Masley agreed with one of our arguments that the accounting firm couldn't essentially rely on the arbitration clause of the engagement agreement and then turn around and say they're not bound in any way by the engagement agreement."

The case could potentially change the precedents on when auditing firms can be sued by hedge fund investors. "It's a fairly established body of case law that makes it extremely difficult to do so," said King. "We argued, under some exceptions to the panel, that we should be allowed to do so here, and we prevailed. And Justice Masley affirmed the panel's award in that regard, and actually went further than the panel did in looking at the case law. She actually entered a stronger decision that, if anything, would broaden investors' access to be able to sue accounting firms for their audits of hedge funds."