Moore Stephens’ Hong Kong firm won a victory in a New York federal appeals court on a case that could have a far-reaching impact on class-action lawsuits involving audit reports.

The U.S. Court of Appeals for the Second Circuit affirmed last Friday prior rulings in a securities class-action lawsuit against Moore Stephens Hong Kong for its audits of Puda Coal, a publicly traded, U.S.-listed company headquartered in China, which at one time held a 90 percent ownership stake in a Chinese coal company, Shanxi Puda Coal Group Co.

In September 2009, Puda’s chairman transferred Puda’s entire interest in Shanxi Coal to himself, leaving Puda a shell company. The transfer was reflected in shareholder meeting minutes and in documents filed in China’s State Administration of Industry and Commerce. But Puda’s financial statements for 2009 and 2010 included all of the assets, liabilities, revenues, expenses, and net income for Shanxi Coal.

Nevertheless, Moore Stephens Hong Kong issued clean audit opinions for Puda’s 2009 and 2010 financial statements under Public Company Accounting Oversight Board standards. When the Shanxi Coal transfer became public knowledge in April 2011, Moore Stephens resigned as Puda’s auditor and announced that its 2009 and 2010 audit opinions could no longer be relied upon.

Puda’s investors filed a securities class-action lawsuit shortly after news broke of the Shanxi Coal transfer, alleging that Moore Stephens (and others) violated Section 11 of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934 (and Rule 10b-5).

At the trial, a witness, Anita C.M. Hou, testified that Moore Stephens failed to comply with the auditing standards of Hong Kong and/or the People’s Republic of China. However, she also admitted that she was not an expert on PCAOB standards and could not opine on whether the audits complied with PCAOB standards.

Moore Stephens brought forward Alexander H. Mackintosh as its own expert witness on PCAOB standards. He opined that Moore Stephens’ 2009 and 2010 audits fully complied with PCAOB standards. The district court struck out Hou’s testimony and granted summary judgment in favor of Moore Stephens on the grounds that Hou did not have the necessary expertise to offer opinions on matters relevant to the case.

The appeals court agreed with the lower court and also found Moore Stephens did not act recklessly or with the intent to deceive, manipulate or defraud. The court cited a 2015 Supreme Court case, Omnicare, Inc. v. Laborers District Council Construction Industry Pension Fund, which found that statements of opinion are actionable under Section 11 of the Securities Act of 1933 as false or misleading only if the issuer of the opinion held a subjective belief inconsistent with the opinion, or if the opinion omits material facts about the issuer’s inquiry into or knowledge concerning a statement of opinion if those facts conflict with what a reasonable investor would take from the statements of opinion itself.

“Audit reports, labeled ‘opinions’ and involving considerable subjective judgment, are statements of opinion subject to the Omnicare standard for Section 11 claims,” said the Second Circuit in its ruling last Friday. “There is no evidence that Moore Stephens did not believe its ‘clean audit opinions’ for Puda’s 2009 or 2010 financial statements. Nor is there evidence that Moore Stephens omitted material facts about the basis for its audit reports. Plaintiffs-appellants cannot sustain their Section 11 claim.”

Of critical importance for accountants, the Second Circuit held that audit reports involve significant subjective judgment and are statements of opinion subject to the Supreme Court’s ruling in Omnicare.

“The court ruled it is essentially an opinion on the financial statements, and you have to meet the standard under a Supreme Court decision called Omnicare to show that the auditors either didn’t believe that opinion at the time that they offered it, or omitted facts that would make the opinion untrue, which is a pretty big step up in the proof you would have to make against an auditor than merely showing that the underlying financial statements have an error,” said Brian Massengill, a partner at the law firm Mayer Brown LLP, which represented Moore Stephens in the case.

The ruling could be influential on future cases involving audit firms, even if it doesn’t establish a direct precedent. However, the Second Circuit includes the Southern District of New York, where most securities lawsuits are brought, including this one.

“Because they did it in a summary order, it is not precedential, so it doesn’t require any court to follow it,” said Massengill. “But it is the reasoning of a panel in the Second Circuit, so I think courts would certainly look to this decision and the Second Circuit’s reasoning under Section 11.”

The chances of a successful appeal to the full court or the Supreme Court are remote, as the full appeals court agrees to hear only a tiny fraction of cases decided by the panel that handed down last week’s ruling.

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