Shareholders of a company that went bankrupt after a fraud by some officers can sue its accounting firm on charges it failed to detect the fraud, New Jersey's Supreme Court ruled this week.

The 5 to 2 decision is a setback for KPMG, which had won a trial court dismissal of the original lawsuit by shareholders of the failed Physician Computer Network. PCN, of Morris Plains, N.J., developed and marketed software to help doctors communicate with hospitals, insurers and laboratories.

Two executives at the company constructed fake deals to inflate the company's revenues in the 1990s, transactions which were not detected by KPMG for several years. When audits uncovered the fraud, the company had to report previously losses in the tens of millions and declared bankruptcy. Shareholders have already settled a suit against PCN for $21 million.

Shareholders sued KPMG, arguing that the accounting firm failed to perform proper audits, but KPMG asked for dismissal based on the imputation doctrine, which says that an agent's knowledge is attributable to their principal. The state Supreme Court ruling, which opens up as many questions as it answers, says that the doctrine does not prevent shareholders who were unaware of the fraud from collecting damages from an auditor who was negligent by failing to report company officers' fraud.

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