A California court has ruled that a lawsuit can proceed against the accounting firm Rothstein Kass, which has been sued by two hedge fund managers claiming that the firm never uncovered the fabricated trading activity of one of their business partners.

The lawsuit was filed in August by Paron Capital Management CEO Peter McConnon and CFO Timothy Lyons, who hired Rothstein Kass in 2010 to verify that the investment returns of over 20 percent claimed by a trader they wanted to do business with were legitimate. The trader, James Crombie, wanted to attract investors to his platform for trading futures contracts, and the hedge fund managers hired the risk consulting firm Kroll and Rothstein Kass to perform due diligence checks on him.

The plaintiffs, Paron Capital Management CEO Peter McConnon and CFO Timothy Lyons, claimed that Rothstein Kass promised to perform independent verifications of Crombie’s track record and account statements to identify any known fraud or misconduct Crombie may have committed. They allege that the firm instead concealed Crombie’s fraud in hopes of obtaining hundreds of thousands of dollars in recurring audit work from the hedge fund. Investors in the fund lost tens of millions of dollars as a result.

They claimed the firm never actually verified the existence of the trading accounts and statements that, like Bernard Madoff, Crombie had essentially fabricated. The firm allegedly learned about a fraud lawsuit brought against Crombie by a former investor that prompted them to consider dropping out of the engagement, but they never informed Paron about the lawsuit. A member of the firm's board was friends with Crombie from a previous job, according to an email quoted in the complaint, but the plaintiffs only found out about the relationship later.

After the firm signed off on the review, the hedge fund began marketing the fact that the track record returns had been auditor verified, not knowing that the “verified track record data” was false. Several investors who had been waiting for the report opened up accounts in the fund and began trading. The National Futures Association began auditing Paron after receiving an anonymous complaint against Crombie. McConnon and Lyons halted all trading in the fund and notified the fund’s current and prospective clients, but by then the damage had been done.

Crombie has since been charged with fraud by industry regulators, including the Commodity Futures Trading Commission, which allege that the trading history Rothstein Kass was paid to verify was fabricated. 

On Wednesday, a court denied Rothstein Kass’s motion to dismiss the lawsuit, in which the firm claimed that the plaintiffs had benefited from the fraud.

“We are gratified by the court’s decision,” McConnon said in a statement. “Rothstein Kass has attempted to skirt responsibility from the very beginning of this matter. In addition to aiding Mr. Crombie’s fraud, the firm refused to help us cooperate with regulators and even ignored requests for access to our own client files and work papers. It is not what I expected from an established CPA firm. We look forward to presenting the case to a jury.”

A spokesman for Rothstein Kass declined to comment.

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