Board of Trustees of Community College District No. 508 v. Lybrand

• Decision Date: 18 December 2003
• Docket Number: No. 94676.,94676.
• Citation: 281 Ill.Dec. 56,803 N.E.2d 460,208 Ill.2d 259
• Parties: The BOARD OF TRUSTEES OF COMMUNITY COLLEGE DISTRICT No. 508, COUNTY OF COOK, Appellee, v. COOPERS & LYBRAND, Appellant.
• Court: Illinois Supreme Court

803 N.E.2d 460

208 Ill.2d 259

281 Ill.Dec. 56

The BOARD OF TRUSTEES OF COMMUNITY COLLEGE DISTRICT No. 508, COUNTY OF COOK, Appellee, v. COOPERS & LYBRAND, Appellant.

No. 94676.

Supreme Court of Illinois.

December 18, 2003.

Jeffrey R. Tone, Linton J. Childs, David A. Gordon and Carter G. Phillips, of Sidley, Austin, Brown & Wood, Chicago, for appellant.

Reuben L. Hedlund, James W. Joseph, Erin H. Walz, Sarah J. Deneen and Thomas C. Koessl, of Hedlund & Hanley, L.L.C., Chicago, for appellee.

Todd A. Rowden, of Quarles & Brady, L.L.C., Chicago, and Kelly M. Hnatt, of Willkie, Farr & Gallagher, New York, New York (Richard I. Miller, New York, New York, of counsel), for amicus curiae American Institute of Certified Public Accountants.

Justice KILBRIDE delivered the opinion of the court:

The Board of Trustees of Community College District No. 508 (Board) sued the accounting firms of Coopers & Lybrand (Coopers) and Arthur Andersen (Andersen). The Board sought more than $50 million in compensatory damages, allegedly resulting from the failure of those firms to discover and report to the Board inappropriate investments made by Phillip R. Luhmann, the treasurer and chief financial officer of City Colleges of Chicago (City Colleges). The Board sought damages in tort from both Andersen and Coopers, jointly and severally, and also sought damages resulting from breach of contract from both firms. Prior to trial, Andersen settled with the Board and the Board filed an amended complaint seeking relief against only Coopers. The, jury found damages on the tort claim in the amount of $23 million, reduced to $12.65 million because of the Board's contributory fault. The jury also awarded damages on the Board's contract claim. Both parties appealed.

The appellate court affirmed. 333 Ill. App.3d 225, 266 Ill.Dec. 493, 775 N.E.2d 55. We granted Coopers' petition for leave to appeal (177 Ill.2d R. 315), and the Board seeks cross-relief (155 Ill.2d R. 318). We granted the American Institute of Certified Public Accountants leave to file a brief as amicus curiae in support of Coopers. 155 Ill.2d R. 345. We now affirm in part and reverse in part, and remand the cause to the trial court with directions.

I. BACKGROUND

The Board is a body politic and corporate created under the Public Community College Act (110 ILCS 805/1-1 et seq. (West 1994)). The Board operates and manages the City Colleges of Chicago. City Colleges is a public agency and its investment policies must comply with the Public Funds Investment Act (Investment Act) (30 ILCS 235/1 et seq. (West 2002)). Accordingly, in 1988, 1990, and 1992, the Board adopted resolutions authorizing its treasurer to invest City Colleges' funds only in instruments permitted by the Investment Act. The resolutions provided that the funds should be invested only in securities guaranteed as to payment of principal and interest by the full faith and credit of the United States of America. The securities were required to be of a type that would mature or be redeemable before funds were needed, in the opinion of the treasurer, to provide for the Board's expenditures. The investment policy directed that securities should generally be purchased with the intent of holding to maturity so as to minimize interest rate risk. Despite this clear mandate, the treasurer, Luhmann, invested in securities not authorized by the resolutions. Further, he repeatedly engaged in a practice known as "pairing off" securities, buying a security and expecting to sell it for a profit before he was required to pay for it.

In February 1994, the Board chairman, Ron Gidwitz, learned that Luhmann had violated the City Colleges' investment policy and declared a "financial emergency." Luhmann was terminated, and the Board instructed City Colleges to sell the securities that did not comport with the investment policy as soon as prudently possible.

In its original complaint, the Board alleged that during fiscal years 1991, 1992, and 1993, Luhmann invested in securities not authorized by the Board's investment policy and in violation of the Investment Act. Andersen audited City Colleges' financial statements for the fiscal years 1991 and 1992. Coopers audited the financial statements for fiscal year 1993. The complaint alleged that the failure of the auditors to identify and report Luhmann's investment policy violations to the Board amounted to a breach of each firm's duty to comply with generally accepted accounting procedures. The Board claimed that if it had been informed of the investment policy violations, it would have taken steps to respond and avoided a dramatic decline in the value of the securities, claimed to be in excess of $50 million and not discovered until 1994. Thus, the conduct of both accounting firms was alleged to be the proximate cause of City Colleges' financial losses, and the prayer for relief sought recovery against both firms, jointly and severally.

Although Luhmann's investment policy violations occurred throughout the fiscal years in question, the investments resulting in the precipitous losses were not made until both Andersen and Coopers had completed their audits. Thus, the gravamen of the complaint was that if either auditing firm had informed the Board that the securities in the City Colleges' portfolio violated its investment policy, the Board would have ended those investment practices. Hence, the later investments that ultimately resulted in the claimed losses would not have occurred.

Andersen and the Board settled prior to trial. The trial court found the settlement to be in good faith. The Board filed an amended complaint, deleting all references to Andersen and the 1991 and 1992 audits, but identical in all other respects to the original complaint.

Coopers asserted the affirmative defense of comparative fault. However, prior to trial, the court ruled that pursuant to the "audit interference" doctrine, only conduct by the Board affecting Coopers' preparation of the audit could be considered. Thus, Coopers was not permitted to argue that extensive evidence of the Board's oversight of Luhmann's investment activities and its knowledge of possible violations of investment policy supported a finding of contributory fault.

At trial, Board chairman Ronald Gidwitz testified that Luhmann furnished the Board with regular summaries of the current status of City Colleges' investments at various times during the fiscal year. Five reports were furnished during fiscal year 1993, showing the investments Luhmann had made, including treasury, Government National Mortgage Association (GNMA) Securities, and other agency mortgage-backed securities. The reports reflected wide fluctuations in securities from quarter to quarter, indicating that securities were not being held to maturity. No objection was raised by the Board to this practice.

Gidwitz admitted that he knew some mortgage-backed securities were not being held to maturity. He testified that Luhmann told him he had sold treasury bonds prior to maturity. He admitted making "mental notes" of these matters, intending to discuss them with Luhmann, but he never spoke with either Luhmann or Coopers about any investment noncompliance.

On October 9, 1993, shortly before the audit was concluded, Luhmann told Coopers that there had been no significant change in the investment portfolio since June 30, 1993. At another meeting, Luhmann and City Colleges' acting controller, Michael Wagner, represented to the auditors that there had been no significant events or transactions since the fiscal year-end that should be considered for inclusion or disclosure in the financial statements and that there were no significant new commitments or contingencies since the end of the fiscal year. Despite these representations, Luhmann testified at trial that City Colleges' portfolio changed after June 1993, a fact confirmed by Coopers' expert witness, Professor John McConnell.

City Colleges also furnished Coopers with a representation letter dated October 15, 1993, signed by Wagner, stating that City Colleges was not aware of any "violations or possible violations of laws or regulations whose effects should "be considered for disclosure in the financial statements or as a basis for recording a loss contingency" and that "no matters or occurrences have come to our attention to the date of this letter that would materially affect the financial statements and related disclosure for the year ended June 30, 1993." Gary Seidelman, Coopers' engagement partner, testified that Coopers delivered its audit report on October 16, 1993, and that it would not have done so without the representation letter in hand.

The jury heard expert testimony regarding the financial losses caused by Luhmann's investment practices. Dr. Lisette Cooper, the Board's expert, attributed nearly $65 million in losses to Coopers" failure to monitor compliance with the investment policy and to advise the Board of the noncompliance. Coopers disputed that any losses resulted from its failure to comply with applicable professional accounting standards. However, Coopers' investment expert, Dr. John McConnell, concluded that financial losses on securities purchased by Luhmann after June 30, 1993, but before Coopers finished its audit, amounted to approximately $23 million.

The jury returned a verdict for the Board, and both sides appealed, asserting various grounds for relief. The appellate court affirmed judgment on the verdict, rejecting Coopers' argument that the trial court erred in applying the audit interference doctrine, and holding that Coopers was not entitled to a setoff for the Andersen settlement, 333 Ill.App.3d at 239, 241, 266 Ill.Dec. 493,775 N.E.2d 55.

The appellate court also rejected the Board's contentions that it was entitled to a judgment notwithstanding the verdict on the issue of comparative fault and that the jury was' improperly instructed on that issue. 333 Ill.App.3d at 243, 266...