Congregation of the Passion, Holy Cross Province v. Touche Ross & Co.
| Decision Date | 21 April 1994 |
| Docket Number | No. 73224,73224 |
| Citation | 159 Ill.2d 137,636 N.E.2d 503,201 Ill.Dec. 71 |
| Court | Illinois Supreme Court |
| Parties | , 201 Ill.Dec. 71, 62 USLW 2673 CONGREGATION OF THE PASSION, HOLY CROSS PROVINCE, Appellee, v. TOUCHE ROSS & COMPANY, Appellant. |
Daniel P. Ward, Francis J. Higgins and John J. Verscaj, Bell, Boyd & Lloyd, Chicago, for appellant.
Thomas P. Ward, McBride, Baker & Coles, and David C. Gustman, Margaret S. Garvey and Thomas Kottler Freeborn & Peters, Chicago, for appellee.
Plaintiff, Congregation of the Passion, Holy Cross Province, brought suit against the defendant, Touche Ross & Company, in the circuit court of Cook County alleging damages resulting from defendant's preparation of financial statements for plaintiff's use. The jury returned verdicts in favor of plaintiff and against defendant for $3.9 million on the negligence count and $1.5 million on the breach of contract count. A directed verdict in favor of defendant had previously been entered on a fiduciary duty count. The trial court entered judgment against defendant for $3,819,352, and the appellate court affirmed. (224 Ill.App.3d 559, 166 Ill.Dec. 642, 586 N.E.2d 600.) We allowed defendant's petition for leave to appeal (134 Ill.2d R. 315), and now affirm the judgment of the appellate court.
Plaintiff is a corporate entity and an order of the Roman Catholic Church. It operates monasteries, retreat houses, and schools. Plaintiff meets its operating expenses by use of contributions and investment income. Rather than make its own investment decisions, plaintiff hires investment advisors to manage its accounts. Defendant is an accounting firm with offices in Chicago and in many other cities throughout the world.
In 1973, plaintiff decided to replace its previous accounting firm with defendant, Touche Ross. Plaintiff and defendant executed an "engagement letter" which listed the services defendant would render for plaintiff. The engagement letter was for a term of one year. On or about June 30 each year, when plaintiff's fiscal year ended, defendant presented a new engagement letter to plaintiff. In each of the engagement letters, defendant agreed to prepare an unaudited financial statement for plaintiff's use for the fiscal year just ended.
Between defendant's preparation of the 1975 and 1976 fiscal year financial statements, plaintiff appointed Cranford D. Newell of San Francisco, California, as an investment advisor. Plaintiff committed two funds to Newell's control: the "retirement fund" and the "permanent fund." Each fund initially consisted of approximately $1 million. By written agreement, Newell was given full discretionary authority over all investment decisions regarding the two funds.
Newell dealt mainly in government bonds with fixed interest rates. Newell employed a modified "arbitrage" trading strategy. He would buy a bond issue that seemed to be trading lower than government bonds generally, and simultaneously sell short an issue trading higher than securities with similar coupons and maturities. If the market stabilized as Newell anticipated, market forces would move each issue price closer to the prices of other government bonds. The transaction could then be liquidated at a profit. Newell entered into these transactions The reports that Newell submitted to plaintiff recorded "open arbitrage positions" at cost. Plaintiff's internal bookkeepers also recorded Newell's arbitrage positions at cost. While the cost figure accurately reflected the market value of an arbitrage position at the moment the transaction took place, any future changes in the market values of the bonds would not be reflected in the cost figure. Hence, any unrealized losses or gains occurring due to fluctuations in market prices would not be reflected in the cost figures which were reported in the annual financial reports.
[201 Ill.Dec. 74] through accounts held with numerous securities dealers. These transactions were highly leveraged, and although plaintiff had entrusted to Newell only $2 million, Newell held positions on behalf of plaintiff totaling $44.5 million on June 30, 1976. The only cash required by Newell to enter into these transactions was the amount of the purchase less the amount of the short sale. This initial difference between the two amounts is called "margin" or "cost," hereinafter referred to as "cost."
Defendant first encountered the Newell investments in the course of preparing plaintiff's 1976 financial statement. The accountants assigned by defendant to prepare plaintiff's 1976 financial statement left in their work papers the following note regarding the Newell investments:
"3) Arbitrage--when Newell determines that there is a temporary fluctuation in the price of a government security in relationship to other government securities he buys or sells long that security and purchase [sic] or sells short another government security at the same time. When the fluctuation is eliminated he reverses his previous purchase and short sale and takes a profit (or loss). These arbitrages are generally for over $1 million dollars [sic ] and a small fluctuation ( 1/32 of 1%) can involve a substantial amount of money. The only money actually invested by the Congregation is for margin [cost] required by the dealers (typically the amount of the purchase less the amount of the short sale). The risk is minimized since only U.S. government securities are traded and the chance of default is small.
At June 30, 1976 the Congregation had open arbitrages aggregating $22.25 million at par value and short positions in the same amount. Since the trades in these securities involve minor fluctuations in price ( 1/32 or even 1/64 of a point) and there is no source which can tell us market value closer than 1 point ($222,500) it was decided not to gross up the balance sheet to reflect these items at market.
Instead footnote disclosure will be made of the total amounts involved and only the margin [cost] outstanding on these arbitrages will be included in investments.
W. Cornfield
10/4/76"
During the preparation of the 1976 financial report, the partner of defendant in charge of plaintiff's account, Philip Melchert, called plaintiff's assistant treasurer, Brother James Kent, to inquire about the Newell investments. Plaintiff claims Melchert recommended that the Newell investments be recorded at cost. Melchert purportedly explained that cost was approximately equal to market value. Plaintiff claims that Brother James did not understand the Newell investments and that in agreeing that the investments be recorded at cost, Brother James deferred to defendant's expertise.
Defendant denies that Brother James did not understand the Newell investments. Defendant claims that Melchert and Brother James mutually agreed to report the Newell investments at cost, and that Brother James fully understood the import of that decision.
After defendant completed its work at plaintiff's offices in 1976, Melchert met with plaintiff's governing body, the Provincial Council (the Council), to discuss the annual report. The 1976 financial report contained a footnote which specified that Newell's investments were carried at cost rather than market value. Plaintiff claims Melchert explained this footnote by again stating that cost was essentially equal to market value.
By reporting arbitrage transactions at cost, defendant reported the Newell investments at $2,166,322 in the 1976 financial report.
[201 Ill.Dec. 75] The actual market value of the investments on June 30, 1976, the date of the report, was $1,951,520. By reporting the transactions at cost, there was a discrepancy between the market value of the Newell investments and the figure reported by defendant in plaintiff's financial reports for each fiscal year from 1976-79. The amounts of the discrepancies are shown in the following chart:
Figure Reported by Actual Market Value
Fiscal Year Defendant in Report at Time of Report Discrepancy
1976 $2,166,322 $1,951,520 ($ 214,802)
1977 1,795,346 1,471,720 ( 323,626)
1978 1,792,748 319,861 ( 1,472,887)
1979 2,226,014 878,638 ( 1,347,376)
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Kenneth Witt, an employee of defendant, did the field work for plaintiff's 1980 financial statement. Witt prepared a draft of the 1980 financial statement which defendant sent to plaintiff in September 1980. The 1980 draft reported the Newell accounts at approximately $3.6 million. Because the $3.6 million cost figure did not reflect unrealized losses, the actual market value of Newell's investments was later shown to have been approximately $1.2 million at the time of the report.
Prior to defendant's submitting to plaintiff a final report for 1980, Melchert contacted Witt and asked him where the $3.6 million reported in the draft financial report was located. Witt was unable to answer the question. Melchert then began an independent investigation of the Newell investments and their values. In October 1980, Melchert contacted Newell and requested information regarding plaintiff's funds. Newell was unable to furnish the material that Melchert requested. Melchert next contacted the securities dealers with whom Newell held accounts on plaintiff's behalf. By January 1981, Melchert had received June 30, 1980, market values for the Newell accounts totaling approximately $1.2 million. When Melchert called Newell with this information, Newell informed him that the $1.2 million figure rather than the $3.6 million cost figure reported in the 1980 draft financial report could be the total market value of Newell's accounts with plaintiff.
On February 11, 1981, a week after Melchert spoke with Newell, Melchert attended a meeting of the Council. Plaintiff claims that Melchert...
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...v. Velsicol Chemical Corp. , 24 F.3d 809 (6th Cir. 1994), §7:23 Congregation of the Passion, Holy Cross Province v. Touche Ross & Co ., 636 N.E.2d 503 (Ill. 1994), §22:15 Cooper Industries v. Leatherman Tool Group, Inc. , 532 U.S. 424, 121 S.Ct. 1678, 149 L.Ed.2d 674 (2001), §19:15 Corkery ......
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Table of cases
...v. Velsicol Chemical Corp. , 24 F.3d 809 (6th Cir. 1994), §7:23 Congregation of the Passion, Holy Cross Province v. Touche Ross & Co ., 636 N.E.2d 503 (Ill. 1994), §22:15 Cooper Industries v. Leatherman Tool Group, Inc. , 532 U.S. 424, 121 S.Ct. 1678, 149 L.Ed.2d 674 (2001), §19:15 Cornell ......
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Table of cases
...v. Velsicol Chemical Corp. , 24 F.3d 809 (6th Cir. 1994), §7:23 Congregation of the Passion, Holy Cross Province v. Touche Ross & Co ., 636 N.E.2d 503 (Ill. 1994), §22:15 Cooper Industries v. Leatherman Tool Group, Inc. , 532 U.S. 424, 121 S.Ct. 1678, 149 L.Ed.2d 674 (2001), §19:15 Corkery ......
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Table of Cases
...v. Velsicol Chemical Corp. , 24 F.3d 809 (6th Cir. 1994), §7:23 Congregation of the Passion, Holy Cross Province v. Touche Ross & Co ., 636 N.E.2d 503 (Ill. 1994), §22:15 Cooper Industries v. Leatherman Tool Group, Inc. , 532 U.S. 424, 121 S.Ct. 1678, 149 L.Ed.2d 674 (2001), §19:15 Corkery ......