Standard Chartered PLC v. Price Waterhouse, Nos. 1

• Court: Court of Appeals of Arizona
• Writing for the Court: FIDEL, GARBARINO and WEISBERG
• Citation: 190 Ariz. 6,945 P.2d 317
• Parties: , 229 Ariz. Adv. Rep. 26 STANDARD CHARTERED PLC, a United Kingdom Corporation, Standard Chartered Bank, a United Kingdom Banking Entity, and Standard Chartered Overseas Holdings Ltd., a United Kingdom Corporation, Plaintiffs-Appellees, v. PRICE WATERHOUSE, a General Partnership, Defendant-Appellant. STANDARD CHARTERED PLC, a United Kingdom Corporation, Standard Chartered Bank, a United Kingdom Banking Entity, and Standard Chartered Overseas Holdings Ltd., a United Kingdom Corporation, Plaintiffs-Appellants, Cross Appellees, v. PRICE WATERHOUSE, a General Partnership, Defendant-Appellee, Cross Appellant. 93-0461, 1 93-0442.
• Decision Date: 07 November 1996
• Docket Number: Nos. 1,CA-CV

Page 317

945 P.2d 317 190 Ariz. 6, 229 Ariz. Adv. Rep. 26 STANDARD CHARTERED PLC, a United Kingdom Corporation, Standard Chartered Bank, a United Kingdom Banking Entity, and Standard Chartered Overseas Holdings Ltd., a United Kingdom Corporation, Plaintiffs-Appellees,
v.
PRICE WATERHOUSE, a General Partnership, Defendant-Appellant.
STANDARD CHARTERED PLC, a United Kingdom Corporation, Standard Chartered Bank, a United Kingdom Banking Entity, and Standard Chartered Overseas Holdings Ltd., a United Kingdom Corporation, Plaintiffs-Appellants, Cross Appellees,
v.
PRICE WATERHOUSE, a General Partnership, Defendant-Appellee, Cross Appellant. Nos. 1 CA-CV 93-0461, 1 CA-CV 93-0442. Court of Appeals of Arizona,
Division 1, Department A. Nov. 7, 1996.
As Corrected on Denial of Reconsideration
Jan. 13, 1997.
Review Denied Oct. 21, 1997. ^*

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Beus, Gilbert & Morrill, P.L.L.C. by Leo R. Beus, L. Richard Williams, Mark C. Dangerfield, Martin A. Aronson and Michael R. Devitt, and Gust Rosenfeld by Richard A. Segal, Phoenix, for Plaintiffs-Appellees.

Snell & Wilmer by Daniel J. McAuliffe and Robert B. Hoffman, Phoenix, Cravath, Swaine & Moore by Thomas D. Barr, Rory O. Millson and Francis P. Barron, New York City, Brown & Bain, P.A. by Paul F. Eckstein, H. Michael Clyde and Joel W. Nomkin, Phoenix, and Price Waterhouse by Eldon Olson, General Counsel, Rodman W. Benedict, Associate Counsel, New York City, for Defendant-Appellant Price Waterhouse.

Gammage & Burnham by Grady Gammage, Jr., Phoenix, for Amici Curiae Society of Certified Public Accountants and American Institute of Certified Public Accountants.

Willkie Farr & Gallagher by Louis A. Craco, David P. Murray and Randy J. Branitsky, and American Institute of Certified Public Accountants by Richard I. Miller, General Counsel, New York City, for Amicus Curiae American Institute of Certified Public Accountants.

OPINION

FIDEL, GARBARINO and WEISBERG, Judges.

The plaintiffs are Standard Chartered PLC, a British banking corporation, and two of its subsidiaries, Standard Chartered Bank and Standard Chartered Overseas Holdings, Ltd. (collectively "SC"). The defendant is Price Waterhouse, an accounting firm ("PW"). SC brought this action as assignee or successor in interest to certain tort and statutory damages claims owned originally by Union Bancorp of California ("Union") and United Bank of Arizona ("United"). The gravamen of the action is that Union was caused to buy United, a bank that it would not otherwise have bought, by PW's negligent audit of United and approval of misleadingly favorable financial statements that United had prepared. After a lengthy trial by jury, the jury rendered multiple plaintiffs' verdicts of $338,053,778; and the trial court granted PW a new trial on two of many asserted grounds. SC appeals from the grant of a new trial. PW appeals from the trial court's refusal to grant it judgment notwithstanding the verdict ("JNOV"), and asserts by cross-appeal several additional grounds to support the grant of a new trial.

In the course of our opinion, we consider the following issues:

1. Is a negligence claim against an auditor assignable? Yes.

2. Did PW "participate in or induce" Union's purchase of United so as to subject PW to liability under the Arizona Securities Act? No.

3. In serving as United's independent auditor and in certifying United's financial soundness to Union, did PW act as a fiduciary to either United or Union? No.

4. Does a party irretrievably waive a ground for JNOV by neglecting to include that ground within a motion for directed verdict at the close of the evidence? Or may the motion be considered nonetheless

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if the issue (a) is purely legal, (b) was aired in prior motions so that the adverse party cannot reasonably claim surprise, and (c) is not one to which the adverse party, had there been a motion for directed verdict, might have responded by seeking leave to reopen to present further evidence? The latter.

5. Is there a claim for "auditor negligence" separate and distinct from a claim for negligent misrepresentation? No.

6. Does Arizona law measure the range of liability for negligent misrepresentation by the ordinary negligence yardstick of reasonable foreseeability, or does it employ the more circumscribed range of liability set forth in section 552 of the Restatement (Second) of Torts? The latter.

7. Must a plaintiff in a negligent misrepresentation claim prove loss causation and out-of-pocket damages? Yes.

8. When the negligence that a third party attributes to an auditor is the failure to detect and report the financial mismanagement and inaccurate reporting of the auditing client, may the auditor attempt to reduce its share of liability by allocating fault to the negligent client? Yes.

9. Does apportionment of fault in Arizona Revised Statutes Annotated ("A.R.S.") § 12-2506 apply to economic damage claims? Yes.

After addressing these and other issues, we conclude that this case must be retried, but on SC/Union's negligent misrepresentation claim alone. On all other claims that SC brought on behalf of Union, and on all claims that SC brought on behalf of United, we conclude that PW is entitled to JNOV.

I. FACTUAL AND PROCEDURAL HISTORY

SC is a United Kingdom banking corporation with subsidiaries worldwide and more than $35 billion in assets. In the mid-1980s, SC decided to expand its bank holdings in the United States. Through Union, a wholly-owned subsidiary, SC sought to acquire United, then the fourth largest bank in Arizona.

PW had functioned as United's independent auditor since 1970. As an auditor, PW annually examined United's books and records to investigate and verify the accuracy of its financial statements. United's financial statements, including balance sheets and income statements, were a primary source of information, both for United itself and for others outside the company, concerning the actual condition of United's operations, assets, and liabilities.

PW audited United for fiscal years 1985 and 1986 for an annual fee of approximately $140,000, and each year issued unqualified opinions supporting the accuracy, completeness, and regularity of United's financial statements. An auditor's "unqualified" opinion on a company's financial statements is an opinion without reservations or qualifications and amounts to a representation that the contents are reasonably accurate with no material exceptions.

In September 1985, Union and United entered into a merger agreement by which Union would purchase all of United's capital stock. PW was not a party to the agreement. The agreement did not require an audit or certification of United as a condition of closing, and neither took place. The agreement did require, however, that Union be given all United financial statements audited by PW, other United financial information reviewed by PW, and "management letters" prepared by PW describing any weaknesses that it found in United's internal controls. Within the agreement, United also consented for Union to receive from PW any information about United that Union might request. The agreement conditioned Union's obligation to perform on the absence of a material adverse change in United's financial condition and on receipt of certification that United's shareholders' equity was at least $135 million as of the merger's effective date.

United's "loan portfolio" consisted of the aggregated short-term and long-term debts that United's loan customers owed the bank. The loan portfolio was a significant component of United's assets, comprising $1.4 billion of United's total assets of $2.1 billion in 1985. As United's independent auditor, one

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of PW's functions was to periodically evaluate the loan portfolio, the individual customer accounts that comprised the loan portfolio, and United's internal lending controls in order to predict what proportion of the loans would ultimately be repaid. This evaluation in turn tested the accuracy of United's allowance for uncollectible loans, which United showed on its financial statements as a charge against income.

In November of 1985, PW representatives met with Union's chief financial officer, Jack Frazee, and others to solicit the retention of PW as United's auditor. One subject they addressed was the public financings that Union would undertake to raise money to fund the purchase of United. Frazee later met individually with PW's lead audit partner, Karl Almquist, to discuss PW's working relationships with United's managers and directors. Before the holidays in 1985, Frazee decided to rely on PW for ongoing financial information about United through the closing, and he communicated that decision to PW, to representatives of United, and to PW's competitor, Peat Marwick.

In early 1986, PW issued an unqualified audit opinion on United's 1985 financial statements. PW stated that it had conducted its audit in accordance with generally accepted auditing standards and that the information in the financial statements was fairly presented in accordance with generally accepted accounting principles. Based on the audited financial statements, Union bought United stock in the open market and proceeded toward closing.

An expert witness for SC testified at trial, however, that United's 1985 income statement had actually overstated income by approximately $27 million. The same expert testified that PW had not followed generally accepted auditing standards in preparing its audit opinion. Frazee further testified that, if Union had known of the undisclosed dwindling of United's shareholders' equity, Union would not have gone forward with the transaction.

In 1986, Union raised $300 million to help fund its acquisition of United by selling its own securities in three public offerings. PW helped Union prepare the financial information for these offerings. PW formally consented to the inclusion of its audit report on United's 1985 financial statements in...