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Schein v. Ernst & Young, LLP

Florida Court of Appeal, Fourth District

January 11, 2012

Alan SCHEIN and Results Technologies, Inc., a Florida corporation, Appellants,
v.
ERNST & YOUNG, LLP, a Delaware limited liability partnership, Appellee.

Page 828

Jack Scarola, Patrick E. Quinlan of Searcy Denney Scarola Barnhart & Shipley, P.A., West Palm Beach, and Robert M. Mayer, Miami, for appellants.

Elliot H. Scherker, Julissa Rodriguez, Paul R. Lipton, Elliot B. Kula, and Brigid F. Cech Samole of Greenberg Traurig, P.A., Miami, and Barry Richard, Laureen E. Galeoto of Greenberg Traurig, P.A., Tallahassee, and Stanley J. Parzen of Mayer Brown, LLP, Chicago, Illinois, for appellee.

LEVINE, J.

Appellants appeal from a judgment in their favor, and appellee cross-appeals. We affirm all issues raised without discussion, with the exception of one issue raised on direct appeal, which we reverse. The issue we discuss is whether Illinois's audit interference doctrine, which permits evidence of a client's negligence only where the client interferes with an auditor's services, should be extended to apply to a third party. We find, under the specific facts of this case, that the doctrine applies to the third party appellants. We further find that, because there was no evidence that appellants interfered with appellee's services, the trial court erred in denying appellants' motion for directed verdict on appellee's comparative negligence defense.

Appellant Alan Schein developed a telemarketing system known as the Results System. In 1998, Schein sold a 50% interest in the Results System to Superior Bank. Schein was placed in charge of the bank's Universal Lending Division (" ULD" ), which utilized this system. An " unwind" provision allowed either party to force a sale of the division with the proceeds to be equally divided between Schein and Superior.

As part of the 1998 agreement, Superior was required to provide appellants with " copies of its audited financial statements as soon as practicable after the preparation and distribution thereof." Superior informed appellee Ernst & Young, LLP, of Superior's contractual obligation to provide original copies of the audit reports to appellants.

Appellee served as Superior's auditor since 1988, during which time Superior relied on appellee's accounting methodology. Appellee consistently issued " clean"

Page 829

audit opinions for Superior. In 1996, Schein contacted appellee and was assured by appellee that Superior's accounting methodology was " conservative." In 1998, an independent review partner for appellee refused to " sign off" on Superior's audit due to concerns he had about the methodology used to calculate gains on the sale of loans, the valuation of residuals, and the accounting treatment of cash. Neither Superior nor appellants were aware of the independent review auditor's refusal to sign. [1]

In 2000, Superior hired appellee for a special engagement, specifically to review Superior's accounting methodology and valuation methods as it pertained to the bank's interest in securitized mortgages. This special engagement would assist Superior in evaluating the current method of calculating " the present value of financial residuals resulting from the securitization and sale of mortgage loans." Superior's chief accounting officer stated that the special engagement was " for everybody within the organization, as well as our investors, and our regulators and our contractual partners." Appellee was informed that a primary purpose of the special engagement was to benefit contract partners of Superior, such as appellants.

Appellee issued a report concluding that Superior's accounting methodology was in accordance with generally accepted accounting procedures (GAAP). The chairman of Superior provided appellants with a copy of the report. The special engagement report was important to appellants because it affirmed that Superior was financially sound. Additionally, the report would have alerted appellants to any financial concerns, allowing them to unwind to protect their investment.

Federal regulators, after receiving this report, requested that Superior reduce its reported assets by $117 million. Appellee initially disputed this, but a few days later admitted to Superior's chairman that appellee " made a mistake." Appellee determined that the proper reduction, due to accounting methodology, was a total of $420 million dollars in " write-downs."

Federal regulators took control of Superior. At that point, appellants sought to " unwind" ULD, but the federal regulators would not allow Superior to proceed. In 2001, appellant Results Technologies sold its 50% interest in the Results System to Superior for $12 million dollars. In 2004, the FDIC, which was the appointed receiver for Superior, entered into a settlement agreement with appellee.

In 2003, appellants filed a complaint against appellee claiming causes of actions for professional negligence, gross negligence, and fraud as well as punitive damages. The trial court determined that since Superior was an Illinois company, Illinois law would govern the claims for negligence and gross negligence. Subsequently, the trial court granted appellee's motion for summary judgment regarding the causes of action for professional negligence and gross negligence for the annual audits performed by appellee. The trial court denied summary judgment for the claims of professional negligence and gross negligence for the special engagement report as well as ...


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