Auditors granted summary judgment in securities case.

The U.S. District Court for the Northern District of California granted summary judgment to Deloitte & Touche in a securities fraud action filed by investors in a public offering of stock by Software Tool-works, Inc.

Deloitte audited the financial statements for the fiscal year ended March 31, 1990. These statements were incorporated in Toolworks' July 1990 prospectus for its public stock offering.

The investors alleged the financial statements had improperly included under the revenue category sales of software that were subject to price-protection allowances, sales of software that Deloitte knew or should have known would be returned by vendors and slow-moving and obsolete software in inventory that Deloitte knew or should have known was subject to writedown.

In granting summary judgment to Deloitte, the court noted the accounting firm performed extensive testing of Toolworks' revenue recognition policy. Pointing out a few cases in which bits of negative information were presented to Deloitte is not sufficient to establish actual knowledge or recklessness, the court ruled.

In the court's view, all audits present some adverse information. Deloitte, when presented with negative information, investigated and acted on it.

Moreover, the fact that in some cases Deloitte dismissed negative information because it was outweighed by contrary information may have presented a case of bad judgment, the court held. However, such instances did not represent the extreme departure from the standards of ordinary care that must be established to sustain a securities fraud action. (In re Software Toolworks, Inc. Securities Litigation, 92 Daily Journal D.A.R. 6617, no. C-90-2906 FMS U.S. District Court for the Northern District of California)

Editor's note: Thanks to Dennis Zaragoza of Wild & Zaragoza for providing the Toolworks case.

Edited by Wayne Baliga, CPA, JD, vice-president, AON Corp.