Court raises standard for expert testimony against accounting firms.

The U.S. District Court for the District of New Mexico ruled that an expert witness for the plaintiff in a case against an accounting firm could not render an opinion on the legality of a transaction and could not render testimony that would confuse and mislead the jury.

This case began when Robert Sanchez, an investor in Everyday Discount Drug, sued KPMG Peat Marwick for failure to disclose material omissions of fact regarding the financial well-being of Summa Medical Corp., a client of the firm's. In 1989, Everyday Discount Drug, another client of the firm's, had entered into a stock swap agreement with Summa. Sanchez alleged that Everyday was unable to sell the Summa shares from the swap because Summa's chairman had previously violated federal securities laws by selling restricted Summa shares in transactions disguised as loans. Everyday subsequently went bankrupt. Sanchez alleged that the CPA firm, as auditor for both Summa and Everyday, failed to disclose the alleged illegal loan transactions.

Robert Sanchez hired an accounting expert to offer testimony on the firm's conduct in this matter. The accounting expert said the firm had committed malpractice in not informing Sanchez, as a shareholder, that the loans were illegal before he agreed to the stock swap. The firm filed a motion to limit the expert's testimony on the basis that it was unreliable and would not help the trier of fact--the jury--to understand the evidence or determine the facts in issue.

In ruling to exclude the expert's testimony on the firm's alleged malpractice, the court said the expert, as an accountant, was not qualified to opine on the legality of a transaction. It referred to American Institute of CPAs standards, which state that determining whether an act is illegal is normally beyond the auditor's professional competence (see Statement on Auditing Standards no. 54, Illegal Acts by Clients [AICPA Professional Standards, vol. 1, AU section 317.03 and 317.06]). The court also ruled such testimony would not be allowed because of"the dangers of confusing and misleading the jury." In this regard, the court said that Sanchez's own securities law expert had testified he did not view the loan transactions as illegal.

The U.S. district court also rejected the accounting expert's testimony that the firm was the sole cause of Sanchez's losses. The court said Sanchez had even claimed otherwise and had sued the attorneys who represented him, as a shareholder of Everyday, in connection with the stock swap transactions. The court said, "His methodology in this area, if one can be found, is seriously flawed .... He did not examine the conduct of other parties that, ironically, Everyday blames for its demise, such as Everyday's law firm.........."

This case is significant because the court refused to allow an accounting expert to opine on legal issues. The court also disallowed expert testimony that was at best speculative in nature. This is contrary to the trend of many courts that do allow "experts" to render opinions that are remotely supported by the facts and law of the case. (Sanchez v. KPMG Peat Marwick, no.