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Court rules on liability for financial forecasts.

A California appellate court ruled that an accounting firm can be sued by third-party investors based on the firm's work in reviewing financial forecasts in conjunction with a private offering of limited partnership interests. Vintech Inc. is a California corporation specializing in acquisition, management and development of agricultural property. The company had sought investors for four limited partnerships -- the company was a general partner in each case -- to purchase four wineries, generate cash from their operations and realize capital appreciation on their sale.

Vintech made information available to prospective investors through a confidential offering memorandum for each winery investment. Vintech retained Deloitte & Touche to prepare financial statements and tax returns for the partnerships. In two of the four offering memoranda, Vintech also included an "independent accountant's report" (IAR) prepared by the firm, which said the firm had reviewed the forecasted income tax basis statements of income, expense, partners' capital and cash flow for each of the years included in the forecasts. All four partnerships failed shortly after formation; this litigation involved the two partnerships in the two IARs.

The investors sued the firm shortly after the partnerships filed chapter 11 bankruptcy petitions. They alleged the firm knew, but failed to disclose in the offering memoranda, that the partnerships would be required to incur significant debt to continue in business and that the necessary loans were unavailable. They also alleged the firm continued to participate in the partnership offerings even though it was aware of the partnership's lack of funding, marketing difficulties and management problems. The investors said they had relied on the offering memoranda in their decision to invest. The trial court granted summary judgment in favor of the firm; the plaintiffs appealed.

On appeal, the firm argued that

* It had not prepared die forecasts -- Vintech had.

* It had examined the forecasts using American Institute of CPAs guidelines governing such examinations.

* The assumptions underlying the forecasts provided a reasonable basis for the forecasts at the time.

* It had no knowledge that the assumptions were false.

The appellants retained an expert, Mike Fisher, who had degrees in both enology and accounting. He opined that not only had the firm failed to conduct its examination of the forecasts according to relevant AICPA guidelines but also its accounting procedures "were so deficient as to constitute an extreme departure from the applicable accounting standards."

In reversing the summary judgment motion in favor of the firm, the court concluded that with Fisher's testimony, appellants raised a triable issue concerning reliability of the respondent's IARs. According to the court, if the acts of an accountant fall below the applicable standard of care for the profession -- that is, the accountant failed to examine or acquire the necessary information required to support the professional opinion disseminated to potential investors -- the opinion is made without reasonable ground for believing it to be true. Further, the appellants were not precluded from suing die firm because of their standing as third parties (as opposed to being actual clients). There was ample evidence to support a finding that the firm knew its reports were not limited to Vintech's internal or personal use but were to be included in the offering memoranda and thus communicated to potential investors. The forecast and underlying assumptions to which the IARs referred were designated for the specific purpose of attracting investors in the limited partnerships and could not be reasonably understood to have any other purpose.

This case is significant because it is the first instance in which the California appellate court considered whether an accounting firm that issues a report in connection with a forecast engagement could be sued by nonclient investors who allegedly relied on the report. "Opinions" generally do not constitute a representation of fact sufficient to constitute a negligent misrepresentation. However, the court held that if an accountant that holds superior expertise renders an opinion as a deliberate affirmation of the matters stated in a report, then the accountant's opinion can constitute a positive assertion of fact. Also significant was the court's ruling that nonclient third-party investors who relied on the independent accountant's report were not precluded from bringing art action against the firm.
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Article Details
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Title Annotation:California
Author:Baliga, Wayne
Publication:Journal of Accountancy
Date:Nov 1, 1997
Previous Article:Guidance on assurance services.
Next Article:Administration introduces its own IRS restructuring bill.

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