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Case 6-4 Anjoorian et al.: Third-Party Liability
In the 2007 case of Paul V. Anjoorian v. Arnold Kilberg & Co., Arnold Kilberg, and Pascarella
& Trench, the Rhode Island Superior Court ruled that a shareholder can sue a company’s outside
accounting firm for alleged negligence in the preparation of the company’s financial statements
even though the accountant argued it had no duty of care to third parties like the shareholder,
with whom it never engaged in a direct financial transaction. Judge Michael A. Silverstein
disagreed, saying an accountant owes a duty to any individual or group of people who are meant
Exhibit 1
Anjoorian et al.: Third-Party Liability
Facts of the Case
The defendants Pascarella and Trench, general partners of the accounting firm Pascarella &
Trench (P&T), asked the court for summary judgment in their favor with respect to plaintiff
Anjoorian’s claim that P&T committed malpractice in the preparation of financial statements,
and that the plaintiff (Anjoorian) suffered pecuniary harm as a result.
Beginning in 1990, P&T provided accounting services to FCC. The firm audited FCC’s annual
financial statements following the close of each calendar year between 1990 and 1994. In its
representation letter (similar to the current Section 302 requirement under SOX), P&T stated that
FCC was “responsible for the fair presentation in the financial statements of financial position.”
P&T’s responsibility was to perform an audit in accordance with GAAS and to “express an
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On March 2, 1994, Anjoorian filed a complaint and motion for a temporary restraining order
seeking the dissolution of FCC on various grounds. P&T was not a party to that suit. As a result
of that action, the three Kilberg children exercised their right to purchase the plaintiff’s shares of
the corporation. The court appointed an appraiser to determine the value of Anjoorian’s shares,
which the other shareholders would have to pay. The bulk of FCC’s assets comprised its right to
receive payment for the loans that it had made. The appraiser determined that the value of the
corporation was $2,395,000, plus a payroll adjustment of $102,000, and minus a “loss reserve”
adjustment to account for the fact that 10 of FCC’s 30 outstanding loans were delinquent. The
loss reserve adjustment reduced the total appraised value of the corporation by $878,234.
Accountants’ Liabilities to Third Parties
Silverstein observed that while the question of accountant liability to third parties was unsettled
in Rhode Island, the Rhode Island Supreme Court had identified three competing interpretations.
The first interpretation was the “foreseeability test,” under which an auditor has a duty to all
foreseeable recipients of information he provides. “This rule gives little weight to the concern for
limiting the potential liability for accountants and is not widely adopted,” Silverstein noted.
Case Analysis
The court found that the addressing of the reports to the shareholders, while not conclusive, is a
strong indication that P&T intended the shareholders to rely upon them. Therefore, the court
concluded that genuine issues of fact exist as to whether P&T intended for Anjoorian to rely on
these financial statements. Perhaps the court would have reached a different conclusion for a
widely held public corporation with a potentially unlimited number of shareholders whose
identities change regularly. Here, however, FCC was a close corporation with only four
shareholders, giving greater significance to the fact that the financial statements were addressed
“to the shareholders.”
The defendants also argued that, in order to find a duty to third parties, an accountant must have
contemplated a specific transaction for which the financial statement would be used and that no
The court opined that it would have no difficulty finding a duty in this case, in the absence of a
specific financial transaction, if it could be shown that P&T intended the shareholders to rely on
the financial statements for the purpose of evaluating the financial health of the company and,
therefore, their investment in the company. In this case, the “particular transaction” contemplated
by the Restatement relates to the purpose for which the financial statements would be used—the
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Questions
1. The court found that the addressing of audit reports to the shareholders, while not
conclusive, is a strong indication that P&T intended the shareholders to rely upon
them. Do you agree, in general, that addressing the reports to a class of owners
should be sufficient to hold an auditor legally liable to any shareholder who can
demonstrate a lack of reasonable care? What about in applying the facts of this
case? Would your conclusion change? Explain.
Generally, addressing the audit report to a group of shareholders of a public company
with a potentially unlimited number of shareholders whose identities change regularly is
a more difficult situation in which a shareholder sues an auditor for negligence because
his identity (Anjoorian) would not be known by the auditors. The Credit Alliance case
2. Judge Silverstein relied on the Restatement (Second) of the Law of Torts for his
ruling. Assume he had relied on the “near–privity relationship” ruling in Credit
Alliance, and evaluate the legal liability of the auditors using that standard.
The New York Court of Appeals expanded the privity standard in the case of Credit
Alliance v. Arthur Andersen & Co. to include a near-privity relationship between third
parties and the accountant. In the case, Credit Alliance was the principal lender to the
client and demonstrated that Andersen had known Credit Alliance was relying on the
intended reliance. The 1992 New York Court of Appeals decision in Security Pacific
Business Credit, Inc. v. Peat Marwick Main & Co sharpens the last criterion in its
determination that the third party must be known to the auditor, who directly conveys the
audited report to the third party or acts to induce reliance on the report.
It seems less likely that a ruling using the near-privity standard would have led to legal
transaction for which the financial statement would be used and that no such transaction
was contemplated.
Regardless, the court found this argument unconvincing, stating that the case is unusual
in that the alleged malpractice did not arise from a specific financial transaction. The
typical case involves a person whose reliance on a defective financial statement induces
whether to withdraw capital or not. While it remains to be proved that P&T actually did
foresee that its financial statements would be used by the shareholders in this manner, the
absence of a particular financial transaction does not preclude the finding of a duty in this
case. Because the value of the shareholders’ investment was limited to the amounts
reflected in the company balance sheets, any loss from malpractice was an insurable risk
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3. The court decision refers to the importance of the auditors’ knowing about third–
party usage of the audited financial statements. What role does such knowledge play
in enabling auditors to meet their professional and ethical responsibilities?
In addition to what is mentioned above, an auditor must balance the risks and rewards
involved with the uses of financial information if he knows how the information will be
used and who will use the information. The auditor must know the uses of the