Section 11 imposes liability for false statements in registration statements.  See 15 U.S.C. §77k.  Section 11 is distinctive in that the plaintiffs do not have to show fault on the part of any defendants – a sharp contrast with Section 10(b), which requires plaintiffs to prove that the defendants acted with scienter.

When it comes to imposing liability on corporate auditors who approve false financial statements, very often, Section 11 is the only viable option for plaintiffs.  This is because it is very, very hard to show that auditors acted with scienter – especially at the pleading stage.  When a company blows up, typically a lot of information becomes available that would help the plaintiffs demonstrate that there was fault within the corporate ranks.  But it is far less typical for information to become available against the auditor.  So Section 11 is really the only way for plaintiffs to go.

In Querub v. Moore Stephens Hong Kong, 2016 U.S. App. LEXIS 9213 (2d Cir. N.Y. May 20, 2016) (unpublished), the Second Circuit held that for Section 11 purposes, audit opinions are “opinions” in the manner described in Omnicare, Inc. v. Laborers Dist. Council Constr. Indus. Pension Fund, 135 S. Ct. 1318 (2015).  This means that audit opinions can only be shown to be false – and liability based on them can only be imposed – if the plaintiffs show either that the auditors did not believe the opinion (the functional equivalent of scienter), or that the auditors left out critical facts regarding the manner in which the opinion was formed (which in most cases is likely to mean that the auditor failed to comply with Generally Accepted Accounting Standards (GAAS)).

It’s my view that this holding contradicts the text of Section 11. 

Section 11, provides that if a registration statement contains a false statement or material omission, liability will lie against:

every accountant, engineer, or appraiser, or any person whose profession gives authority to a statement made by him, who has with his consent been named as having prepared or certified any part of the registration statement, or as having prepared or certified any report or valuation which is used in connection with the registration statement, with respect to the statement in such registration statement, report, or valuation, which purports to have been prepared or certified by him…

On my reading, this language directs courts to ask whether the corporate financial statements are false.  If they are, then liability is imposed on the auditor who “certified” the statements – automatically.  The act of auditor certification of a false financial statement is what triggers liability, period.  No further inquiry into the truth or falsity of the certification itself – independent of the underlying financial statement – is permitted.

But, the auditor is permitted to offer a defense.  Auditors (who are “experts”) may avoid liability if they prove that:

as regards any part of the registration statement purporting to be made upon his authority as an expert or purporting to be a copy of or extract from a report or valuation of himself as an expert … he had, after reasonable investigation, reasonable ground to believe and did believe, at the time such part of the registration statement became effective, that the statements therein were true and that there was no omission to state a material fact required to be stated therein or necessary to make the statements therein not misleading….

In other words, the auditor will not be liable if it believed the financial statements were true, based on a reasonable investigation.  Presumably, the auditor will try to meet this standard by showing that it complied with GAAS, which itself would require a showing of good faith and professional due diligence.  If the auditor makes that showing, it avoids liability.

The Second Circuit (and, I must confess, several other courts) undermine this scheme when they put the burden on the plaintiff to make an initial showing that there was a failure to comply with GAAS.

This is a problem that may be broader than audit certifications, and extend to the proper interpretation of Section 11 generally – occasioned not so much by Omnicare‘s definition of opinion falsity, but by its capacious definition of what counts as opinion in the first place – but in the context of audit opinions, the tension looms particularly large.

Now, one counterargument is that auditors do not “certify” financial statements any more.  Certification is an old terminology; it fell out of favor several decades ago (after the passage of the Securities Act), to be replaced by the “opinion” phrasing, which more accurately reflects the fact that auditors don’t guarantee the accuracy of corporate financial statements.  And indeed, today, SEC regulations dictate that auditors offer “opinions” (not certifications) of financial statements.

But to me, this is beside the point.  As far as I know – and I’d be curious if anyone has any contrary evidence – these changes in terminology were never intended to change the liability scheme, let alone shift Section 11’s burden of proof (something that presumably auditors could not do unilaterally).