Judge Rules Accountants Not Liable In Hedge Fund Collapse

Date: Friday, July 11, 2008
Author: FINalternatives

Auditors are not liable for negligence where hedge fund managers exercise “nearly unfettered control” over a fund’s (fraudulent) activities, a New York judge has ruled.

New York Supreme Court Justice Charles Ramos granted a summary judgment motion to Ernst & Young, which was sued by the liquidators of a collapsed hedge fund E&Y audited. Ramos ruled that liquidators cannot bring claims against an auditor where the wrongdoing in a case “is imputable” to the fund itself.

The fund in question is Beacon Hill Asset Management, which collapsed in 2002. The Securities and Exchange Commission alleged the fund’s investment managers committed securities fraud leading to more than $300 million in losses, charges eventually settled. The liquidators of the Beacon Hill Master fund also accused the fund’s managers of fraudulently inflating the value of the mortgage-backed securities it owned, and also claimed that E&Y had failed to detect the wrongdoing in the first quarter of 2002 due to a deficient audit.

The “fundamental principle of agency that the wrongdoing of corporate management committed within the scope of their employment will generally be imputed to the corporation,” Ramos ruled.

“This decision is significant because it strengthens the state courts’ defenses available to auditors defending against claims of negligence by their former clients,” E&Y’s lawyer, Richard Martin, said.

The liquidators’ attorney, Scott Berman, rejected Ramos’ reasoning and said he has filed notice of appeal.

“The judge’s decision was contrary to other case law in New York and the trend nationwide,” he said.

The liquidators sued Beacon Hill’s managers, administrators, auditors and Beacon Hill Asset Management itself. All save E&Y has since settled the case.