Tag Archives: plaintiff

How to Know When a Claim Should Settle

Case evaluation is part art and part math. And we’re not even talking calculus; we’re talking arithmetic.

A surprisingly large number of lawyers tell me they’re bad at math. They’re not alone. CNN anchor Chris Cuomo recently had his math corrected by co-anchor Michaela Pereira while discussing Powerball lottery numbers.

 

You can’t come up with a realistic evaluation of a workers’ compensation claim if you can’t quantify the component parts: permanent disability, life pension, Medicare-eligible and non-Medicare-eligible future medical.

In mediation caucus, when parties give me their offer or demand, I often ask how they came up with that number. I want their best argument, the one that will convince the other side. The first answer I get is often vague, something like, “We thought it would settle the case.” Workers’ compensation professionals often neglect running the numbers. Getting parties to see the same numbers moves them toward settlement.

I recently got a call about an offer in a personal injury case. I questioned the plaintiff’s attorney about what he thought this number represented. His answer didn’t sound right to me. I asked him, “Did you ask them how they came up with that number?” No, he hadn’t. I suggested the attorney ask opposing counsel that question to allow things to move forward, toward settlement.

Random demands and offers are unlikely to settle a claim. Before you assume the other side is being unreasonable or before you respond, ask: How did you get to that number?

A Victory for Exclusive Remedy on Asbestos

In a recent case, the 2nd Appellate District of California declined to open an new avenue to avoid the exclusive remedy of workers’ compensation in Melendrez v Ameron International Corporation, not only upholding the lower court’s grant of summary judgment for defendant/employer but also allowing the defendant to recover expert witness fees.

The employee, Lario Melendrez, was employed by Ameron for 24 years and was exposed to asbestos from insulation products. In 2011, he died from mesothelioma related to his asbestos exposure. His survivors/plaintiffs attempted to circumvent the exclusive remedy rule by alleging the employee had been allowed to take waste and scraps of insulated pipe home for personal use. Plaintiffs asserted the employee should not be shielded by workers’ compensation exclusivity for his non-work-related use of the employer’s asbestos products. Neither the trial court nor the appellate courts agreed with the effort to create a new exception to the exclusive remedy rule. The Appellate Court commented as follows:

“While we agree that a triable issue of fact exists whether Melendrez’s exposure to asbestos at home arose out of and in the course of his employment with Ameron, that issue is not material to the viability of Ameron’s defense of workers’ compensation exclusivity. It is undisputed that Melendrez’s exposure to asbestos in his employment with Ameron substantially contributed to his mesothelioma. Therefore, under the contributing cause standard applicable in workers’ compensation law, his mesothelioma is covered by workers’ compensation, and his separate exposure at home does not create a separate injury outside workers’ compensation coverage. Thus, plaintiffs’ lawsuit is barred by workers’ compensation exclusivity.”

Citing the recent California Supreme Court holding in South Coast Framing, the 2nd district held:

“Given the purposes of workers’ compensation, courts have long applied a broad concept of contributing cause to bring injuries within workers’ compensation coverage. In short, if a substantial contributing cause of an injury arises out of and in the course of employment, the injury is covered by workers’ compensation, even if another, nonindustrial cause also substantially contributed to the injury. As recently explained in South Coast Framing, Inc. v. Workers’ Comp. Appeals Bd. (2015) 61 Cal.4th 291 (South Coast Framing): “[T]he workers’ compensation system is not based upon fault. ‘It seeks (1) to ensure that the cost of industrial injuries will be part of the cost of goods rather than a burden on society, (2) to guarantee prompt, limited compensation for an employee’s work injuries, regardless of fault, as an inevitable cost of production, (3) to spur increased industrial safety, and (4) in return, to insulate the employer from tort liability for his employees’ injuries.’…”

The court also cited case law that had established that the exclusivity provisions of workers’ compensation also apply to collateral or derivative injuries:

“[C]ourts have regularly barred claims where the alleged injury is collateral to or derivative of a compensable workplace injury.”… see also Vacanti, supra, 24 Cal.4th at p. 815 [“courts have barred employees from suing for psychic injuries caused by their termination, or their employer’s abusive conduct during the termination process]; LeFiell, supra, 55 Cal.4th at p. 284 [“‘[c]ourts have held that the exclusive jurisdiction provisions bar civil actions against employers by nondependent parents of an employee for the employee’s wrongful death, by an employee’s spouse for loss of the employee’s services or consortium, and for emotional distress suffered by a spouse in witnessing the employee’s injuries…'”

The court further distinguished authorities proposed by plaintiff to expand the ability to escape the exclusivity clause. In each of the cases cited by plaintiff, the court noted there were findings that the employee was not performing any service related to employment or even actions prohibited by his employer. In each of those cases, the injury was solely related to the non-work-related episode, and the plaintiff offered no authority to support severing a single injury into separate components as would be required in this case.

Comments and Conclusions:

This case represents an interesting effort to evade the exclusive remedy provisions in workers’ comp. A successful plaintiff’s result could potentially have expanded the ability to file civil actions whenever an employee took home something from work that eventually contributed to a work injury. Think a carpenter who receives permission to take home a tool and later files both a WC injury claim and a civil action against his employer for allowing him to use a work tool at home that resulted in injury. The potential combinations are endless for such scenarios.

Luckily, with this case the exceptions noted by plaintiffs in their brief will remain isolated and not expanded under this ruling.

Future of Securities Class Actions

Securities litigation has a culture defined by multiple elements: the types of cases filed, the plaintiffs’ lawyers who file them, the defense counsel who defend them, the characteristics of the insurance that covers them, the way insurance representatives approach coverage, the government’s investigative policies – and, of course, the attitude of public companies and their directors and officers toward disclosure and governance.

This culture has been largely stable over the nearly 20 years I’ve defended securities litigation matters full-time. The array of private securities litigation matters (in the way I define securities litigation) remains the same – in order of virulence: securities class actions, shareholder derivative litigation matters (derivative actions, board demands and books-and-records inspections) and shareholder challenges to mergers. The world of disclosure-related SEC enforcement and internal corporate investigations is basically unchanged, as well. And the art of managing a disclosure crisis, involving the convergence of shareholder litigation, SEC enforcement and an internal investigation, involves the same basic skills and instincts.

But I’ve noted significant changes to other characteristics of securities-litigation culture recently, which portend a paradigm shift. Over the past few years, smaller plaintiffs’ firms have initiated more securities class actions on behalf of individual, retail investors, largely against smaller companies that have suffered what I call “lawsuit blueprint” problems such as auditor resignations and short-seller reports. This trend – which has now become ingrained into the securities-litigation culture – will significantly influence the way securities cases are defended and by whom, and change the way that D&O insurance coverage and claims need to be handled.

Changes in the Plaintiffs’ Bar

Discussion of the history of securities plaintiffs’ counsel usually focuses on the impact of the departures of giants Bill Lerach and Mel Weiss. But although the two of them did indeed cut a wide swath, the plaintiffs’ bar survived their departures just fine. Lerach’s former firm is thriving, and there are strong leaders there and at other prominent plaintiffs’ firms.

The more fundamental shifts in the plaintiffs’ bar concern changes to filing trends. Securities class action filings are down significantly over the past several years, but I’m confident they will remain the mainstay of securities litigation and won’t be replaced by merger cases or derivative actions. There is a large group of plaintiffs’ lawyers who specialize in securities class actions, and there are plenty of stock drops that give them good opportunities to file cases. Securities class action filings tend to come in waves, both in the number of cases and type. Filings have been down over the last several years for multiple reasons, including the lack of plaintiff-firm resources to file new cases as they continue to litigate stubborn and labor-intensive credit-crisis cases, the rising stock market and the lack of significant financial-statement restatements.

Although I don’t think the downturn in filings is, in and of itself, very meaningful, it has created the opportunity for smaller plaintiffs’ firms to file more securities class actions. The Reform Act gave plaintiffs’ firms incentives to recruit institutional investors to serve as plaintiffs. For the most part, institutional investors, whether smaller unions or large funds, have retained the more prominent plaintiffs’ firms, and smaller plaintiffs’ firms have been left with individual investor clients who usually can’t beat out institutions for the lead-plaintiff role. At the same time, securities class action economics tightened in all but the largest cases. Dismissal rates under the Reform Act are pretty high, and defeating a motion to dismiss often requires significant investigative costs and intensive legal work. And the median settlement amount of cases that survive dismissal motions is fairly low. These dynamics placed a premium on experience, efficiency and scale. Larger firms filed most of the cases, and smaller plaintiffs’ firms were unable to compete effectively for the lead plaintiff role, or make much money on their litigation investments.

This started to change with the wave of cases against Chinese issuers in 2010. Smaller plaintiffs’ firms initiated most of them, as the larger firms were swamped with credit-crisis cases and likely were deterred by the relatively small damages, potentially high discovery costs and uncertain insurance and company financial resources. Moreover, these cases fit smaller firms’ capabilities well; nearly all of the cases had “lawsuit blueprints” such as auditor resignations or short-seller reports, thereby reducing the smaller firms’ investigative costs and increasing their likelihood of surviving a motion to dismiss. The dismissal rate has indeed been low, and limited insurance and company resources have prompted early settlements in amounts that, while on the low side, appear to have yielded good outcomes for the smaller plaintiffs’ firms.

The smaller plaintiffs’ firms thus built up a head of steam that has kept them going, even after the wave of China cases subsided. For the last year or two, following almost every “lawsuit blueprint” announcement, a smaller firm has launched an “investigation” of the company, and these firms have initiated an increasing number of cases. Like the China cases, these cases tend to be against smaller companies. Thus, smaller plaintiffs’ firms have discovered a class of cases – cases against smaller companies that have suffered well-publicized problems that reduce the plaintiffs’ firms’ investigative costs – for which they can win the lead plaintiff role and can prosecute at a sufficient profit margin.

To be sure, the larger firms still mostly will beat out the smaller firms for the cases they want. But it increasingly seems clear that the larger firms don’t want to take the lead in initiating many of the cases against smaller companies, and are content to focus on larger cases on behalf of their institutional investor clients.

These dynamics are confirmed by recent securities litigation filing statistics. Cornerstone Research’s “Securities Class Action Filings: 2014 Year in Review” concludes that (1) aggregate market capitalization loss of sued companies was at its lowest level since 1997, and (2) the percentage of S&P 500 companies sued in securities class actions “was the lowest on record.” Cornerstone’s “Securities Class Action Filings: 2015 Midyear Assessment” reports that two key measures of the size of cases filed in the first half of 2015 were 43% and 65% lower than the 1997-2014 semiannual historical averages. NERA Economic Consulting’s “Recent Trends in Securities Class Action Litigation: 2014 Full-Year Review” reports that 2013 and 2014 “aggregate investor losses” were far lower than in any of the prior eight years. And PricewaterhouseCoopers’ “Coming into Focus: 2014 Securities Litigation Study” reflects that in 2013 and 2014, two-thirds of securities class actions were against small-cap companies (market capitalization less than $2 billion), and one-quarter were against micro-cap companies (market capitalization less than $300 million). These numbers confirm the trend toward filing smaller cases against smaller companies, so that now most securities class actions are relatively small cases.

Consequences for Securities Litigation Defense

Securities litigation defense must adjust to this change. Smaller securities class actions are still important and labor-intensive matters – a “small” securities class action is still a big deal for a small company and the individuals accused of fraud, and the number of hours of legal work to defend a small case is still significant. This is especially so for the “lawsuit blueprint” cases, which typically involve a difficult set of facts.

Yet most securities defense practices are in firms with high billing rates and high associate-to-partner ratios, which make it uneconomical for them to defend smaller litigation matters. It obviously makes no sense for a firm to charge $6 million to defend a case that can settle for $6 million. It is even worse for that same firm to attempt to defend the case for $3 million instead of $6 million by cutting corners – whether by under-staffing, over-delegation to junior lawyers or avoiding important tasks. It is worse still for a firm to charge $2 million through the motion to dismiss briefing and then, if it loses, to settle for more than $6 million just because it can’t defend the case economically past that point. And it is a strategic and ethical minefield for a firm to charge $6 million and then settle for a larger amount than necessary so that the fees appear to be in line with the size of the case. .

Nor is the answer to hire general commercial litigators at lower rates. Securities class actions are specialized matters that demand expertise, consisting not just of knowledge of the law but of relationships with plaintiffs’ counsel, defense counsel, economists, mediators and D&O brokers and insurers.

Rather, what is necessary is genuine reform of the economics of securities litigation defense through the creation of a class of experienced securities litigators who charge lower rates and exhibit tighter economic control. Undoubtedly, that will be difficult to achieve for most securities defense lawyers, who practice at firms with supercharged economics. The lawyers who wish to remain securities litigation specialists will thus face a choice:

  1. Accept that the volume of their case load will be reduced, as they forego smaller matters and focus on the largest matters (which big law firms are uniquely situated to handle well, on the whole);
  2. Rein in the economics of their practices, by lowering billing rates of all lawyers on securities litigation matters and by reducing staffing and associate-to-partner ratios; or
  3. Move their practices to smaller, regional defense firms that naturally have more reasonable economics.

I’ve taken the third path, and I hope that a number of other securities litigation defense lawyers will also make that shift toward regional defense firms. A regional practice can handle cases around the country, because litigation matters can be effectively and efficiently handled by a firm based outside of the forum city. And they can be handled especially efficiently by regional firms outside of larger cities, which can offer a better quality of life for their associates and a more reasonable economic model for their clients.

Consequences for D&O Insurance

D&O insurance needs to change, as well. For public companies, D&O insurance is indemnity insurance, and the insurer doesn’t have the duty or right to defend the litigation. Thus, the insured selects counsel, and the insurer has a right to consent to the insured’s selection, but such consent can’t be unreasonably withheld. D&O insurers are in a bad spot in a great many cases. Because most experienced securities defense lawyers are from expensive firms, most insureds select an expensive firm. But in many cases, that spells a highly uneconomical or prejudicial result, through higher than necessary defense costs or an early settlement that doesn’t reflect the merits, but that is necessary to avoid using most or all of the policy limits on defense costs.

Given the economics, it certainly seems reasonable for an insurer to at least require an insured to look at less expensive (but just as experienced) defense counsel before consenting to the choice of counsel – if not outright withholding consent to a choice that does not make economic sense for a particular case. If that isn’t practical from an insurance law or commercial standpoint, insurers may well need to look at enhancing their contractual right to refuse consent, or even to offer a set of experienced but lower-cost securities defense practices in exchange for a lower premium. It is my strong belief that a great many public company CFOs would choose a lower D&O insurance premium over an unfettered right to choose their own defense lawyers.

Because I’m not a D&O insurance lawyer, I obviously can’t say what is right for D&O insurers from a commercial or legal perspective. But it seems obvious to me that the economics of securities litigation must change, both in terms of defense costs and defense-counsel selection, to avoid increasingly irrational economic results.

Appeals Court Settles Key Work Comp Issue

The U.S. Court of Appeals for the 9th Circuit has issued its long-awaited decision in the Angelotti Chiropractic Inc. v Baker case. In what can only be considered a resounding win for both the legislature’s power to create the workers’ compensation system and the Department of Industrial Relation’s authority to enforce the provisions of SB 863, the appeals court has, in its 32-page decision, upheld the portions of the lower court’s decision that were favorable to the DIR and reversed the portion that had challenged the validity of the statutory scheme. The result is a knockout, but not necessarily final, victory for the legislature and employer community’s efforts to rein in lien litigation madness.

One of the hallmarks of the most recent reforms to the worker’s compensation system in SB 863 was the adoption of both lien filing and lien activation fees. The intent of the fees was to filter out some of the less valid liens, encourage realistic settlement of liens before litigation and ultimately reduce the backlog of pending liens. Under the structure legislatively created, liens filed before Jan. 1, 2013, (the effective date of the statute) would be subject to an “activation fee” of $100 to actively pursue the lien before the W.C.A.B. Additionally, all pending liens as of Jan. 1, 2013, were required to have paid an activation fee by Jan. 1, 2014, or else be dismissed by operation of law. The second prong of the effort to reduce the backlog was to require lien claimants filing after Jan. 1, 2013, to pay a $150 filing fee. The challenge in this case was to the lien activation fee only, but the case has been watched carefully as similar arguments have been made in opposition to the lien filing fee. For many, Angelotti was considered a bellwether case on the lien fee validity.

Not surprising, shortly after its passage, the issue of the validity of the lien fee provisions in SB 863 was attacked in court with various challenges. In a ruling with what appeared to have the most potential for the challengers, a lower court had previously ruled that the plaintiffs in the Angelotti litigation had demonstrated a substantial likelihood of prevailing in their efforts to have the lien activation fee provisions declared unconstitutional. While by no means final, the resulting decision was accompanied by a temporary restraining order prohibiting the DIR from enforcing the lien activation fee provision. In its decision, the lower court rejected some of the plaintiff’s arguments that the lien activation fee violated constitutional prohibitions under the takings clause and the due process clauses of the U.S. Constitution. That part of the claim was dismissed. The lower court, however, was much more impressed with the equal protection arguments advanced by the plaintiffs, finding that the different treatment of institutional lien claimants vs. direct medical providers did not constitute a rational distinction. As a result of the temporary injunction, the DWC suspended its enforcement of the lien activation fee provisions but appealed the ruling.

In its decision, the appeals court upheld the district court’s rulings dismissing the plaintiff’s causes of action based on the takings and due process arguments, finding that the lower court’s rationale was well-founded. (The dismissal of those issues had been sought by the Angelotti plaintiffs.) However, in response to the defendant’s appeal of the restraining order and the failure to dismiss the equal protection claim, the court soundly rejected the lower court’s ruling that plaintiffs had established a probability of prevailing on an equal protection argument, reversing that holding and vacating the existing restraining order prohibiting the DIR from enforcing the lien activation fee provisions. That argument was based on the different treatment between institutional lien claimants (such as insurance companies) and private lien claimants (such as individual practitioners).

In reversing the lower court, the circuit court found the distinctions created by the legislature were both rational and within the wide latitude of the legislature to create:

“The legislature’s approach also is consistent with the principle that ‘the legislature must be allowed leeway to approach a perceived problem incrementally.’ Beach Commc’ns, 508 U.S. at 316; see also Silver v. Silver, 280 U.S. 117, 124 (1929) (stating that ‘[i]t is enough that the present statute strikes at the evil where it is felt and reaches the class of cases where it most frequently occurs.’). Targeting the biggest contributors to the backlog-an approach that is both incremental, see Beach Commc’ns, 508 U.S. at 316, and focused on the group that “most frequently” files liens, see Silver, 280 U.S. at 124,-is certainly rationally related to a legitimate policy goal. Therefore, on this record, ‘the relationship of the classification to [the Legislature’s] goal is not so attenuated as to render the distinction arbitrary or irrational.'”

The appellate court further noted it was the plaintiff’s burden to negate “every conceivable basis” that might have supported the distinction between exempt and non-exempt entities. The circuit (appellate) court said the district court did not put the plaintiffs to the proper test in this regard, instead rejecting the argument made by the defendants (DIR) that the activation fee was aimed at clearing up a backlog of liens. The circuit court found multiple flaws with the lower court’s analysis on this argument, including that it failed to give proper deference to the legislature’s fact finding. Instead, the court held the proper application of correct legal principles demonstrated the plaintiffs, rather than showing a likelihood of success, actually showed no chance of success:

“…that plaintiffs have no chance of success on the merits because, regardless of what facts plaintiffs might prove during the course of litigation, ‘a legislative choice is not subject to courtroom fact-finding and may be based on rational speculation unsupported by evidence or empirical data.’ See Beach Commc’ns, 508 U.S. at 315. Thus, the presence in the commission report of evidence suggesting that non-exempt entities are the biggest contributors to the backlog is sufficient to eliminate any chance of plaintiffs succeeding on the merits.”

While the plaintiffs in this matter have further appeal rights, it does not appear that under this decision the plaintiffs will be entitled to a trial at the lower court. The court not only vacated the injunction but took the unusual step of reversing the trial court’s denial of defendant’s petition to dismiss the equal protection cause of action. As noted in the above quote, the legislative authority to fashion a remedy effectively eliminated any chance of plaintiff’s prevailing.

Comments and Conclusions:

While the decision in this appeal took some time to come, the finality of the decision, and the tenor of the court’s ruling, will undoubtedly be considered well worth the wait. By reversing the lower court’s failure to dismiss the equal protection clause, the appellate court left very little opening for preservation of this lawsuit. While the plaintiffs can both ask for a rehearing and appeal to the U.S. Supreme Court, those levels of appeal come with rapidly diminishing probability of success.

With the DIR no longer hamstrung by the restraining order, we can anticipate a rapid enforcement of the lien regulations requiring activation fees. What will be a fascinating sideshow to this will be what happens to the provisions of Labor Code § 4903.06(a)(5), the requirement to pay the activation fee on any pre-1/1/13 lien claim on or before 1/1/14, a date long since passed. The DWC stopped collecting activation fees pursuant to the now vacated restraining order shortly after the TRO issued. Interestingly the language on the W.C.A.B.’s website indicated lien claimants were not obligated to pay the activation fee to appear at a hearing or file a DOR. However, it makes no mention of the dismissal language in 4903.06.

It is highly likely that few if any lien claimants paid activation fees by 1/1/14. It also seems unlikely, though not necessarily impossible, that the DIR or W.C.A.B. will be able to enforce the dismissal by operation by law provisions without allowing some kind of grace period for lien claimants to comply with the activation fee requirement before lowering the boom on liens without such fees. Lien claimants are now in something of a no man’s land with the faint hope that a further appeal may save them from the lien activation cost, but the compliance clock will probably be ticking, and once it stops the jig will be up on their liens.

It would certainly make sense for any current lien claimants, especially those who are set for hearings, to start looking into complying with the activation fee requirements. Showing up at the W.C.A.B. on a pre- 1/1/13 lien claim without having paid the activation fee may very well result in dismissal in the very near future. For defendants, with the TRO no longer in force, it is game on as far as activation fees are concerned. I intend to start raising the issue tomorrow…(or at least at my next hearing with a pre-1/1/13 lien claim).

On a side note, a similar case in state court, Chorn v Brown, was also recently decided in an unpublished decision. In that case, a lien claimant had challenged the lien statutes on both activation and lien filing fees. The case has been dismissed for lack of subject matter jurisdiction in the superior court. As a practical matter, the dismissal is really more of a procedural issue than a substantive one. The court of appeal noted the proper remedy for Chorn was to pursue a petition for writ of mandamus in the court of appeal, a step Chorn has actually initiated. However, a petition for writ of mandamus requires an appellate court to decide the issue has merit, a rather dubious proposition at this point. However, it is one more step to finally clearing up the DIR/DWC/W.C.A.B.’s authority to deal with the lien morass that, while somewhat abated in the past couple of years, continues to plague the system.

Do Accountants Face Risk as Fiduciaries?

Outside accountants – including auditors, those providing other attestation and compilation services, tax preparers and even mere advisers – are increasingly facing allegations that they served their clients in a fiduciary capacity. These are not simply idle observations: In general, they are made by clients and third parties seeking to obtain monetary damages from the accountants as a result of, inter alia, errors in financial reporting, tax positions that are subsequently rejected by the IRS or other authorities and losses incurred by clients or third parties following advice presented by the accountants. The reason adverse parties seek to impute fiduciary obligations to the accountants is that this offers them the opportunity to seek larger settlements or court-imposed awards, if the defending accountants are found liable. Fiduciary duties pose major risk for accountants and for those writing insurance coverage for them.

Traditionally, accountants were not considered to be fiduciaries, and in some instances still cannot be held to be such, either because of the nature of the services being rendered or the character of the client organization. However, over time the threshold for finding (or, at least, being permitted to argue in litigation) that the accountants were de facto fiduciaries has been lowered by court rulings. The implications for the accountants are serious – and they warrant taking steps to mitigate, by use of appropriate engagement letter language, and by exercising greater caution in taking on clients and in performing services for them. Those underwriting accountants’ malpractice insurance should be equally concerned with how well, if at all, their insureds have dealt with this risk factor.

What makes a party a fiduciary?

Fiduciary status is not well defined under the law, and this lack of precision has led, over time, to a creeping extension that now sometimes even reaches to outside accountants. A fiduciary relationship gives rise to fiduciary duties, the primary one of which is that of loyalty. As expressed more expansively in a number of key court decisions, “[a] fiduciary relationship carries with it the duty of candor, rectitude, care, loyalty and good faith.”[1]

Fiduciaries are required to hold their beneficiaries’ (i.e., clients) interests uppermost. Generally, fiduciary relationships are characterized as involving two parties, with the one (the fiduciary) acting on behalf of another (the beneficiary). The acting party exerts control over a critical resource that belongs to the other party – for example, the fiduciary invests funds belonging to the beneficiary, or controls the official filings (e.g., financial reports or tax returns) that are the obligation of the other party. The other party must have a relevant vulnerability (lack of investing expertise, technical knowledge, etc.) that places the beneficiary in what amounts to a subservient position vis-à-vis the fiduciary regarding the object of that relationship.

A fiduciary duty arises by either of two means: by operation of law or by application of legal factors. The first of these connotes a formal relationship between the parties, whereas the latter arises from informal relationships. Furthermore, in matters that have been elevated to the domain of litigation, there have been various ad hoc determinations that fiduciary obligations have attached, beyond those set forth in established law.

Examples of formal relationships to which fiduciary obligations will be ascribed include trusts, guardianships, agency arrangements, partnerships and joint ventures, corporations (regarding the duties of directors and officers) and counseling relationships (this being the most controversial). Counseling relationships may be those of attorneys and accountants and their respective clients, medical doctors and psychiatrists and their respective patients and even clergy and their parishioners. More generally, counseling relationships may include any others where the giving of advice in confidential settings is a central defining condition.

Informal relationships may also be interpreted as requiring the duty of loyalty. To rise to this status, there must be “trust” or “confidence” reposed by one person (or entity) in another, and there must be a resulting “domination,” “superiority” or “undue influence” of or over the other party (the putative beneficiary of the fiduciary relationship). It is important to stress that neither trust nor vulnerability alone suffice – it is widely held that both must be present to successfully assert that such an informal relationship creates fiduciary obligations.

More generally, if any person solicits another to trust her in matters in which she represents herself to be expert as well as trustworthy, and the other party is not expert and accepts the offer and reposes complete trust in that person, a fiduciary relation is likely established.

However, sharing expertise with another party is not, per se, enough: It is clear that not every expert is or can be held to be a fiduciary.[2]  There is a wide range of informal relationships, not all of which will connote fiduciary obligations. As the Restatement of Trusts notes, “Although the relationship between two persons is not a fiduciary relationship, it may nevertheless be a confidential relationship. Conversely, a fiduciary relationship may exist even though the parties do not enjoy a confidential relationship.” Thus, this is a grey area in the law, and this very ambiguity is what creates risk for the unwary.

For example, a financial reporting expert may advise a client on the various ways a particular transaction or event might be reported, or even opine that only a single approach would meet professional standards, but the ultimate decision remains that of the client, who may reject such advice or seek other opinions. The accountant does not dictate how the transaction or event has to be reported in the client’s financial report (although, if serving as independent auditor, the accountant may elect to render a less-than-unqualified opinion if the client elects an improper method of accounting having material impact on those financial statements).

As already noted, determinations establishing fiduciary obligations have been sometimes made on an ad hoc basis by the courts. Of greatest relevance to the present discussion, this tendency has increasingly brought accountants under the fiduciary duty umbrella, sometimes to the accountants’ great surprise and dismay. Most commonly, in the author’s experience as a practicing accountant, this has involved tax preparers who may rather casually offer investing advice to their clients. For example, upon noting a particular client’s high tax bracket, some tax preparers will make offhand comments about the virtues of, say, municipal bonds or real estate as investment options, or wax enthusiastic about a specific bond issue or mutual fund, which is more of a concern. More recently, this logic – applying fiduciary obligations to accountants offering investment counseling – has been extended to those offering a range of non-tax services, even if tradition and professional standards clearly prohibit the accountants performing those services from also serving in a fiduciary role.

What are the duties of a fiduciary?

Being defined as a fiduciary (whether or not a formal fiduciary relationship has been documented) brings with it a range of obligations. As noted, the most significant of these is the duty of loyalty. The interest of the principal (the beneficiary, or the client) must come first – even to the exclusion of the interests of the fiduciary. For example, if our hypothetical tax preparer suggests a certain class of investment to his client, it must be believed that this is an optimal investment strategy for the client, unrelated to the accountant’s own investment interests. Touting an investment in the hopes that, e.g., an increased demand will lift prices and thus benefit the accountant’s own holding of the same asset would clearly be a breach of this obligation.

In addition to making (or seeking to make) a hidden profit from advice given to the beneficiary, competing against the beneficiary (e.g., putting in a bid for property sought by the beneficiary, or “front running” an investment in securities), or simultaneously acting on behalf of another party whose interests are adverse to the beneficiary, would constitute breaches of the loyalty obligation. Because accountants typically have a large number of clients, there is a real risk that this prohibition could inadvertently be contravened.

A fiduciary also has a duty to disclose all relevant facts to its beneficiary. Again harking to the tax preparer/adviser situation, if the accountant is positioned to benefit if the client follows this investment advice (e.g., will obtain a referral fee or commission), this must be clearly communicated to the putative beneficiary. If an accountant is placed in the role of a fiduciary, the duties to exercise reasonable care and to maintain client confidences, found in the professional technical and ethical standards, must still be observed. Additionally, the fiduciary has a duty to maintain client confidences, which might carelessly be disobeyed even in the course of casual conversations with the accountants’ other clients.

Why is being held to be a fiduciary a risk for accountants?

Being held accountable as a fiduciary has one very crucial implication. Whereas assertions of failure to exercise due care (the normal standard to which outside accountants are held) lie within the domain of tort law, assertions of failure to meet the requirements of loyalty are found within fiduciary obligations. In the instance of allegations of breach of fiduciary duty, the burden of proof shifts to the respondent accountant, who must show, inter alia, that all material facts had been provided to the beneficiary and that all other fiduciary obligations have been satisfied.

In the event of a finding of failure to exercise ordinary due care, as defined in the professional standards with which the accountant is obligated to comply, damages are limited, typically, to actual damages suffered by the plaintiff, assuming that the tripartite required demonstrations of liability, reliance and damages have been achieved by the complaining party. In contrast, a failure to meet fiduciary obligations may result in punitive damages as well as the awarding of plaintiff’s legal fees, and thus presents a significantly greater financial risk for the accountants and for their insurers. The burden of proof, coupled with the potentially greater monetary damages, makes defending against well-founded accusations of having been a fiduciary and having breached associated duties to the beneficiary a much more serious concern.

The evolution toward fiduciary obligations for accountants has accelerated over the past few decades. During the 1970s and 1980s, claims against CPAs were commonly based on fraudulent misrepresentation and negligence (i.e., professional malpractice), as well as on contractual breaches (in the case of suits by clients against their accountants, who had purportedly failed to perform the assignment for which they had contracted). The 1990s witnessed an increase in claims made against CPAs that argued that they had served as financial advisers. This led to allegations of breach of fiduciary duty and a range of other assertions, such as functioning as an unlicensed investment adviser.

In the early 2000s, courts readdressed fiduciary duty claims, as they might pertain to CPA liability matters. In a seminal case, Miller v. Harris, decided in 2013,[3] a state appellate court reversed and remanded the trial court’s dismissal of a complainant’s breach of fiduciary duty claim against the respondent accountants. It found that contracts (such as that between the accountant and his client) between litigating parties do not control a claim for breach of fiduciary duty, because the latter are not based on contract law. This distinction is a vital one, establishing an important principle. Further, the court stated that a claim for breach of fiduciary duty must allege the existence of a fiduciary relationship and a breach of duties imposed as matter of law as a result of that relationship. The net effect of the Miller v. Harris appellate decision was to set a new, lower bar for fiduciary status by operation of law (i.e., for an informal relationship).

Given this decision and others, there is an enhanced likelihood that future actions against accountants will attempt to assert as fiduciary those relationships that, in the past, were not deemed to be such. Accountants, and their insurers, thus would be wise to give increased attention to this risk, and take steps to mitigate it, where possible.

What steps should be taken in actual practice to guard against this risk?

Although the record has been mixed, there has been some expansion of fiduciary duties over past decades to include accountants. Traditionally, of course, accountants generally had not been deemed fiduciaries. Indeed, their obligations to third parties and requirement for independence historically confirmed non-fiduciary status on accountants, inasmuch as duties to third parties could not coexist with loyalty to the client entity’s management.

Whereas at one time any attempt to attribute fiduciary status to accountants, for the purpose of alleging breach of fiduciary duty by them, would have been almost automatically dispensed with, today accountant defendants are very unlikely to obtain summary dismissal of breach of fiduciary duty claims. Instead, courts are holding this matter to be a fact issue to be resolved at trial. For the accountants, one important implication is that, even if the defense ultimately prevails, they will be forced to incur costs to defend against such claims. In litigation, even when you win, you often lose.

The existence of a fiduciary relationship is now defined to be a question of fact. If the facts support the assertion that an accountant acted as a fiduciary for the client, that accountant will be exposed to liability for breach of fiduciary duty, which may result in economic harm greater than in the situation of a garden-variety failure to exercise due care in a professional negligence suit, including the possibility of punitive damages and attorney’s fees being levied. The burden of proof is essentially placed on the defending party once the existence of a fiduciary relationship has been established by the complainant. Summary dismissals of fiduciary obligation claims against accountants are now unlikely to be obtained, meaning costs of defense must be borne even when ultimate exoneration is achieved.

Engagement letter limitation of damages language will often not be effective in precluding punitive damages, so this risk element cannot easily be protected against, if a fiduciary relationship can be established by the complaining party.

Contractual language defining the assignment as not implying fiduciary duties may not be sufficient to defend the suit. Nevertheless, having a well-crafted engagement agreement with clients remains an important defensive strategy – and such letters are mandated under professional standards for most ordinary accounting and auditing services. In the author’s opinion, the role of “adviser” should be avoided or severely constrained, if later allegations of breach of a fiduciary relationship-based obligation are to be averted.[4]

If advice is provided in circumstances in which the client can later plausibly claim to have been in a subservient role – thus, where the accountant was effectively making decisions for the client – there will be risk. Obtaining “informed consent” for recommendations made to the client would be one procedure providing some reduction in such risk. All recommendations should be couched in language that requires the client to consider and then independently conclude upon the matter, by either accepting and acting upon it, or rejecting it.

Finally, for both insureds and insurers, it would be wise to consult with a qualified attorney regarding the language used or proposed for accountants’ engagement letters for the various services being offered. Only in this way will risks, including that of being held accountable for breach of fiduciary duties, be most effectively addressed and, to the extent possible under evolving legal standards, contained.



[1]  See, e.g., Miller v. Harris, 2013 IL App (2d) 120512, ¶21; In re the Estate of Abernethy, 2012 Tex. App. LEXIS 4272; and Gracey v. Eaker, 2002 Fla. LEXIS 2662.

[2]  Burdett v. Miller, 957 F. 2nd 1375, 1381 (7th Circuit, 1992).

[3]  Miller v. Harris, Appellate Court of IL, Second District, 2013

[4]  Somewhat ironically, the trade association of public accountants, the AICPA, long promoted the catch-phrase “trusted (business) adviser” as a marketing tactic for CPAs to employ. It no longer does this, but a review of recent on-line articles and firm web sites reveals that this proclamation, or a close variant, continues in wide usage. Knowingly or not, many accountants are playing a dangerous game, wanting to tout their roles as adviser while rejecting status as fiduciaries.