In an important recent decision in the Business Litigation Session of the Massachusetts Superior Court, Judge Kenneth W. Salinger rejected Merrimack College’s attempt to hold its auditor KPMG, LLP liable for its failure to discover an employee’s fraud.
In Merrimack College v. KPMG, LLP, No. 1484CV02098-BLS2, 2017 WL 2347049 (Sup. Ct. May 16, 2017), the Court held that Merrimack’s claims against KPMG were barred by the in pari delicto doctrine. As explained by the Massachusetts Appeals Court, “the doctrine of in pari delicto bars a plaintiff who has participated in wrongdoing from recovering damages for any loss resulting from the wrongdoing.” Choquette v. Isacoff, 65 Mass. App. Ct. 1, 3 (2005). If both the plaintiff and the defendant have engaged in misconduct, the “less guilty” party is able to recover damages or obtain equitable relief in some instances. Id. at 4. However, where the plaintiff is equally culpable or more culpable in any wrongdoing as the defendant, the in pari delicto doctrine will generally bar recovery of damages or equitable relief. Id.
In Merrimack College v. KPMG, LLP, Merrimack’s longtime financial aid director awarded far more financial aid than she was authorized to spend over a period of multiple years, and “made the college’s financial aid budget appear balanced by replacing grants and scholarships with fake Perkins loans, the proceeds of which were used to pay tuition owed to Merrimack.” 2017 WL 2347049 at *1. After the fraud was discovered and the financial aid director pleaded guilty to federal criminal charges of mail and wire fraud, Merrimack sued its former auditor KPMG, claiming that KPMG noticed discrepancies in some student loan accounting records but failed to follow up on such irregularities, which caused KPMG to fail to discover the fraud. Id.
KPMG moved for summary judgment, in part on the basis of the in pari delicto doctrine, arguing that Merrimack was more at fault than KPMG and should not be entitled to recover damages from the company. The Court held that Merrimack was legally responsible for the financial aid director’s fraud, as her misconduct was committed squarely within the scope of her employment, intending the fraud to benefit the college. Id. at *3-4.
Consequently, for purposes of the analysis under the in pari delicto doctrine raised by KPMG, the Court treated the fraud as misconduct committed by and for Merrimack. Id. at *5. The Court held that the “intentional misconduct by Merrimack’s agent in authorizing fraudulent Perkins loans is far more serious than KPMG’s failure to ferret out that fraud when auditing Merrimack’s finances. Merrimack’s claims against KPMG are therefore barred by the doctrine of in pari delicto.” Id.
Finally, Merrimack urged the Court to recognize an exception to the doctrine of in pari delicto, on public policy grounds, for claims by an organization against its auditor. The Court rejected that argument, holding that such a “proposal would ‘creat[e] a double standard whereby the innocent stakeholders’ of the outside auditor ‘are held responsible for the sins of their errant agents while the innocent stakeholders of’ the entity injured by its employee’s fraud ‘are not charged with knowledge of their wrongdoing agents.'” Id. at *7, quoting Kirschner v. KPMG, LLP, 938 N.E.2d 941, 958 (N.Y. 2010) (applying New York law). The Court explained that Merrimack had not shown a “compelling public policy justification for letting entities that were injured by the deliberate fraud of their employees sidestep the in pari delicto doctrine and shift responsibility to an independent auditor that negligently failed to discover the fraud.” Id.
In the wake of Merrimack College v. KPMG, LLP, auditors and other service providers can continue to take some comfort in the fact that their clients will not be able to sue them for negligence in failing to discover misdeeds when the clients or their agents were equally or more responsible than the service provider for the underlying malfeasance. By the same token, employers and organizations must continue to be vigilant in monitoring their employees and ensuring that they do not rely on outside auditors to discover improper recordkeeping or financial practices.
Fitch Law Partners will continue to monitor changes and occurrences in this area of the law.