Investors Seek Justices'Review in Auditor Scienter Case

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By Phyllis Diamond

July 18 — Investors in a China-based company that collapsed under the weight of a massive accounting fraud by its chief executive officer are asking the U.S. Supreme Court to take up a federal appeals court ruling they didn't state a claim against the Deloitte unit that audited the company's financials ( Special Situations Fund III QP LP v. Deloitte Touche Tohmatsu CPA Ltd., U.S., No. 16-52, cert petition filed, 7/7/16 ).

The U.S. Court of Appeals for the Second Circuit made it too hard for plaintiffs to plead scienter—culpable intent—against auditors compared to other securities fraud defendants, the investors said in a July 7 certiorari petition.

Red Flags Ignored

According to the investors, Deloitte Touche Tohmatsu CPA Ltd. disregarded numerous “red flags” when it issued clean audit reports for ChinaCast Education Corp. Inc., an e-learning services provider. The U.S. District Court for the Southern District of New York dismissed the complaint, saying the investors didn't plead with particularity that Deloitte had the scienter—or culpable intent—required under the Private Securities Litigation Reform Act.

The Second Circuit affirmed (69 SLD, 4/11/16). In an April order, it said that at most, the “red flags” indicate that Deloitte may have been negligent in its audits.

In their certiorari petition, the investors said the appeals court followed Second Circuit precedent that set out a more stringent substantive standard for pleading scienter on the part of auditors, giving accountants “enhanced protection from liability to injured investors” not available to other 1934 Securities Exchange Act Section 10(b) defendants.

“A substantial Circuit split exists on the question of whether a special standard for auditor scienter applies and, if so, what the substantive content of that standard should be,” the plaintiffs said. High court review in this case could resolve that split “and clarify that there is no special enhanced scienter rule for auditors under Section 10(b),” the plaintiffs wrote.

DTTC's response is due Aug. 10.

The plaintiffs are represented by Lowenstein Sandler LLP, Roseland, N.J.

To contact the reporter on this story: Phyllis Diamond in Washington at

To contact the editor responsible for this story: Susan Jenkins at

For More Information

To see the petition, go to

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