Auditors win ruling over Madoff-style frauds

Auditors have won a crucial court ruling limiting their liability in Bernard Madoff-style fraud cases, where a determined criminal drives a company to financial ruin.

With the big accountancy firms widely predicted to be the next targets of lawsuits alleging failure to spot the warning signs of international investment frauds, Thursday’s decision will be greeted with relief by auditors such as Ernst & Young, KPMG and Deloitte.

In one of their last decisions before decamping to the UK’s new Supreme Court in the autumn, the law lords dismissed a negligence lawsuit brought against a City accountancy firm for allegedly failing to detect a massive fraud at Stone & Rolls, a trading company that collapsed in the late 1990s.

Britain’s highest court ruled that Stone & Rolls’ liquidators, who were pursuing the case on behalf of the creditors, could not bring a claim for damages when the company itself was responsible for the fraud.

Legal experts said the judgment would block creditors from pursuing lawsuits against accountancy firms when a powerful executive masterminded a criminal scheme.

Stone & Rolls’ liquidators had argued that the company’s auditors, Moore Stephens, should have spotted the fraud because that was what they had been hired to do. But the law lords refused to depart from an ancient legal maxim – known in Latin as “ex turpi causa non oritur actio” – that nobody can bring a cause of action based on his own criminal conduct.

Clare Canning, a lawyer at Mayer Brown who specialises in litigation against accountants, said the decision was “particularly acute” in the current regulatory climate, when more criminal investigations were being brought by agencies such as the Serious Fraud Office.

Big legal battles lie ahead over who could – or should – have prevented the kinds of global investment frauds perpetrated by Mr Madoff and others. In a sharply worded dissenting opinion to the judgment, Lord Mance warned that it was contrary to public policy to insulate auditors from the consequences of failing to scrutinise the activities of “one-man” fraudsters.

“In my opinion, English law does not require it,” Lord Mance said.