Nearly six years after 1,600 investors were bilked, left holding an estimated $130-million of worthless promissory notes when Montreal financial group Mount Real Corp. was shut down by the Quebec securities regulator, a Quebec judge authorized a class action against two former executives, two financial service companies and three accounting firms.
In a ruling that appears to have lowered the bar for class action certification against accounting firms, Quebec Superior Court Justice Jean-François Buffoni held that the representative plaintiff demonstrated that the allegations she is trying to establish between the fault allegedly committed by the accounting firms and the harm suffered by the class does not “appear to be frivolous nor manifestly unfounded” and stands a reasonable chance of succeeding, even though the representative plaintiff admitted that she did not rely on the audited financial statements to make an investment decision.
“This ruling represents an important precedent regarding the civil responsibility of accounting firms,” noted Bruce Johnston, a Montreal lawyer for one of the three law firms representing the investors. “I hope it sends a message to auditors. It’s very important that auditors do their work properly and be held accountable if they fail to do so.”
The class action alleges Mount Real executives Lino Matteo and Paul D’Andrea conceived a “vast fraud, which was made possible by the negligence of the professionals and financial services businesses.” Launched three years ago, the class action is seeking to recoup $130-million in losses incurred by investors, plus interest, by seeking to establish the liability of the accountants who audited Mount Real’s “fraudulent” financial statements and the trustees who sent “erroneous” statements of account to class members.
The class action targets Mount Real’s former chief executive Matteo and his right-hand man D’Andrea, two CMAs who were struck off the roll three years ago by the Quebec Order of Certified Management Accountants after a three-person disciplinary committee found them guilty of three counts of ethical breaches. Matteo, who handed a letter of resignation to the Order on December 2007, had his license revoked permanently on November 2008. D’Andrea had his license revoked for a period of 10 years on June 2008.
More significantly, the class action also names three major accounting firms, including Deloitte & Touche, who audited Mount Real’s financial statements from fiscal 1993 to 2002, BDO Dunwoody who audited fiscal 2003, and Schwartz Levitsky Feldman who audited fiscal 2004. Also cited in the class action are financial service companies B2B Trust, a federally chartered trust company that is a wholly-owned subsidiary of Laurentian Bank of Canada, and Services Financiers Penson Canada Inc., a member of the Penson Worldwide group of companies.
The legal team behind the class action suit argued that if the accounting firms had diligently performed the audited financial statements according to Generally Accepted Auditing Standards (GAAS) then regulatory authorities would have shut down Mount Real early on, which could have possibly pre-empted the elaborate Ponzi scheme allegedly conjured by Matteo. In short, they argued that the accounting firms committed a fault in its professional work. Under section 1457 of the Civil Code of Quebec, every person has a duty to abide by the rules of conduct which lie upon him, according to the circumstances, usage or law, so as not to cause injury to another – and when he fails in this duty, he is responsible for “any injury he causes to another person” and is liable to reparation for the injury.
Mount Real was a firm that provided financial management and accounting services and strategic advice to companies and individuals. Its principal business activity, though, was selling magazine subscriptions. Its corporate structure was extremely complex, with over 120 companies linked to it, and by all appearances it was thriving. Listed on the Toronto Stock Exchange, Mount Real boasted revenues of $5.7-million and $89.7 million in assets in fiscal 2004. In 2005, however, Mount Real began missing interest payments on investment notes it issued, prompting investor panic. Mount Real also drew the attention of Quebec’s securities regulator, who after probing its brokerage and advisory practices, shut down its offices in November 2005, alleging that investment notes had been issued and sold illegally. The Mount Real investment notes were almost all distributed by investment representatives working for now bankrupt iForum Securities and its sister firm, iForum Financial Services.
“If the accountants had done their work, the fraud would have been unmasked,” said Johnston, a Montreal lawyer who co-founded the law firm Trudel & Johnston in 1998. “If the auditors had refused to sign the financial statements or sign them under reserve, then the public company would have suffered the consequences.”
The accounting firms argued, without success, that it could not be held liable unless each individual investor relied on the financial statements to make their investment decisions. It’s an issue that cropped up in the in a ruling that put an end to a chapter to one of the longest running judicial sagas in the legal history of Quebec and Canada – the Castor Holdings case. In a 763-page ruling that found a former accounting giant and its partners negligent in the preparation of the audited consolidated financial statements of a Montreal real-estate financing and investment firm that collapsed nearly three decades ago under the weight of a $1.6-billion debt, Quebec Superior Court Justice Marie St-Pierre held that Coopers & Lybrand committed a fault in its professional work. Justice St-Pierre also found that the plaintiff suffered damages, and that there was a causal connection between the damages he suffered and Coopers & Lybrand’s fault.
While the Castor Holdings ruling “makes it clear that according to the law of the province of Quebec if a fault, a damage and a causal link between the two is established, then the auditor does have liability to a third party,” Avram Fishman points out that in the Castor case it was proven that the plaintiff relied upon the audited financial statements that were issued by Castor Holdings and prepared and audited by Coopers & Lybrand.
“In this case there is no direct and immediate causal link that appears nor was no reliance on the audited financial statements,” said Fishman of Fishman Flanz Meland Paquin LLP in Montreal. A member of the legal team who successfully pled the Castor case, Fishman is representing BDO Dunwoody in the Mount Real class action suit.
“This is a ruling on authorization of a class action. It does not hold any audit firm liable. If the theory which is put forward by the plaintiffs is accepted on the merits, then that could represent a significant departure from existing jurisprudence and would expose auditors to additional liability – and that would certainly be a serious concern to auditors.”
After years of frustration Mount Real investors are pleased with the latest development. The long three-year delay before the class action was finally heard was just one of the disappointments investors had to cope with, remarked Janet Watson, a spokesperson for the investors. To the dismay of investors, the Autorité des marchés financiers, Quebec’s financial securities watchdog, did not compensate investors through its indemnity fund, with the exception of a single investor. Just as disappointing was a decision by the Royal Canadian Mounted Police force to seemingly abandon pursuing the case.
“The class action has given us a ray of hope,” said Watson, a Mount Real investor who says she lost approximately $70,000. “If it hadn’t been authorized, I don’t know what we would have done. If the accounting firms had done their job, millions of dollars would have been saved by investors. So when we win, it’ll send a very clear message to these accounting firms that they have to be much more vigilant.”