Litigation

Partner and co-chair of Herrick's Securities Litigation and Enforcement Group, Arthur G. Jakoby and partner David R. King, were featured in an Accounting Today article highlighting a lawsuit involving their clients, investors in a defunct hedge fund, who successfully sued an auditing firm for negligence, breach of contract and breach of fiduciary duty. This is an important case as the ruling could potentially change the precedents on when auditing firms can be sued by hedge fund investors.

Herrick's clients were investors in Platinum Partners, a hedge fund manager, that had faced charges from the Securities and Exchange Commission and the Department of Justice. The hedge fund collapsed in December 2016 when the DOJ arrested its top executives and charged them with a $1 billion investment fraud. BDO was one of the fund's auditors, along with CohnReznick.

Herrick's clients alleged that BDO negligently performed its audits, but they had relied on the BDO audit reports in making their investment decisions. The court directed the investor claims against BDO to an arbitration panel. In a July 29, 2024, decision, the arbitrators found BDO was negligent in its 2012 and 2013 audits for failing to uncover Platinum's overvaluation of its assets and awarded over $9 million to the investors.

According to the article, Platinum stopped working with BDO after the firm issued a 2013 audit and engaged CohnReznick to prepare the 2014 audit. CohnReznick was also sued by the investors and chose to settle, according to David. The CohnReznick settlement is confidential, he told Accounting Today, but he estimates that BDO was the most culpable firm and could end up owing the investors and other claimants approximately $20 million, including interest accruing at New York's high rate, if the award is ultimately upheld. 

"We recovered roughly $9 to $10 million in an award representing the claims of, I believe, 13 out of the 90 or some investors who we represent," said David, who is representing the investors alongside Arthur Jakoby. "Each side picked a group of investors, and there was an arbitration just on the smaller group of claims. They're called bellwether claims, essentially to try to get a feel for what the arbitrators thought about the case generally and hopefully enable some sort of a broader settlement for the entire group of investors. That hasn't happened at this point."

The article highlighted that "the award is now on appeal after BDO tried to vacate it. The investors also moved to have a portion of the award vacated because they wanted a larger damage award on some of the panel's rulings. Both sides' applications were denied and the matter is now before the First Department Appellate Division of the New York State Supreme Court." 

"We have to hear what the First Department thinks about Justice Masley's decision, who affirmed the arbitration award and refused to vacate any aspect of it," said David. "Now, the standard for overturning an arbitration award is pretty high, and the standard in reviewing Justice Masley's decision is going to rely in part on that standard. We'll see what the First Department does. That appeal could take most of 2026 to get resolved. Meanwhile, with respect to the other claims by the claimants who have not yet had their claims tried, their claims would basically stay while we find out what the court is going to do with the bellwether claims. Once the decision is in from the First Department, assuming it doesn't go to the Court of Appeals, we'll have a framework, essentially, for how to deal with the remaining claimants' claims against BDO."

He believes the case could have wider implications for accounting firms. Securities class-action lawsuits against auditing firms actually declined last year to a record low of 34, according to a report released Wednesday by Cornerstone Research.

"What's interesting about the case is it's extremely difficult to sue accounting firms for their audit work, particularly where you are an investor, as here in a hedge fund, because the argument is made that there's no privity between the investors and the accounting firm," said David. "The contract is between the accounting firm and the hedge fund, not the accounting firm and the investors. Now, before that, they compelled arbitration against our clients by arguing essentially that we were trying to sue under the contract and Justice Masley agreed with one of our arguments that the accounting firm couldn't essentially rely on the arbitration clause of the engagement agreement and then turn around and say they're not bound in any way by the engagement agreement."

The case could potentially change the precedents on when auditing firms can be sued by hedge fund investors. "It's a fairly established body of case law that makes it extremely difficult to do so," said David. "We argued, under some exceptions to the panel, that we should be allowed to do so here, and we prevailed. And Justice Masley affirmed the panel's award in that regard and actually went further than the panel did in looking at the case law. She actually entered a stronger decision that, if anything, would broaden investors' access to be able to sue accounting firms for their audits of hedge funds."

Read the full article in Accounting Today here. Access may require a subscription.