Bechtle v. Master, Sidlow & Associates, P.A.

Citations: 766 F. Supp. 2d 547; 2011 U.S. Dist. LEXIS 12950; 2011 WL 476535Docket: Civil Action 10-5195

Court: District Court, E.D. Pennsylvania; February 8, 2011; Federal District Court

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Louis C. Bechtle, as Receiver for Acorn II, L.P. and Acorn Capital Management, LLC, initiated a professional negligence lawsuit against Master, Sidlow & Associates, P.A. and several individuals associated with the firm. The suit arises from the accounting and auditing services provided to the Acorn Entities. The defendants filed a Motion to Dismiss, claiming that the doctrine of in pari delicto should bar the Receiver's claims, asserting that the Acorn Entities share equal responsibility for the alleged misconduct. The court, led by District Judge Padova, denied this motion.

The complaint indicates that Master Sidlow served as the auditor for Acorn II, L.P., with William Master, Frank Sidlow, and Michael McCuddon as licensed accountants, and Juan Pablo Vasquez as an employee under McCuddon's supervision. The Acorn Entities were established to invest in U.S. securities, with Acorn Capital Management, LLC acting as their General Partner and investment advisor. Donald Young, the managing member of Acorn Capital, exerted control over the firm, and in 2005, R. Stewart Strawbridge became a partner by acquiring a 20% interest.

The Limited Partnerships solicited investor funds but were mismanaged by Young, who ran a Ponzi scheme, using new investors' money to pay earlier investors and diverting funds for personal use. Young's income was primarily derived from the Acorn Entities from their inception until June 2009. In 2003, Young engaged Master Sidlow and McCuddon for auditing and tax services for Acorn II, which continued through 2007. Master Sidlow provided an "unqualified audit opinion" each year, asserting that the financial statements conformed to Generally Accepted Accounting Principles. Additionally, the firm offered services beyond auditing, including bookkeeping and financial disbursement oversight.

Master Sidlow, while providing bookkeeping and compilation services for Acorn II, relied on monthly account statements from CRESAP, the custodian of Acorn II's brokerage account. The Complaint asserts that Master Sidlow violated Generally Accepted Auditing Standards (GAAS) by failing to maintain professional skepticism and disregarding signs indicating that Young was operating a Ponzi scheme. Allegations include a lack of independent verification of account activities, reliance on misleading information from Young, and acceptance of questionable explanations regarding suspicious transactions. 

Specifically, Defendants are accused of not documenting their work adequately, failing to test for fraud, and ignoring significant irregularities such as numerous transfers from Acorn II's accounts to Young's personal account and unusual patterns of deposits and withdrawals. This lack of oversight and failure to act independently from their bookkeeping responsibilities, which created a conflict of interest, further enabled Young's fraudulent activities. The SEC subsequently filed a civil Complaint against Young and the Acorn Entities for violating securities laws related to the Ponzi scheme, seeking to freeze their assets.

On June 25, 2009, Louis C. Bechtle was appointed as Receiver for the Acorn Entities, tasked with investigating and preserving the entities' assets to maximize recovery for defrauded investors due to Young's Ponzi scheme. Young admitted to misappropriating funds, using them to pay other investors and for personal expenses. On July 20, 2010, he pled guilty to mail fraud and money laundering related to these activities. The current Complaint asserts five claims against Defendants, alleging they facilitated Young's wrongful conduct, encompassing professional negligence, aiding and abetting fraud, aiding and abetting breach of fiduciary duty, breach of contract, and unjust enrichment. Defendants argue these claims are barred by the in pari delicto doctrine, which prevents recovery when the plaintiff was an active participant in the wrongful conduct. In evaluating a motion to dismiss under Federal Rule of Civil Procedure 12(b)(6), the court considers the factual allegations in the complaint as true and analyzes whether they present a plausible claim for relief. The in pari delicto doctrine applies when the plaintiff shares equal or greater responsibility for the wrongful conduct compared to the defendant, thereby potentially relieving the defendant of liability.

The in pari delicto defense serves the public interest by preventing courts from mediating disputes between wrongdoers, but it is subject to necessary public policy limits. These limits ensure the defense is not applied rigidly in all cases where the plaintiff’s culpability is equal to that of the defendant. The defense primarily hinges on the precedent set by the Pennsylvania Supreme Court in Allegheny I, which addressed imputation of fraudulent conduct in accountant liability cases. The court responded to questions from the Third Circuit regarding when a plaintiff company's agents' fraudulent actions can be attributed to the company and whether the in pari delicto doctrine can bar recovery against accountants who conspired with those agents. 

The court determined that imputation is essential for asserting an in pari delicto defense and clarified that the test for imputation involves whether the defendants acted in good faith. While protecting innocent parties is a primary goal, imputation may apply in cases of auditor negligence, but not when the auditor has not dealt in good faith with the company. The court concluded that the in pari delicto defense can be applicable in auditor-liability settings, contingent on the usual requirements for pleading and proof, particularly in cases involving fraud. However, it is not available if the auditor has engaged in secretive collusion with company officers to misrepresent financial information, which would prevent the assertion of this defense. For a defendant accountant to claim the in pari delicto defense based on an agent's fraud, it must first prove that the agent's fraud can be appropriately imputed to the company, fulfilling specific conditions.

Establishing liability against a corporation for the actions of its agent requires demonstrating that those actions benefited the corporation rather than being adverse to its interests. Under the "adverse interest" exception, a third party cannot impute an agent's misconduct to the corporation if the misconduct only served the agent’s self-interest. Additionally, accountants must engage in "good faith" dealings with the corporation for the in pari delicto defense to apply. This defense hinges on the absence of public policy constraints that would oppose imputation. 

Defendants argue for dismissal of the Receiver's Complaint based on the in pari delicto defense, asserting that the Complaint fails to show any facts against imputation. Specifically, they claim there are no allegations of their knowledge of fraud or collusion with the individual responsible for the financial misstatements. They further argue that the "adverse interest" exception is inapplicable because the alleged fraudster had complete control over the corporation, thus invoking the "sole actor" doctrine, which allows the imputation of fraud if the agent solely represents the principal.

Defendants assert that the in pari delicto defense can be used against a court-appointed receiver, citing cases from the Seventh Circuit and the Middle District of Florida. However, the court expresses skepticism towards these arguments, noting that the Receiver has not been definitively shown to lack a claim for relief based on the allegations in the Complaint. The court highlights the absence of clear Third Circuit or Pennsylvania authority on the applicability of the in pari delicto defense against receivers and is cautious about relying on Seventh Circuit precedents that may diverge from Pennsylvania law.

Pennsylvania law does not align with Cenco v. Seidman regarding auditor liability, particularly in balancing internal corporate monitoring with traditional liability objectives of fair compensation and deterrence. The court emphasizes that the in pari delicto defense should not be rigidly applied and must consider public policy in its availability. The absence of collusive behavior does not imply that defendants acted in good faith, particularly when allegations suggest otherwise, such as the defendants’ failure to scrutinize suspicious activities linked to Young, who was implicated in a Ponzi scheme. The defendants’ claim for the "sole actor" exception lacks supporting authority, as the complaint indicates that another individual, R. Stewart Strawbridge, had significant involvement with Acorn Capital, thus questioning the applicability of this exception. The court rejects the defendants' argument that the in pari delicto defense absolves them of liability, deeming their legal rationale underdeveloped and oversimplified. The complaint presents sufficient factual allegations to support a plausible claim for relief, leading to the denial of the defendants' motion to dismiss. An order was issued accordingly, denying the motion.