PHA Accountants May Be Held Liable for Former Director’s Fraud
Facts: A local PHA sued its former accountants, seeking to recover losses from their alleged negligent failure to detect the fraudulent conduct of its former executive director and former finance director. The former executive director’s employment agreements established his annual salary at $107,000 for the 2001 fiscal year. The PHA was required to submit annual budget reports to the Department of Housing and Community Development (DHCD) for approval, subject to regulatory limits on the amount by which a PHA could increase administrative salaries. But the former director quickly sought and obtained board approval for salary increases vastly higher than those permitted by the regulatory limits imposed by DHCD.
At the former director’s direction, the PHA “misallocated and misused” federal funds granted to the PHA by HUD under its capital funds program. Some of these funds were diverted to pay the difference between his actual salary and the falsified figures reported to DHCD. Eventually, HUD investigators uncovered his excessive compensation and the misuse of federal funds. HUD has since demanded the PHA reimburse HUD $2.7 million: $500,000 of excessive compensation paid to the former executive director and $2.2 million of misused capital funds program monies.
In July 2013, the former executive director pleaded guilty in the United States District Court for the District of Massachusetts to four counts of falsifying a record in a matter pertaining to a federal agency.
In this lawsuit, the PHA sought a judgment against the accountants, claiming that they committed professional malpractice by failing to detect the fraud perpetrated by the former executive director and former finance director. The accountants opposed the PHA’s request, asserting that there’s a dispute of fact whether they were negligent in the performance of their duties.
The accountants also argued that, even if they were negligent, under the common law rule of “in pari delicto” the fraudulent conduct of the former directors is imputed to the PHA. In pari delicto is the idea that since both parties are equally at fault, the court won’t involve itself in resolving one side’s claim over the other. Therefore, according to this doctrine, an entity that committed fraud can’t recover judgment against its accountants for failing to detect that fraud.
The trial court granted the accountants’ request for a judgment without a trial in their favor. But the accountants’ alleged misconduct occurred after the effective date of a law the state passed that replaced the legal theory the trial court had relied upon. The replacement law says that, where an accounting firm is sued for its failure to detect fraud by a client’s employee, the accounting firm is liable for its percentage of fault.
The PHA appealed the lower court’s decision and asked the higher court to review the decision in light of the new legislation.
Ruling: The Massachusetts Supreme Court ruled that the new legislation supersedes the common law rule and sent the case to the lower court for a ruling consistent with this decision.
Reasoning: After examining the language of the new statute, viewed in the context of its legislative history, the court concluded that the legislature intended in situations where a plaintiff sues an accountant for negligently failing to detect the fraudulent conduct of the plaintiff, the plaintiff may recover damages from the accountant, but only for the percentage of fault attributed to the accountant. In so doing, the lawmakers preempted the common law doctrine of in pari delicto as it applies to the negligent conduct of accountants and auditors in failing to detect fraud.
- Chelsea PHA v. McLaughlin, July 2019