Anwar et al v. Fairfield Greenwich Limited et al

Filing 1044

MEMORANDUM OF LAW in Opposition re: #1032 MOTION for Settlement Notice of Motion for Final Approval of the Proposed Partial Settlement and Plan of Allocation. PwC Defendants' Limited Objections to Plaintiffs' Motion. Document filed by Pricewaterhouse Coopers Accountants N.V., Pricewaterhousecoopers L.L.P.. (Attachments: #1 Exhibit A (Part 1), #2 Exhibit A (Part 2), #3 Exhibit B)(Duffy, Timothy)

EXHIBIT A (PART 2)

A-2.doc

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"Sentry, Sigma and Lambda are hereinafter collectively referred to as the "Debtors""

and PwC Nederland and PwC Canada are named as the Funds' auditors (margin
number 17, p. 10, para 1):

"Prior

to

the

fiscal

year

ended

2006,

the

Debtors'

auditors

were

PricewaterhouseCoopers Accountants N. V. of Rotterdam, the Netherlands ("PwC
Netherlands"). From 2006 on, PricewaterhouseCoopers LLP of Toronto Canada
("PwC Canada") served as the Debtors' auditors."

3.43

Every year PwC issued an unqualified opinion on the relevant financial statements of
the Funds. As a result of the fraud perpetrated over a number of years by BMIS, it is
clear that the Funds' financial statements over the years, and certainly in the period
2000 to 2007 inclusive, presented a misleading picture of the financial position of the
Funds.

3.44

For 2008, the year in which the fraud came to light, no financial statements were
produced.

IIL4

Importance and significance of PwC's role as auditor of the Funds

3.45

The role of PwC as auditor of the Funds and as a beacon of trust for investors and
others, including the .Plaintiffs, can hardly be underestimated. The issue, year after
year without interruption, of unqualified audit opinions on the annual financial
statements of funds as those involved in this case is an indicator for anyone doing
business with or wishing to invest in such funds. An unqualified opinion means that, at
the very least, qualitatively adequate audits have been performed by an auditor with
professional skepticism. Banks, intermediaries, brokers, etc. do not sell or recommend
funds if there is no such unqualified opinion. PwC's unqualified opinions did not have
value only for investors, but also served a general interest.

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3.46

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PwC has presented itself in the market as "the" expert when it comes to auditing
alternative - non stock-exchange traded - investment funds such as the Funds in
question (exhibit 31).

3.47

Through PwC's active promotion of its expertise, the idea arose that, since PwC
audited the Funds, a high degree of professionalism and expertise might and could be
expected from these audits.

3.48

If no unqualified opinions had been given, it would have been impossible for the
Funds to attract or continue attracting money from investors worldwide - including
from the Plaintiffs and the Plaintiffs would not have lost their investment.

3.49

It is furthermore significant that, as will be extensively discussed hereunder, there was
a strong need for thorough, effective and ongoing control mechanisms on the Funds in
view of the heavy concentration of duties at BMIS and the absence of any other
effective external supervision of the Funds by stock exchange or other authorities for
example and/or supervisors. In this respect there was also a strong need for external
checks on the Funds' internal control mechanisms, specifically on whether such
mechanisms were actually in place and were being correctly applied. The foregoing
underscores once again the importance and value of PwC's role as sole external and
independent supervisor.

3.50

As one of the "Key Risks" mentioned in the PPM for Sentry, the following appears
with regard to the risk of sub-custody (by BMIS) of Sentry's assets (Exhibit 1, p.19,
Exhibit 2, p. 21):

"Possibility of Misappropriation of Assets. When the Fund invests utilizing the "split
strike conversion" strategy or in a Non-SSC Investment vehicle, it will not have
custody of the assets so invested. Therefore, there is always the risk that the personnel
of any entity with which the Fund invests could misappropriate the securities or funds
(or both) of the Fund."

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The PPM for Sigma makes explicit mention ofBMIS (Exhibit 12, p. 20):

"17. Possibility of Misappropriation of Assets. When FSL invests with Bernard L.
Madoff Investment Securities or in a Non-SSC Investment vehicle, it will not have
custody of the assets so invested. Therefore, there is always the risk that the personnel
of any entity with which the Fund invests could misappropriate the securities or funds
(or both) ofthe Fund."

3.51

Actually these docwnents already point to the fact that the sub-custody of the assets
entails a potential danger.

3.52

It is also significant that the Sentry PPM for 2006 refers to the following as key
docwnents that can be requested from Sentry (exhibit 2, p. 35):

.

:

"Documents Available for Inspection

Copies of the following documents will be available for inspection at the offices of the
Fund's registered office in the British Virgin Islands and the offices of the sponsoring
broker during usual business hours on any weekday (Saturdays, Sundays and holidays
excepted):

a) the Memorandum and Articles ofAssociation ofthe Fund;
b) the material contracts of the Fund with the Investment Manager, the Administrator,
Registrar and Transfer Agent;
c) the British Virgin Islands Mutual Funds Act, 1996;
d) when available, the latest financial statements o(the Fund:
e) audited accounts as ofthe close o[the last immediately fiscal year;
f) Auditors letter o[consent; and
g) a list of all past and present directorships and partnerships held by each Director

over the past five years."

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This undeniably indicates that PwC's role was substantial, in view of its involvement
in the production of a ril;llilber of key documents relating to the Funds.

3.53

As will be explained in more detail in the legal context discussed hereunder in the
light of the Vie d'Or ruling, the audit and approval of financial statements has external
effects. Moreover, in expressing its opinion, PwC clearly addresses third parties such
as investors in the Funds (see for example exhibit 22, p.23 under the heading "To the

directors and shareholders of'). PwC thus knew that the declaration was not
addressed only to the directors.

3.54

Lastly, in this context it is important to mention that a cloud of mystery and nontransparency hung over BMIS, and that this was known to the markets. That this too
was known to PwC will be shown later. BMIS refused for example any form of due
diligence by third parties. BMIS/Madoff did occasionally agree to 'conversations'
with third parties, but the scope of these conversations was extremely limited.

3.55

All these factors meant that PwC's audits can be considered as being of great
importance and even indispensible for forming a judgement as to the reliability of the
Funds and their activities.

III.5

The disciplinary proceedings

3.56

In a complaint dated 3 January 2011, the Plaintiffs submitted a complaint to the

Accountantskamer (Disciplinary Court for Auditors) in Zwolle against Mr. H.F.M.
Gertsen R.A. in his capacity as partner of PricewaterhouseCoopers Accountants N.V.
Mr. Gertsen signed unqualified opinions on the financial statements of Sentry for the
financial years 2003, 2004 and 2005. Sentry's fmancial statements for fmancial years
2000 to 2002 inclusiVe1were audited under the responsibility of two other partners of
PwC.

3.57

In the disciplinary hearing, the Plaintiffs and Mr. Gertsen exchanged the usual court
filings (including reply and rejoinder). On 6 January 2012 the Disciplinary Court for
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Auditors declared the complaint unfounded. Exhibits 32 to 37 inclusive relate to the
documents produced in the disciplinary proceedings.

3.58

For reasons of their own, the Plaintiffs did not appeal against the decision of the
Disciplinary Court for Auditors. Part of those reasons was the fact that it has become
clear to the Plaintiffs that production of the audit files is necessary for the
establishment of their legal position vis-a-vis PwC Nederland and PwC Canada, and
that a claim under Article 843a of the Dutch Code of Civil Procedure in a civil action
lends itself better thereto than a disciplinary action. Furthermore at that time the
decisions of the District Court of Amsterdam regarding Article 843a of the Dutch
Code of Civil Procedure (16 December 2011 LJN: BP3071 and 27 March 2012 LJN:
BW0075) had not yet been pronounced or published. The Plaintiffs are therefore
requesting in these present proceedings that the audit files be produced. Furthermore
the Plaintiffs are seeking compensation for the damage that they have suffered, and
this too cannot be claimed in disciplinary proceedings.
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3.59

I

;

It is also significant that the ruling of the Disciplinary Court for Auditors focused only
on (i) Mr. Gertsen's conduct as partner of PricewaterhouseCoopers Accountants N.V.
regarding (ii) fmancial years 2004 and 2005 (because of the statute of limitations
applying to disciplinary cases brought before the Disciplinary Court for Auditors) of

(iii) Sentry and (iv) made no judgement as to the contents of any relevant audit files.
Mr. Gertsen had curiously enough refused to produce his audit files voluntarily, in
spite of repeated requests by the Plaintiffs. On this last point - which is crucial to the
present claim - the Disciplinary Court for Auditors did however expressly state that it
did not exclude the possibility that "an (in-depth) investigation of the audit files in

dispute" might give rise to '"new facts and/or circumstances" being identified. The
subject of these present proceedings moreover is not only the improper actions of
PricewaterhouseCoopers Accountants N.V., but also those ofPricewaterhouseCoopers
N. V. and PwC Canada. Furthermore the present proceedings relate also to the
auditor's reports on Sigma and Lambda, and are not limited to financial years 2004
and 2005 but also encompass financial years 2001, 2002, 2003, 2006 and 2007. The

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present proceedings also focus on an investigation into PwC's actual performance of
its audit assignments as must appear from the audit files.

3.60

Both the parties to the proceedings and the factual and legal points in dispute are
therefore so different aS to resist application of the disciplinary judge's ruling to the
present civil case. The Supreme Court has determined that it must be accepted as a
starting point that disciplinary proceedings cannot be referred to as a reasonable
standard for establishing liability, because the disciplinary judge applies partly
different criteria

(Supr~me

Court 10 January 2003, NJ 2003, 537, Supreme Court 13

October 2006, NJ 2008, 528 and District Court of Rotterdam, 18 January 2012, LJN
BV1975) so that for this reason too no binding authority can be derived from the
ruling of the Disciplinary Court for Auditors. Accordingly the defences and arguments
raised by PwC in the disciplinary proceedings will also be addressed in that light in
the present summons.

IV.

APPLICABLE LAW

IV.l

Misconduct (tort)

4.1

With effect from 1 January 2012 the WCOD (Wet conjlictenrecht onrechtmatige daad
or Conflict of Laws (Tort Cases) Act (hereinafter the "WCOD")) was replaced by
Title 14, Book 10 of the Dutch Civil Code. However the provisions of the WCOD are
relevant to the claims in hand re tort since the events having caused damage and loss
took place before 1 January 2012.

4.2

Pursuant to the WCOD, claims arising from tort are in principle, subject to a choice of
law, governed by the law of the country where the tort has occured (lex loci delicti).
This rule is laid down in Article 3 section 1 of the WCOD, which also refers to the
standard ruling ofthe Supreme Court of 19 November 1993, NJ 1994,622, nt JCS and
PvS (COVA).

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4.3

In the present proceedings the most important connecting factors point to the law of
the Netherlands as lex loci delicti. The Plaintiffs' claim for liability is based on (1)
deficient checks by PwC on inter alia the Funds' assets and (2) unqualified and
misleading opinions issued on the basis of these deficient checks.

4.4

The core ofPwC's activities concerned checks on (the existence of) the Funds' assets.
As already mentioned above, the Funds' assets were entrusted for custody to a Dutch
custodian, Citco. The fact that a sub-custodian (BMIS) was appointed does not affect
the issue. This is confirmed by the Brokerage and Custody Agreement with Sentry of
17 July 2003: "The Securities held at any one time by the Custodian or any sub-

custodian shall be recorded in and ascertainable from the books and/or ledgers of the
Bank and the Custodian" (Article 7.2.). The Brokerage and Custody Agreement was
moreover subject at all times to Dutch law. The - deficient - performance of the audit
assignment also took place in the Netherlands. Moreover the assignment to PwC was
entrusted to PwC Nederland. The activities were thus connected only to the Dutch
legal sphere. The Plaintiffs do not know why or by whom PwC Canada was at some
point in time brought into the picture. PwC Canada did however immediately replace
PwC Nederland, which brought with it a certain continuity in the - deficient - auditing
of the Funds' financial statements. The above allegations regarding audits by PwC
Nederland apply equally to PwC Canada. There is no point of connection whatsoever
with the Canadian legal sphere.
4.5

Regarding the unqualified opinions given by PwC Nederland, there is also a second
connecting factor that points to Dutch law. For the issuance of the unqualified yet
misleading opinions, Rotterdam has to be cited herein as the place where this tort (the
issuance of unqualified yet misleading opinions) took place.

4.6

The foregoing means that the conduct of PwC Nederland vis-a-vis the Plaintiffs and
the Plaintiffs' claims against PwC Nederland can be governed only by Dutch law. The
conduct ofPwC Canada vis-a-vis the Plaintiffs and the Plaintiffs' claims against PwC
Canada are also governed by Dutch law.

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IV.2

Petformance of task

4.7

The financial statements to be audited by PwC were prepared in accordance with the
International Financial Rep(>rting Standards ("IFRS"). The IFRS are accounting
standards for corporate financial statements. The body responsible for setting the IFRS
is the International Accounting Standards Board ("IASB"). Auditors are supposed to
check whether companies have followed the IFRS in drawing up their financial
statements.

4.8

PwC Nederland carried out its audits on the basis of the International Standards on
Auditing ("ISA") (see for example exhibit 22, p. 23):

"We conducted our audit in accordance with international standards on auditing.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material misstatement.
An audit includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements. An audit also includes assessing the
accounting principles used and significant estimates made by management, as well as
evaluating the overall presentation of the financial statements. We believe that our
audit provides a reasonable basis for our opinion."

4.9

The ISA contain rules and guidelines for performing audits, and are set by the
International Auditing and Assurance Standards Board, a private organisation of
auditors ("IAASB") under the International Federation of Accountants. In the
Netherlands these ISA were incorporated in the RAC (Richtlijnen voor de

Accountantscontrole or Audit Guidelines), which were updated and converted with
effect from 1 February 2007 into the COS (Controle- en overige standaarden or
'Auditing and other standards', hereinafter the "COS"). During 2007 these were
confirmed in the form of more detailed regulations under the name Nadere

Voorschriften Controle- en overige standaarden or 'further regulations on auditing
and other standards', hereinafter the "NV COS", as a result of which they acquired a
more obligatory charac~er for auditors.
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4.10

PwC Canada conducted its audits on the basis of the United States Generally Accepted
Auditing Standards ("US GAAS") (see for example exhibit 23, p. 6):

"In our opinion, the accompanying balance sheet and the related income statement,
the statement of changes in net assets attributable to holders of redeemable
participating shares and the cash flow statement present fairly, in all material
respects, the financial position .(.. .) and the results of its operations, the changes in its
net assets attributable to holders ofredeemable participating shares and its cash flows
for the year then . en(ied in conformity with International Financial Reporting
Standards. ( .. .) We conducted our audit of these financial statements in accordance
with auditing standards generally accepted in the United States of America. Those
standards require that we plan and perform the audit to obtain reasonable assurance
about whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and disclosures
in the financial statements, assessing the accounting principles used and significant
estimates made by the Company's management, and evaluating the overall financial
statement presentation. We believe that our audit provides a reasonable basis for our
opinion."
4.11

The US GAAS are American guidelines supporting auditors in their audits of annual
financial statements. They are issued by the American Institute of Certified Public
Accountants ("AICPA,"). These standards prescribe the minimum levels of
performance and quality that audits must meet. The standards laid down in the US
GAAS are in all respects consistent with those of the ISA. That means that the audit
activities of PwC Nederland and PwC Canada are effectively subject to the same
auditing standards.

4.12

This implies that for these proceedings reference can be made to the applicable ISA.

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V.

LEGAL FRAMEWORK

V.I

Auditor's duty of care vis-a-vis third parties

5.1

Under Dutch law the auditor is required generally to act with the degree of care that
may be expected of a reasonably competent and reasonably acting professional in
carrying out his activities. If he fails in his duty of care, he can be held liable to his
client for the damage arising from such failure.

5.2

An auditor can also be held liable to third parties: such liability may arise in relation to

activities the outcome of which has a certain external effect: third parties must be able
to be informed of the outcome of the activities and must be able to rely on them. Such
an external effect applies in any case to the auditing and approval of financial
statements. On the subject of this 'public role' of financial statements, we quote from
the preamble to the Wta (Wet toezicht accountantsorganisaties or Act on the
Supervision of Audit Firms (hereinafter "Wta") (Parliamentary documents II 2003/04,
29 658, no. 3, p. 2 (preamble): ''financial reporting- for which the Management is

primarily responsible - accompanied by an unqualified audit opinion, forms a source
of information to which society attaches more than average value." Article I of the
Wta also describes the audit of financial statements as being for the benefit of society.

5.3

In its Vie d'Or ruling of 13 October 2006 (NJ 2008, 528), the Supreme Court, in r.o.

5.4.1, confirmed the external effect of the financial statements:

"The interests served by proper performance of the external auditor's task are not
confined to those of the company whose financial statements are involved In the
social environment third parties are entitled to expect that the information as
published, often mandatorily, and. accompanied by an auditor's unqualified opinion,
will reflect, in the auditor's independent and objective view, a true andfair picture of
the assets, results, solvency and liquidity of the company and that the financial
statements will comply with the requirements of the law and of applicable regulations
including EU regulations and will conform to the relevant rules and standards
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generally accepted in this profession. Third parties must also be able to base their
behaviour on this information and be able to rely on the picture presented not being
misleading when taking their financial or other decisions. Thus the auditor's
performance of his tasks also serves a vital public interest."

5.4

The Supreme Court thus points to the fact that the auditor's task also serves a vital
public interest. The interests served by the performance of his task are not confined to
those of the company whose annual report and financial statements are concerned. The
Supreme Court adds that this is particularly the case with the legal audit of financial
statements and that consequently stringent demands must be made as to the degree of
care to be exercised by the auditor.

5.5

In the Vie d'Or case the Supreme Court also elaborated, in r.o. 5.4.2, on the demands
made regarding the auditor's duty of care:

"In answering the question as to whether the external auditor has acted in accordance
with the degree of care called for ·in the specific case, bearing in mind the foregoing
assumptions, all the circumstances of the case have to be assessed.
In so doing an investigation must be carried out into whether and if so to what extent
(mandatory) guidelines set out in national or European legislation regarding the
performance of that task - such as in the present case those regarding the financial
reporting of life insurance companies - have been complied with. Other factors to be
taken into account in the assessment include the nature of the rule breached and the
seriousness of an established breach thereof, the measures taken or information
provided by the auditor, the extent to which the risk of damage by harm to the
financial interests involved in this case was reasonably foreseeable for the auditor
and, partly in this connection, whether control and other measures have been taken
and such warnings given as in the given circumstances the auditor could reasonably
be expected to give in order to prevent this danger."

5.6

Thus according to the Supreme Court, in assessing the question as to whether the
auditor is liable to a third party in any given case, all the circumstances of the case
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must be taken into account. According to the Supreme Court the following questions
will in any case play an important role in this:

1)

has the auditor complied with the rules (national and European) in place for the
activities in question?

2)

which rule has been broken, and how serious is the breach?

3)

what measures has the auditor taken, and what information has it provided to
its client?

4)

to what extent was the damage actually suffered foreseeable?

5)

as regards this predictability: has the auditor taken reasonable controlling or
other measures or issued warnings aimed at preventing the damage?

5.7

In Steens I Crossroads c.s. (District Court of Rotterdam, 15 October 2008, JOR 2009,
65) the District Court considered, in r.o. 5.5, that the extent of the auditor's duty of
care is greater when he is performing his activities in the context of his legally
assigned task, than when he is performing activities that fall outside it. In the case of
activities connected with the task assigned to him the starting point is a certain duty of
care on the part of the auditor towards third parties. The District Court confirmed that
third parties are in principle entitled to base their behaviour on the information
provided concerning the auditor's report and that in taking or maintaining their
decisions, financial or otherwise, they may rely on the picture presented not being
misleading.

V.2

Audit standards to be complied with

5.8

The answer to the question as to which extent PwC can be held liable vis-a-vis the
Plaintiffs thus depends on the answer to the question as to which extent PwC complied
with the ISA in carrying out its audits. There follows a brief discussion of the relevant
ISA auditing standards.

5.9

ISA 200 obliges the auditor to apply professional care in planning and performing the
audit so as to obtain a reasonable assurance that the financial statements do not contain
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material misstatements as a result of error or fraud. ISA 200 establishes that the
auditor should set up a,nd perform the audit with a degree of 'professional skepticism',
taking account of the possibility that there may be circumstances that could lead to the
financial statements to be audited containing material misstatements. According to
ISA 200, professional skepticism involves the auditor making a critical assessment,
with a questioning mind, of the validity of audit evidence obtained and is alert to audit
evidence that contradicts or brings into question the reliability of documents or
management statements. ISA 200 also stipulates that representations from the
management are not a substitute for obtaining sufficient appropriate audit evidence to
be able to draw reasonable conclusions on which to base the audit opinion. From that
starting point it is stressed that in performing his audit the auditor may not
unquestioningly rely on information provided by the company being audited.

5.10

ISA 240 deals particularly with the auditor's responsibility with regard to the detection
of fraud or error in the :financial statements. From the planning stage and throughout
the performance of the audit procedures aimed at bringing the audit risk down to an
acceptably low level, the auditor should consider the risks of material misstatement in
the financial statements due to fraud. In obtaining an understanding of an entity's
financial status and environment, the auditor must consider whether the information
that he has gathered gives an indication of the existence of one or more fraud risks
factors. If in the course of his audit work the auditor identifies unusual or unexpected
relationships that could point to material misstatement due to fraud, he is required to
evaluate them. In order to obtain a reasonable degree of assurance that the financial
statements as a whole do not contain any material misstatement due to fraud or error,
the auditor must in any case apply his professional skepticism in considering the
possibility of management having overrided internal controls, and the auditor must
recognise the fact that audit procedures that are effective for detecting error may not
all be suitable in the ·. context of a flagged risk of material misstatement due to fraud.
Thus the auditor must not be satisfied with less-than-persuasive audit evidence based
on a belief that management and those charged with governance are honest and have
integrity.

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5.11

According to ISA 315 the auditor is required to obtain an understanding of the entity
and its environment, including the internal control structure, in order to detect and
assess any risks of material misstatement in the financial statements to be audited and
to plan and perform further audit procedures. ISA 315 prescribes literally that the
auditor must gain an understanding of all internal controls that are relevant to the
audit. Once any risks have been detected, the auditor must then, as part of his risk
assessment, establish which conditions or factors in the audit point to a risk of material
error.

5.12

ISA 330 concerns the auditor's responsibility for determining overall responses and
designing and performing further audit procedures to respond to the assessed risks of
material misstatement at the financial statement level as well as designing and
performing further audit procedures whose nature, timing and extent are based on and
are responsive to the assessed risks of material misstatement at the assertion level.
Furthermore, according to ISA 330 the auditor, irrespective of the assessed risks of
material misstatement,• inust perform substantive procedures for each material class of
transactions, account balance, and disclosure, including notes to the financial
statements. The auditor is also required to consider whether external confirmation
procedures are to be performed as substantive audit procedures. According to ISA 330
the higher the auditor's assessment of a risk, the more persuasive the audit information
obtained must be. To obtain more persuasive audit evidence, the auditor may increase
the quantity of the evidence, or obtain evidence that is more relevant or reliable, or
both. For example he may place more emphasis on obtaining evidence directly from
third parties, or on obtaining corroborating evidence from a number of independent
sources. Requesting external confirmations may also help the auditor to obtain audit
evidence with the degree of reliability that the auditor considers necessary in order to
be able to respond to significant risks of material misstatement due to fraud or error.
According to ISA 330. the audit documentation must show that there is sufficient
appropriate audit evidence forming a proper basis for the auditor's opinion as
expressed. If the auditor has not obtained sufficient appropriate audit evidence as to a
material financial statement assertion, he must attempt to obtain further audit
evidence. If the auditor is unable to obtain sufficient appropriate audit evidence, he
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should express a qualified opinion or a disclaimer of opinion on the financial
statements.

5.13

ISA 402 establishes guidelines for performing audits of companies that make use of
service organisations, and states that the auditor must at least establish the significance
of service organization activities to the entity and the relevance to the audit. If the
auditor concludes that these activities are significant to the entity and relevant to the
audit, he must obtain a sufficient understanding of the financial affairs and internal
controls of the service organisation to be able to identify and assess any risk of
material misstatement and design further audit procedures in order to respond to the
assessed risk. In so doing, the auditor may make use of any report by the auditor of the
service organisation. If the auditor makes use thereof, he must consider making
inquiries concerning the professional competence of the auditor of the service
organisation in the context of the specific assignment undertaken.

5.14

ISA 500 states that the auditor must obtain sufficient appropriate audit evidence to be
able to draw reasonable conclusions on which to base the audit opinion. ISA 500
requires the auditor,

i~;

auditing any particular process, to endeavour to obtain audit

evidence of different kinds and from different sources. As regards reliability, it says
that:
external documents such as third-party confirmations are more reliable than
internal confirmations;
audit evidence is more reliable when the administrative organisation and internal
management to which they are subjected are effective.
audit evidence obtained directly by the auditor is more reliable than information
obtained from the entity to be audited.
written records and communications are more reliable than information obtained
orally.

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V.3

Application of legal framework

5.15

From the information available to date on the financial statements, and the
confirmation that large-scale fraud was perpetrated (the assets of the audited Funds did
not exist), the Plaintiffs can only conclude that PwC failed in conducting its audits and
that PwC failed to comply with some of the most important ISA. PwC continues to
refuse to give access to its audit procedures, and confines itself to adopting a position
without backing it up with documents. PwC did not even make use of the disciplinary
proceedings to produce its audit files. By acting in this mysterious way, PwC leaves
crucial question marks hanging over whether it audited the Funds' financial statements
properly or not. More specifically, the Plaintiffs allege that, in its audits, PwC did not
exercise the required degree of professional care and fell short of its obligation to
conduct the audit with a degree of professional skepticism. Amongst other things,
PwC gave insufficient consideration to the possible existence of the circumstances that
in fact led to the financial statements of the Funds containing material misstatements
due to fraud.

(a) Insufficient understanding
1

5.16

I

PwC obtained insufficient understanding of the Funds and their environment,
including their internal control mechanisms, to be able to detect and assess the risks of
material misstatements in the financial statements as a result of error or fraud. Given
the importance of the service providers' activities, PwC also obtained inadequate
information regarding the financial status and internal control systems of the Funds'
service providers.

5.17

The essential roles performed by the Citco group were sufficiently known to PwC.
PwC wrongfully failed to obtain sufficient understanding of the financial
administration and internal control at Citco and was therefore not in a position to

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detect and evaluate the risk of material misstatement or to set up complementary audit
procedures to counter the assessed risk.

5.18

As explained above (see margin numbers 3.13 to 3.29 inclusive), the Citco entities
performed essential tasks and duties for the Funds, regarding inter alia the assets and
financial transactions of the Funds and information on same. Specifically the
following tasks and duties were involved:
(i) as custodian:

"Citco Custody ( ... ) shall be responsible to the Fund for the duration of
the sub-custody agreement for satisfying itself as to the ongoing
suitability of the sub-custodians to provide custodial services to the
Fund. Citco Custody will also maintain an appropriate level of
supervision over the sub-custodians and will make appropriate
inquiries periodically to confirm that the obligations of the subcustodians continue to be completely discharged." (Exhibit 1, p.15)
"Citco Bank ( .. .) shall be responsible to the Fund for the duration of the
sub-custody arrangement for satisfying itself as to the ongoing
suitability of the sub-custodian to provide custodial services to the
Fund. ,Ci~co Bank will maintain an appropriate level ofsupervision over
the sub-custodian(s) and make appropriate enquiries, periodically, to
confirm that the obligations of the sub-custodian(s) continue to be
competently discharged." (Exhibit 2, p.l6)

(ii) as administrator:

"reconciliation of cash and other balances at brokers";
"reconciliation of bank accounts";
"independent reconciliation ofthe Fund's portfolio holdings";
"calculation of the Net Asset Value and Net Asset Value per Share on a
monthly basis in accordance with the Fund Documents";
''preparation of monthly financial statements, in conformity with the
International Accounting Standards"
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''preparation of books and records (including specific schedules and
analysis) to facilitate external audit, and liaising with the Fund's
auditors in their review and preparation of the annual financial
statements"
"reconciliation of information provided by the Fund's prime broker and
custodian with information provided by the Investment Manager"
(Exhibits 14 and 15, p. 18 and 19)

In view of (i) the involvement of BMIS as sub-custodian in the whole structure of the
Funds, (ii) the combination of essential functions - manager, custodian and
broker/dealer- in BMIS, which placed the Funds under the influence and control of
BMIS and (iii) the position of BMIS as exclusive source of information regarding the
assets and transactions of the Funds, it was all the more important for PwC to check on
whether the abovementioned tasks .were being correctly performed by Citco, the more
so as this intervention of BMIS was considered as a risk:

"17. Possibility of Misappropriation of Assets. When FSL invests with Bernard L.
Madoff Investment Securities or in a Non-SSC Investment vehicle, it will not have
custody of the assets so invested. Therefore, there is always the risk that the personnel
of any entity with which the Fund invests could misappropriate the securities or funds
(or both) ofthe Fund." (Exhibit 1, p. 20)

5.19

Until at least 30 November 2005, PwC wrongfully failed to assess, or at least failed to
adequately assess, the internal control measures at Citco. Indeed, in the disciplinary
proceedings PwC did state that the internal control measures at Citco worked, but
produced no proof whatsoever of this allegation (exhibit 33, p. 10, margin number
3.5.). One of Citco's tasks for example was the external reconciliation of the
information that BMIS provided on the (trading) transactions carried out by BMIS for
the Funds. This task was expressly included in the list of services that CFS provided to
the Funds under the Administration Agreement. Since the only information available
regarding the trading or other activities of BMIS originated from BMIS, the external

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reconciliation by Citco was of crucial importance. In the absence of any evidence, the
Plaintiffs dispute PwC' s assessment of Citco.

5.20

On 30 November 2005 Ernst & Young supposedly issued an SAS 70 statement
showing that Citco had an adequate internal control system (exhibit 33, p. 51, margin
number 7.6.1.). An SAS 70 investigation looks into the internal management of
service organisations such as Citco. PwC has not communicated the SAS 70 statement
to the Plaintiffs. It is therefore unclear what Ernst & Young investigated and at which
Citco entities, what was the outcome of the investigation and whether Ernst & Young
made any observations or expressed any reservations. The question therefore also
arises as to which extent PwC was justified in relying on Ernst & Young's statement
from 2005 onwards. On top of this, even supposing that the SAS statement indeed
showed that Citco' s internal control system was adequate, PwC should have checked
that Citco was actually applying that system to the Funds, in view of the fact that
practically all other controls were with BMIS. After all, this statement gives no
information on how Citco performed its tasks and duties in the specific context of the
Funds. This SAS 70 statement was not issued with reference to the Funds. PwC should
therefore have carried out specific, tangible audits, in the context of the Funds, on
Citco' s performance of its tasks and duties as custodian, depository and administrator
of the Funds. PwC has neglected to do so.

5.21

PwC's defence that CBN and CGC were under the supervision ofDNB does not affect
this obligation (exhibit 33, p. 25, margin number 6.2.33.); DNB supervision does not
provide PwC with the required degree of understanding.

5.22

In the context of its audit procedures of the Funds, PwC failed to carry out an adequate
and appropriate investigation of BMIS. PwC knew that BMIS played an important role
in the Funds' financial affairs. PwC also knew that BMIS acted as sub-custodian for
the Funds. PwC knew too that this was described as a risk factor in the Funds'
documentation. More than 95% of the Funds' assets were consistently entrusted to
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BMIS, which also effectively managed these assets. The performance that BMIS had
recorded on these assets constituted practically the only source of revenue (i.e.
investment results) for the Funds.

5.23

In view of the close relationship between BMIS and the Funds, PwC should have
carried out further investigations into the activities of BMIS, in the context of
obtaining an understanding of the financial affairs and environment of the Funds. PwC
should in any case not have accepted unquestioningly that overviews of the assets on
the Funds' balance sheets - which was based on information coming directly and
exclusively from BMIS - were reliable, without making its own controls on whether
these assets actually existed - all the more so as PwC was well aware of the role and
structure of BMIS in the sense that it combined the functions of custodian and prime
broker/manager and the fact that this structure exposed the Funds' assets to risks of
fraud, loss and bankruptcy. Moreover, these risks were expressly referred to in the
Fund documentation. This remarkable and risky structure, given that not less than 95%
of the Funds' assets were entrusted to BMIS, in combination with the fact that
Madoff!BMIS refused to grant access and disclosure, put PwC under an obligation to
carry out closer investigations of BMIS/Madoff. This obligation follows from its close
relationship with the Funds as sub-custodian, manager and broker/dealer, and in any
case from its capacity as a service organisation.

5.24

PwC knew, or at least should have known, that neither Citco nor Fairfield could exert
any effective control over Madoff/BMIS (and that such control was therefore in effect
non-existent)

other ~,· than

by verifying information from parties other than

Madoff/BMIS (reconciliation with independent third parties). After all, approximately
95% of the Funds' US$7.2 billion of assets were entrusted to BMIS. Given that both
the custody and trading activities were entrusted to Madoff!BMIS and that as a result
complete control of the monies entrusted rested with Madoff/BMIS, PwC should have
paid extra attention to (i) the controlling functions that were present within the Funds
and (ii) the controlling functions that should have been present within the Funds.
Furthermore PwC should have paid extra attention to (iii) Madoff/BMIS in view of
this entity's crucial role for the Funds.
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:: .i

5.25

An investigation ofBMIS was therefore a necessary part of the process of determining

the necessary audit procedures to be applied to the Funds. Moreover, BMIS' financial
statements were audited by a single person, who as such was incapable of performing
a proper audit of the financial statements of BMIS, whose activities consisted in the
management and custody of funds worth several billion dollars. In view of this fact,
PwC should have made further enquiries and performed additional audit controls on
BMIS. The financial statements of BMIS were audited by a firm called Friehling &
Horowitz. Very few people worked at this office: apart from CPA David Friehling,
there was just an administrative assistant and the partly retired Horowitz. On 3
November 2009 Friehling pleaded guilty to a number of criminal charges relating to
BMIS. He admitted to practically rubber-stamping the financial statements of BMIS
over the course of man~ years. PwC should immediately have identified the fact that
BMIS effectively had its financial statements checked by a single person as a risk
factor. After all, one is entitled to expect a firm such as BMIS with assets of several
billion dollars under management and/or in custody to have its financial statements
audited by a firm having the capacity to perform annual audits for organisations of the
scale of BMIS.

5.26

'·

In this respect it is striking that PwC Toronto, in an audit plan for the audit of the
financial statements of 2008, saw the need to perform tests at BMIS (exhibit 38, p.
11):

Bernard L Madoff Investment Securities LLC

I Through discussion and enquiry with Bernard L.

I Madoff Investment Securities LLC, we will obtain an

I
control activities as
!understanding th6 keyand processes over the
relate to the operations
custodian, sub-custodian and prime broker

• custodian
- sub-custodian
- prime broker

of

they

' functions. We will perform transaction testing on the
Investment strategy applied by Bernard L. Madoff
Investment Securities LLC, for the applicable
Funds.

5.27

In the disciplinary proceedings, PWC stated that in view of the reputation of
BMIS/Madoff, made

i~

possible to dispense with tests on internal controls at BMIS

'

and checks on whether BMIS' auditor was equipped to perform audits on BMIS
practically alone,(exhibit 33, p. 36, margin number 6.2. 72). SEC oversight was also
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alleged as having rel~~ed PwC from complying with its obligation (exhibit 33, p. 41,
margin numbers 6.4.1 ). This defence cuts no ice. The supposed success of
BMIS/Madoff, their reputation and SEC oversight are not relevant to the performance
of an audit, and do not release PwC from the obligation to make further enquiries
about BMIS. After all, these circumstances do not provide PwC with the degree of
understanding of BMIS/Madoff and their internal control mechanisms required by the
ISA. It is therefore incomprehensible that PwC should have dispensed with the
obligatory audit procedures based on the aforementioned circumstances.

5.28

Nor did the visit by PricewaterhouseCoopers Bermuda ("PwC Bermuda") to
BMIS/Madoff in December 2004, as alleged in the disciplinary proceedings, provide
PwC with the required degree of understanding; indeed the purpose of this visit was
emphatically not to perform checks on BMIS (exhibit 34, p. 5, margin number 3.9). It
is not clear what

activ~ties

PwC Bermuda did carry out regarding BMIS on that visit,

nor is it clear whether it also visited BMIS before and/or after 2004. The question also
remains as to how much reliance PwC placed on the activities of PwC Bermuda. What
is clear is that PwC performed no testing at BMIS and therefore did not have
knowledge of all internal control mechanisms relevant to its audit procedures.
Fairfield

5.29

PwC also failed to assess the internal control system of Fairfield, which in view of
Fairfield's prominent role as investment manager, was required.

5.30

In the disciplinary proceedings, PwC sought to justify the omission by referring to an
Administrative Complaint filed by the Massachusetts Securities Division Enforcement
Section (exhibit 33i.,p., 9, margin number 3.3.2). The fact that in this Administrative
Complaint Fairfield represented that it 'carefully assess(es) the controls and
procedures that managers have in place and seek to determine actual compliance with
those procedures, often suggesting modifications, separation of responsibilities and
remedial service provider, technology, or staff additions", is not relevant. In any case

it does not constitute grounds for PwC to validly rely on Fairfield having a functioning

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internal control system as claimed, and therefore does not release PwC from its
obligation to assess Fairfield's control systems. Additionally, PwC did not verify
(

'

Fairfield's allegations, made in its marketing materials, that it performed exhaustive
due diligence.

5.31

Supervision of Fairfield by the FSC from 2006 on affords just as little excuse for the
omission (exhibit 33, p. 7, margin number 3.2.1). As said, such oversight does not
'' .

provide PwC with the required degree of understanding. Nor does Fairfield's
supposedly wide experience in investment activities have any effect on the scope of
the audit of the financial statements to be performed by PwC (exhibit 33, p. 49,
margin number 7.4.3).

(b)

5.32

Insufficient tests of controls

With regard to audit evidence, PwC performed insufficient tests of controls. Although
.'

.

audit evidence should in principle be obtained through a suitable combination of
system-based and substantive procedures, PwC opted for the substantive audit
approach, to which there is no objection per se, provided the information thus
obtained is sufficient to enable the auditor to reasonably draw conclusions on which to
base an opinion.

Pw~

jiid not obtain sufficient audit evidence on the adequacy of the

setting up or the effectiveness of the operations of the administrative organisation and
internal control of the Funds. These are aspects of audit evidence that can typically be
obtained by means of tests of controls. Such information would have enabled PwC to
obtain a sufficient understanding of the internal control mechanisms to be able to
establish an audit plan.

5.33

In the disciplinary proceedings, PwC put forward a number of arguments for opting

for the substantive approach (exhibit 33, p. 49, margin numbers 7.4.2 et seq.). None of
I.

•
i

these arguments implies that sufficient audit evidence was obtained showing that PwC
was justified in expressing its unqualified opinions. So PwC also placed unwarranted
faith in the arguments which it put forward:

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the structure of the Funds was anything but normal, in view of the construction in
which Citco acted as custodian and BMIS as sub-custodian, manager and prime
broker. The involvement of BMIS is even considered as a risk in the information
on the Funds;

.,

by performing no, or at least no sufficient tests of controls, PwC was unable to
confirm whether Sentry was actually professionally managed and whether the
Citco entities had effectively carried out the tasks and duties assigned to them
(supervision and investigation of the sub-custodian, reconciliation of information,
etc.);
the allegations made by Fairfield in its marketing materials that it performed due
diligence were not verified by PwC;
until the SAS 70 declaration of Ernst & Young, PwC was unable to assess the
control mechanisms at Citco, and it is also not clear whether and if so to what
extent PwC performed checks on Citco after the SAS 70 declaration was issued
(this declaration was after all never produced by PwC);
in the absence of an understanding of the operations of the control mechanisms of
the abovementioQed service organisations, PwC had not obtained sufficient
assurance to be able to confirm that information and statements obtained from
them did not contain any material misstatements. A purely substantive audit was
thus not sufficiently effective;
Fairfield's experience in investment activities has no effect on the scope of the
audit of the annual financial statements to be performed by PwC;
the same holds true for reputation and oversight; these circumstances are irrelevant
to the decision as to whether or not to perform tests of controls.

5.34

Because PwC obtained insufficient audit evidence, it did not reduce the risk of
material misstatement in the Funds' financial statements to an acceptable level.
Moreover, the information on which PwC relied in carrying out its audit assignment
was limited to information provided by broker/custodian BMIS, with no verification
at, or confirmation by, an independent third party, and as such this information was
insufficient and unreliable.

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5.35

In the context of the substantive audit, BMIS can hardly be regarded as an
independent third party, since practically all the money invested in the Funds were
passed on to BMIS; so there can be no question of an external confirmation from
BMIS in this context. Consequently the reliability of the information provided by
' '

BMIS is considerabiy limited. PwC should have taken account of this in its
assessment, rather than unquestioningly accepting the information provided by BMIS
as true. Here too PwC showed insufficient professional skepticism, wrongly failing to
perform any additional checks or to obtain external confirmations as required when, as
in this case, there is no segregation of crucial roles.

5.36

PwC did not follow the required procedures to obtain sufficient information so as to be
able to derive comfort from and fully rely on the declarations obtained from BMIS. It
is remarkable, and incomprehensible, that PwC should have drawn such comfort from
a visit by PwC Bermuda to BMIS as to decide that in auditing the Funds' financial
statements a substantive approach would suffice (exhibit 33, p. 33, margin number
6.2.63). IfPwC had actually used the knowledge gained by PwC Bermuda in assessing
the risks associated with the Funds, it would have reached the conclusion that for
I

auditing the Funds

a. substantive

approach would not suffice. A test of controls

approach at Funds level would have been the more obvious choice, in the context of
which PwC would have been able to acquire a greater understanding and could have
revealed the risks associated with BMIS to which the Funds were exposed. In any case
a single visit to BMIS does not suffice. Moreover PwC Bermuda stated explicitly in its
report of 15 March 2005 that the scope of its assignment with BMIS was extremely
limited: "the procedures performed are not directed to the providing of assurance in

respect of internal control, nor to the detection offraud, errors or illegal acts. The
procedures performed do not constitute an audit nor an investigation of the internal
controls of/at BLM." (Exhibit 39, p. 1)

5.37

As a result of its conduct, PwC obtained insufficient appropriate and independent
audit evidence regarding the existence of the investments and the assets of the Funds
that were entrusted to 'BMIS. PwC did not follow the necessary procedures to verify
the existence of assets and liabilities shown in the balance sheets and to check their
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value. It can absolutely not be assumed that the financial assets shown in the balance
sheets in the Funds' financial statements at closing date- mainly US Treasury billsactually existed or at least were actually in the Funds' possession. PwC wrongly
neglected to verify the existence and value of these assets, while the unqualified
opinions on the financial statements are largely based on PwC's erroneous assumption
that these assets existed or had existed. The same is true of the item 'investment
results' in the income statement. PwC obtained no satisfactory assurance that the US
Treasury bills were (i) actually acquired or (ii) registered in the name of the Funds.
The fact that the 'cost price' of the US Treasury bills in the Funds' financial
statements matches the information that PwC apparently requested from BMIS in the
context of its substantive audit is hardly surprising, considering that the Funds'
financial statements were drawn up from the same information as that which BMIS
supplied to the Funds. PwC was thus 'checking' information against identical
information, i.e. not checking anything at all.

5.38

PwC also neglected to carry out the necessary procedures to check the existence of the
transactions implementing the SSC Strategy (see margin number 3.30 of this
summons),

such

as

obtaining

confirmation

from

counterparties,

obtaining

confirmation of settled transactions or through the physical checking of collateral.
·;

5.39

In nevertheless issuing unqualified opinions on the fmancial statements, PwC failed to
comply with audit standards, and at the same time there was no proper basis for such
opinions.

5.40

Based on the foregoing we may conclude that PwC failed to comply with some of the
most important ISA. PwC thus fell short in its (legal) duties as auditor of the Funds by
failing to comply with regulations regarding the performance of its duties. Had PwC
acted as should be expected of a competent and reasonable auditor, it would not have
issued unqualified opinions.

5.41

The seriousness of the breach is thus established. If no such unqualified opinions had
been given, it would have been impossible for the Funds to attract or continue
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attracting investors' money - including that of the Plaintiffs - worldwide, and the
Plaintiffs would not have lost their investment. But since PwC wrongfully issued the
unqualified opinions, the Plaintiffs suffered losses. These losses were predictable in
the sense that it is predictable that investors will suffer losses as a result of financial
statements containing material misstatements and accompanied by wrongly
unqualified auditor's opinions. That predictability further derives from the importance
and significance ofPwC's role as auditor of the Funds. Please refer to margin numbers
3.37 to 3.45 inclusive of this summons.

VI.

IN THE INCIDENTAL CLAIM

VI.l

The demand under Article 843a of the Dutch Code of Civil Procedure

6.1

Without the documents referred to under margin number 6.13 hereunder, the Plaintiffs
cannot possibly determine the nature and scope of PwC's activities and services
relating to the audit of the Funds, nor therefore its tort and liability or the extent
thereof. The Plaintiffs therefore seek, pursuant to Article 843a of the Dutch Code of
Civil Procedure, production by PwC of the records specified hereunder. PwC is in
possession of these documents, whereas the Plaintiffs have an interest in their being
produced. They relate to a legal relationship between the parties.

(a)
6.2

Legitimate interest

The Plaintiffs have a legitimate interest in their claim. Such interest exists when there
is a legally substantive claim to the requested documents (Supreme Court 6 October
2006, JBPr 2007/6) or there is an interest with respect to evidence (preamble,

Parliamentary documents II 1999/2000, 26 855, no. 3, p. 188). There is a legitimate
interest now that the requested records serve to underpin the (not unfounded at first
sight) Plaintiffs'

demand for a declaratory judgment on PwC's liability for

misconduct. In this context it should be stated in advance that, as was considered by
the Supreme Court in its ruling of 13 October 2006 (LJN AW2080), the interests
served by a proper performance of the external auditor's task are not confined to those
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of the company which financial statements are involved. According to what is
generally accepted in society, third parties are entitled to expect that the information as
published, often mandatorily, and accompanied by an auditor's unqualified opinion,
provides a true and fair picture, in the auditor's independent and objective view, of the
assets, results, solvency and liquidity of the company and that the financial statements
will comply with the requirements of the law and of applicable regulations including
EU regulations and will conform to the relevant rules and standards generally accepted
in this profession. Thus the auditor's performance of his tasks also serves a vital public
interest. As regards the demand for a declaratory judgment based on tort, it is also the
case that PwC as auditor has obligations not just towards the audited entities (Sentry,
Sigma and Lambda, the Funds), but also towards third parties having dealings with the
company in question, such as investors, including the Plaintiffs, and if PwC fails in its
task it commits a tort against these third parties. The Plaintiffs refer in this context to
the ruling of the District Court of Amsterdam of 16 December 2010 (LJN: BP3071) in
which the District Court, referring to the aforementioned ruling of the Supreme Court
of 13 October 2006, found that there was a legitimate interest:

"4.6 (. .. )Since it is not disputed that neither JumboDiset nor Koninklijke Jumbo has
access to the documents which KPMG used in auditing the financial statements of
H&H, and KPMG also refuses to make its files available to BDO, this means that only
KPMG currently has any insight into how it performed its audit duties. It can readily
be assumed that KPMG is withholding the documents that are relevant to JumboDiset
in underpinning its claim - which does not appear manifestly unfounded - in view of
the considerations set forth in section 4.5 above, the guidelines and standards
mentioned by JumboDiset and the anomalies in the financial statements noted by
JumboDiset - and that in that sense JumboDiset has a legitimate interest in obtaining
those documents."

6.3

Meanwhile it has become evident that the Funds' financial statements do not give a
true and fair view of reality. The mere fact that PwC issued the auditor's reports with
the statement "in our opinion the financial statements give a true and fair view of the

financial position of the Company (. .. ) and of the results of its operations and its cash
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flows", and without any qualification, in itself constitutes an incorrect observation
resulting from a failure to comply properly with the ISA and US GAAS audit
standards. As previously set forth, the Plaintiffs are of the opinion that in performing
its audits PwC failed to comply with the ISA and the US GAAS. If irrefutable
evidence of this can be produced, then this will demonstrate that PwC acted in a
manner not consistent with the degree of care that an auditor is required to exercise
according to what is generally accepted in society in its dealings with third parties and
that PwC has thus committed a tort against the Plaintiffs and is consequently liable for
the damage suffered by the Plaintiffs. There can thus be absolutely no question of the
claim being manifestly unfounded.

6.4

The Plaintiffs also wish to investigate further when PwC's liability arose, what
specific rules PwC broke and what damage arose therefrom. For this, access to the
information on the performance of the audit procedures is necessary.

6.5

A legitimate interest exists when the requested records are relevant in establishing the
applicant party's legal position (see for example District Court of Utrecht 18 March
2009, LJN BH6556). Only in the light of the audit files can it be established whether

PwC acted as can be expected of a competent and reasonable auditor. Thus only by
allowing PwC's audit files to be examined can it be established whether the damage is
attributable to PwC.

6.6

The Plaintiffs' legitimate interest lies also in the fact that the information from the
audit files will help them to investigate further and, based on that investigation,
subsequently to prove that PwC did not perform its (legal) task properly and that it
therefore should not have issued the unqualified opinions. The requested documents
will show whether PwC considered possible risks of fraud (and, if so, which risks),
and whether and to what extent PwC gave attention to the (controlling) tasks of other
service providers to the Funds, particularly the Citco entities, and BMIS (to the extent
not considered as service provider to the Funds), what activities it performed, what its
findings were and how its opinion that the financial statements were free of material
misstatement can have been substantiated.
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6.7

As per the ruling of the District Court of Amsterdam of 27 March 2012 (LJN:
BW0075, r.o. 5.26), the purpose of these audit files is, inter alia, to be able
subsequently to render account of the procedures performed by the auditor. The audit
files will show how PwC dealt with the audits and what documents it requested from
or via the Funds or Citco, what instructions it gave and what questions it asked. They
will show on what documents PwC based its judgement that there was no need to
refrain from issuing a favourable opinion, what controls it carried out, what the
outcome of these controls was and whether it thereby complied with its (legal) duties.
The fraud is of a size such as to necessitate production of the entire audit
documentation. The various documents comprising an audit file need to be assessed as
a comprehensive whole.

6.8

For an investigation of this kind the Plaintiffs also need to have access to PwC's
internal documents relating to the audit. Insofar as internal documents provide no
insight into how the auditors performed their procedures, PwC will have to give a
description of the document and explain why that document cannot contribute to the
judgement to be formed by the Plaintiffs as to whether or not it properly performed its
task. It is after all only in such a case that there might not be a legitimate interest in the
production of a document. We refer to the ruling of the District Court of Amsterdam
of27 March 2012 (LJN: BW0075, r.o. 5.26):

"In principle the audit file must therefore be made fully available to the liquidators,
since part of the task of the liquidators (whether or not as representatives of the
creditors as a whole) is to investigate whether or not the auditor has fallen short in his
supervision and if so. to hold the auditor liable for the damage suffered. This means
that (copies of) internal documents that have not yet been made available to the
liquidators must also be produced, where necessary with explanatory notes. This can
be otherwise only insofar as there are internal documents in the audit file that provide
no insight into the way in which the auditors performed their procedures. In that case
KPMG will have to give a description of the document and explain why that document
cannot contribute to the judgement to be formed by the Plaintiffs as to whether or not
it properly performed its task. It is after all only in such a case that there might not be

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a legitimate interest in the production of a document. The liquidators can,

if they deem

the alleged reasons unsatisfactory, still demand production of those documents too,
giving reasons, possibly in new proceedings."

6.9

The Plaintiffs point out, albeit redundantly, that in answering the question as to
whether or not PwC was deficient in the performance of its duties, the role of Citco is
also relevant (we refer to margin numbers 3.13 to 3.29 inclusive of this summons).
Citco was responsible, in its capacity as custodian, for the legal and physical
safekeeping and custody of the monies and securities entrusted to it. The custodian
agreement(s) between the Funds and Citco may provide insight inter alia into the
contractual relationship between the Funds and Citco. Given their importance, these
custodian agreement(s) will also form part of PwC's audit files. The same is also
certainly true of the sub-custody agreement(s) between Citco and BMIS.

6.10

Also of relevant importance is the extent to which PwC was right in relying on the
SAS 70 statement issued by Ernst & Young (we refer to margin number 5.20 of this
summons). The Plaintiffs have no insight into the content of Ernst & Young's SAS 70
statement. The Plaintiffs can therefore not establish what Ernst & Young investigated
or what the outcome of their audit was, or whether they expressed any reservations.
The SAS 70 statement will also be included in PwC's audit files.

6.11

Furthermore the Plaintiffs are also unable to establish how the discussion between
Citco and PwC went (in which discussion an SAS 70 specialist was involved on the
part of PwC) regarding the internal control mechanisms at Citco and the SAS 70
statement, since the Plaintiffs have no access to any report or documentation forming
the basis of, or resulting from, this discussion. These documents too will be included
in the audit files.

6.12

The Plaintiffs therefore have a right to and an interest in gaining access to the
complete audit files, including the internal documents, so that they can be indemnified
for loss suffered as a result of wrongful deeds (tort) committed by PwC.

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(b)

6.13

Specified records

The records which the Plaintiffs are demanding to be produced concern the complete
audit files, including the internal documents of PwC relating to Sentry, Sigma and
Lambda for the years 2000-2007.

6.14

For financial years 2000 and 2001 the financial statements were audited by
PricewaterhouseCoopers

N.V.

and

for

financial

years

2002-2005

by

PricewaterhouseCoopers Accountants N.V. For financial years 2006 and 2007 PwC
Canada was the auditor. Under their demand in this incidental claim, the Plaintiffs
request from each of the aforementioned PwC group firms the audit files compiled by
them.
6.15

The Plaintiffs wish to define and improve their legal position with regard to PwC. It
can be readily assumed that for an optimal conduct of such a search for evidence it is
important for the Plaintiffs to gain access to the complete audit files, including the
internal documents for the aforementioned years. Another factor is that only PwC
holds the records that were used in the audit. For the Plaintiffs it is thus impossible to
indicate the records more specifically. The Plaintiffs can therefore not reasonably be
asked to further specify the records than they have already done. In demanding the
complete audit files for 2000-2007 the Plaintiffs have also sufficiently specified which
records PwC are being asked to produce. The Plaintiffs refer to the ruling of the
District Court of Amsterdam of 16 December 2011 (LJN: BP3071, r.o. 4.7):
"An additional factor is that, as already previously considered, KPMG is at present
the only party with access to the records that were used in the audit. For JumboDiset
it is therefore impossible to indicate the records more specifically. JumboDiset can
therefore not reasonq.bfy be asked to provide any other identification of the records
than it has already done. In demanding the complete audit files for 2005-2006 and
2006 JumboDiset has also sufficiently specified for KPMG which records they are
being asked to produce to BDO."

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6.16

In

accordance

with Article

11

section 3 of the

Bta (Bes/uit toezicht

accountantsorganisaties or Decree on the supervision of audit firms, hereinafter
"Bta") at least the following data and records (written or digital) must be kept in the
audit files:
the agreement between the audit finn and the client and any amendments thereto;
the correspondence relating to the client, insofar as it concerns the legal audit;
an audit plan establishing the envisaged scope and conduct of the legal audit;
a description ofthe :nature and scope of the audit activities performed;
the start- and end-dates for the performance of the various stages of audit
procedures specified in the audit plan;
the main findings of the audit procedures performed;
the conclusions drawn from the findings as referred to in sub-section f;
the external auditor's opinion as reflected in the auditor's report to be issued by
him;
the data established pursuant to Articles 12, section 3, Article 13, section 2, 15a,
sections 1, 3 and S~ 17, section 2, 20, section 3, and 37, section 2 of the Bta; and
such other significant data and records as are relevant to substantiate the auditor's
report issued by the external auditor and to the supervision of compliance with the
rules established by the law and the Wet op de Registeraccountants (Registered
Auditors Act) and/or the Wet op de Accountants-Administratieconsulenten
(Certified Accountants Act).

6.17

If the demand for production is not allowed, there is a significant chance that, despite
the information currently available which justifies the objective suspicion that PwC
did not act as might be expected of a competent and reasonable auditor, the Plaintiffs
will not be able to prove this, since it is not presently clear on which documents PwC
based its judgement that there was no need to refrain from issuing an unqualified
opinion, or what audit procedures it performed and what their outcome was, and
whether in so doing it complied with its (legal) duties. There is therefore a risk that,
without the aforementioned documents being produced, the Plaintiffs will be unable to
meet the burden of proof that PwC did not perform its task properly and that it should

..
'

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not have issued unqualified opinions. On top of this PwC still refuses to provide this
information voluntarily.

(c)

Regarding the legal relationship
., .
~

6.18

The requested documents concern a legal relationship between the parties. The legal
relationship between the parties is based on tort, and the records which production is
sought by the Plaintiffs are directly connected with this. The Plaintiffs need the
requested records in order to be able to determine the extent of the tort and hence of
the liability.

(d)
6.19

No compelling reasons

PwC does not qualify as being subject to confidentiality within the meaning of Article
843a section 3 of the Dutch Code of Civil Procedure. Furthermore the files concerned
were in principle compiled for the benefit of Sentry, Sigma and Lambda. The question
is therefore whether in the present case the Funds' interests as regards confidentiality
would be harmed by

the release of the requested records (District Court of Amsterdam

27 March 2012, LJN BW0075). Now that the aforementioned Funds are in liquidation,
and no activity whatsoever is any longer carried out apart from the liquidation itself,
their interests as regards confidentiality can no longer be harmed, and one cannot see
what compelling reasons on the part of the Funds could stand in the way of production
of the requested records. PwC can therefore not avoid this obligation to produce by
reference to an alleged obligation of confidentiality. Furthermore Article 38 section 1
sub-section c of the Bta allows PwC to produce confidential information in the context
of judicial proceedings brought against it concerning a legal audit. Accordingly, the
Wta is also no obstacle to production.

6.20

The Supreme Court ruled that the right to refuse to answer questions does not apply to
auditors (Supreme Court 14 June 1985, NJ 1986/175). According to the Supreme
I{

.

Court, the interests of establishing the truth outweigh everyone's interest in having the
right to hire freely such an adviser. Applying this balance of interests in the context of
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Article 843a of the Dutch Code of Civil Procedure, this means that the interest of
being able to hire an auditor freely and without fear of disclosure provides no
substantial reason. The public interest- and thus the application of Article 843a of the
Dutch Code of Civil Procedure -must prevail.

6.21

To the extent that PwC's internal documents also contain confidential information on
'1 ":'

•

PwC (or its working rtiethods) and the risk would exist that this information will be
made public, this risk can be covered by having PwC explicitly state in these
proceedings which specific documents contain sensitive corporate information on its
working methods which must be kept confidential (District Court of Amsterdam 27
March 2012, LJN BW0075, r.o. 5.23). The District Court can thus judge whether such
documents qualify as sensitive corporate information. In this way it can be avoided
that the Plaintiffs disclose what, according to PwC, needs rightfully to be kept
confidential.

(e)
6.22

Necessary for proper administration ofjustice

From the point of view of proper administration of justice, production of the requested
records is indispensai?.le, because proof cannot be obtained in any other way, given that
only PwC has access t6 the records.

(f)

The obligation to produce also applies to main legal proceedings outside the
Netherlands

6.23

The Supreme Court ruled on 8 June 2012 (LJN BV8510) that a claim for production of
records under Article 843a of the Dutch Code of Civil Procedure may be brought
either in current pending case or in a separate case. In the latter case there is no
requirement for proceedings to be pending or envisaged concerning the legal
relationship in which respect the production of records is being sought, nor that such
proceedings will be launched in the Netherlands. That means that the alleged lack of
jurisdiction of the District Court of Amsterdam with regard to the Plaintiff's claims

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against PwC Canada does not stand in the way of the Plaintiffs' claim against PwC
Canada for the production of records.

VII.

DEFENCES RAISED BY PWC AGAINST THE DEMAND AND THE
CORRESPONDING GROUNDS

7.1

The defences adduced by PwC and the rebuttal thereof follow sufficiently from the
foregoing.

VIII. EVIDENCE OFFERED

8.1

The Plaintiffs' allegations are supported by the aforementioned exhibits 1 up to 40.

8.2

To the extent necessary, Plaintiffs propose, while explicitly denying being obliged to,
evidence of all their allegations, including through the hearing of witnesses, who can
make statements based on their own knowledge.

8.3

May be heard as witnesses, among others:
the partners of PwC who have signed the audit opinions, including Mr. H.F.M.
Gertsen R.A.;
the other partners -or associates of PwC who have taken part m the audit
assignments with respect to the Funds;
the persons within the organisations of CBN, CGC and/or CFS who were in
contact with PwC within the framework of their audit assignments.

IX.

JURISDICTION OF THE DISTRICT COURT OF AMSTERDAM

9.1

The District Court of Amsterdam has jurisdiction by virtue of Article 99 of the Dutch
Code of Civil Procedure to hear the Plaintiffs' claims against PwC Nederland, as set
forth herein, since PwC Ne<;lerland is established within the district covered by the
District Court of Amsterdam. ·
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9.2

The jurisdiction of the District Court of Amsterdam with regard to the Plaintiffs'
claims against PwC Canada follows from Article 7 of the Dutch Code of Civil
Procedure, since that there is such a clause connection between the claims against
PwC Nederland and those against PwC Canada that for reasons of efficiency a
common handling of the claims is justified. After all, the claims are based on the same
facts and circumstances and th~ legal questions to be addressed are also the same. The
close relationship implies also that a proper administration of justice calls for the
simultaneous consideration and judgement of the claims, in order to avoid the
''

possibility of irreconcilable rulings being made in the case of separate judgements.

X.

INDICATION REAPPEARANCE

10.1

The Plaintiffs consider the case appropriate for an informational appearance and/or an
appearance of the parties to reach a settlement.

NOW THEREFORE
IN THE INCIDENTAL CLAIM

May it please the District Court of Amsterdam in its ruling on the incidental demand,
immediately enforceable,

I.

To order PricewaterhouseCoopers N.V. to deliver within seven business days of this
ruling on the incidental claim being served and on the Plaintiffs' first demand, copies
of the complete audit files, including the internal documents, relating to the financial
statements of Sentry, Sigma and Lambda for the years 2000 and 2001, on pain of
payment of a penalty of €50,000 for each day, or part of a day, during which
defendant sub I fails totally or partly to comply with such order;
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II.

To order PricewaterhouseCoopers Accountants N.V. to deliver within seven business
days of this ruling on the incidental claim being served and on the Plaintiffs' first
demand, copies of the complete audit files, including the internal documents, relating
to the financial statements of Sentry, Sigma and Lambda for the years 2002, 2003,
2004 and 2005, on pain of payment of a penalty of €50,000 for each day, or part of a
day, during which defendant sub II fails totally or partly to comply with such order;

III.

To order PricewaterhouseCoopers LLP Chartered Accountants to deliver within seven
business days of this ruling on the incidental claim being served and on the Plaintiffs'
first demand, copies of the complete audit files, including the internal documents,
relating to the fmancial statements of Sentry, Sigma and Lambda for the years 2006
and 2007, on pain of payment of a penalty of €50,000 for each day, or part of a day,
during which defendant sub III fails totally or partly to comply with such order;

IV.

To order PwC jointly and severally, meaning that if the one pays the other is being
discharged, to pay the costs of the proceedings, as well as legal costs incurred in the
amount of€131.00 and in the event that notice of the ruling has to be served, €199.00,
to be paid within fourteen days of the signing of the ruling on the incidental claim,
and, if it is not paid within this established time, plus interest thereon at the legal rate
from fourteen days after the date of signing of the ruling on the incidental claim until
such time as payment shall have been made in full.
(

!

IN THE MAIN CLAIM

May it please the District Court of Amsterdam in its ruling, immediately enforceable in
anticipation,

I.

to declare that PwC acted wrongfully vis-a-vis the Plaintiffs by negligently carrying
out their duties as auditors;

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II.

To order PwC jointly and sevemlly, meaning that if the one pays the other is being
discharged, or each for an equal part, or each for such part as the District Court shall
establish in accordance with the law, to pay to Colima the amount of the losses
suffered by Colima, plus interest thereon at the legal rate from the day on which
Colima invested in Sentry, or from the day of the summons, until such time as
payment shall have been made in full;

III.

To order PwC joint and sevemlly, meaning that if the one pays the other is being
discharged, or each for an equal part, or each for such part as the District Court shall
establish in accordance with the law, to pay the Foundation for collection the amount
of the losses suffered by investors, or at least the losses suffered by the Participants,
plus interest thereon at the legal rate from the day of investment in the Funds, or from
the day of the summons, until such time as payment shall have been made in full;

IV.

To order PwC joint and sevemlly, meaning that if the one pays the other is being
discharged, to pay the costs of the proceedings, as well as legal costs incurred in the
amount of€131.00 and in the event that notice of the ruling has to be served, €199.00,
to be paid within fourteen days of the signing of the ruling on the incidental case, and,
if it is not paid within this established time, plus interest thereon at the legal rate from
fourteen days after the date of signing of the ruling on the incidental case until such
time as payment shall have been made in full.

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.

\

LIST EXHIBITS
COLIMA INTERNATIONAL LIMITED- STICHTING FAIRFIELD
COMPENSATION FOUNDATION

vs

PRICEWATERHOUSECOOPERS

1.
2.
3.
4.
5.
6.
7.

Private Placement Memorandum Fairfield Sentry Limited dated 1 October 2004
Private Placement Memorandum Fairfield Sentry Limited dated 14 Augustus 2006
Articles of Association Colima International Limited
Articles of Association Stichting Fairfield Compensation Foundation
Participation Agreement Stichting Fairfield Compensation Foundation
Structure of the Fairfield Fondsen
Investment Management Agreement between Fairfield and Sentry dated 1 October
2004
8. Investment Management Agreement between Fairfield and Sigma dated 1 October
2004
.. ; ~
9. Brokerage & Custody Agreement dated 1 September 2003 between Citco Bank
Nederland, Citco Global Custody and Fairfield Sentry Ltd
10. Brokerage & Custody Agreement dated 12 augustus 2003 between Citco Bank
Nederland, Citco Global Custody and Fairfield Sigma Ltd
11. Custodian Agreement dated 3 juli 2006 between Citco Bank Nederland, Citco Global
Custody and Fairfield Sentry Ltd
12. Private Placement Memorandum Fairfield Sigma Limited dated 1 October 2004
13. Private Placement Memorandum Fairfield Sigma Limited dated 1 December 2008
14. Administration Agreement dated 20 February 2003 between Citco Fund Services and
Fairfield Sentry Ltd
15. Administration Agreement dated 20 februari 2003 between Citco Fund Services and
Fairfield Sigma Ltd
16. Sub-custody Agreement of 2004 between Citco Global Custody and Bernard L.
Madofflnvestment Securities LLC (not signed)
17. Annual Account of Fairfield Sentry Ltd financial year 2000
18. Annual Account of Fairfield Sentry Ltd financial year 2001
19. Annual Account of Fairfield Sentry Ltd financial year 2002
20. Annual Account of Fairfield Sentry Ltd fmancial year 2003
21. Annual Account of Fairfield Sentry Ltd fmancial year 2004
22. Annual Account of Fairfield Sentry Ltd financial year 2005
23. Annual Account of Fairfield Sentry Ltd financial year 2006
24. Annual Account of Fairfield Sentry Ltd financial year 2007
25. Annual Account of Fairfield Sigma Ltd financial year 2003
26. Annual Account of Fairfield Sigma Ltd financial year 2004
27. Annual Account of Fairfield Sigma Ltd financial year 2005
28. Annual Account of Fairfield Sigma Ltd financial year 2006
29. Annual Account of Fairfield Sigma Ltd financial year 2007
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30. Statement ofKenneth.~s, liquidator of the Fairfield Fondsen dated 14 June 2010
31. Document of PriceWaterhouseCoopers - Auditing Alternative Investment Funds of
April2007
32. "Klaagschrift" dated 3 januari 2011 against Mr. Gertsen including exhibits
33. "Verweerschrift" of Mr. Gertsen dated 23 March2011 including exhibits
34. "Conclusie van repliek" of complainants dated 28 April 2011 including exhibits
35. "Conclusie van dupliek" ofMr. Gertsen dated 27 May 2011 including exhibits
36. "Pleitnotities" of complainants dated 1 July 2011
37. "Pleitnotities" of Mr. Gertsen dated 1 July 2011
38. Audit Plan drawn up by PwC with regard to the financing year ending 31 december
2008
39. Letter ofPriceWaterhouseCoopers Accountants N.V. dated 15 March 2005 toFairfield
Greenwich Advisors, L.L.C.
40. Report KPMG dated 8 September 2008 - Extracts

-0-0-0-0-0-0-0-0-0-

This case Is being handled by:

P.J. Soede
CMS Derks Star Busmann
Postbus 85250
NL-3508 AG Utrecht
Tel. [phone]
Fax [phone]
E-mail: [e-mail] .

72