In re Herald, Primeo and Thema Funds Securities Litigation

Filing 336

REPLY to Response to Motion re: #252 JOINT MOTION to Dismiss. Reply Declaration of Marc A. Weinstein in Further Support of the Ernst & Young Defendant's Motion to Dismiss the Complaints and in Opposition to Plaintiffs' Motion for Leave to Amend the Complaints. Document filed by Ernst & Young (Cayman). (Attachments: #1 Exhibit A)(Weinstein, Marc)

Exhibit A

UNITED STATES DISTRICT COURT
SOUTHERN DISTRICT OF NEW YORK
In Re HERALD, PRIMEO and THEMA
FUNDS SECURITIES LITIGATION

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Civil Action No. 09 CIV 289 (RMG) (HBP)
(Consolidated with 09 CIV 2032 and
09 CIV 2558)

REPLY DECLARATION OF GRAHAM FRASER RITCHIE QC
I, Graham Fraser Ritchie QC, of Charles Adams Ritchie & Duckworth, attorneys-at-law, Zephyr
House, Mary Street, Grand Cayman, Cayman Islands, declare, under penalty of perjury under the
laws of the United States of America that the foregoing is true and correct:-

FIRST DECLARATION

1.

I am the same Graham Fraser Ritchie QC that deposed the First Declaration dated 29 1h
June 2011 ("First Declaration").

2.

For the purposes of this Reply Declaration, I will adopt the definitions and abbreviations
contained in my First Declaration.

PURPOSE OF THIS REPLY DECLARATION
3.

I have been requested by Hughes Hubbard & Reed LLP to respond to the opinions given
by Thomas Lowe QC ("Mr. Lowe") in his affidavit filed in support of the Plaintiffs'
memorandum of law in opposition to the Defendants' joint motion to dismiss made on
30lh September 2011 (the "Lowe Affidavit") on whether or not EY Cayman owed a duty
of care to the Plaintiffs in respect of its audit reports. This is primarily dealt with by Mr.
Lowe at paragraphs 61 to 70 of the Lowe Affidavit.

4.

Whilst I do not agree with Mr. Lowe's opinions on reflective loss and on the other causes
of action under Cayman law as set out in the Lowe Affidavit to the extent that they take
issue with the opinions expressed by Mr. William James Tyre Bagnall ("Mr. Bagnall") in
his Declaration dated 29 1h June 2011, I am instructed by Hughes Hubbard & Reed LLP
that since Mr. Bagnall will deal with this opinion evidence in his reply declaration I am
not required to do so. However, the absence on my part of any commentary should not

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be taken as acceptance by me of any of the differing opinions given by Mr. Lowe on
such matters.
5.

In addition to the documents referred to in my First Declaration and the Lowe Affidavit, I
have also reviewed the following documents:(i)

Declaration of Mark Phillips QC dated 28 'h June 2011; and

(ii)

Declaration of Joseph Serino Jr. dated 29 'h June 2011; and

(iii)

Memorandum of Law in Support of Defendants' Joint Motion to Dismiss and in
Opposition to Plaintiffs' Motion for Leave to Amend Complaints dated 29 'h June
201l.

SUMMARY OF KEY POINTS IN REPLY TO THE LOWE AFFIDAVIT
6.

At paragraph 68 of the Lowe Affidavit, Mr. Lowe accepts that a duty of care is not in
general owed by auditors to shareholders who receive a company's annual accounts to
which audit reports are attached.

7.

Mr. Lowe seeks to distinguish the Plaintiffs' claim against EY Cayman from Caparo on
the basis that the audited accounts were prepared in Caparo for a statutory purpose. In
my opinion Caparo turned on what the House of Lords found to be the purpose of the
statutory requirement for the audited accounts rather than the existence of the statute.

8.

The facts pleaded in the Consolidated Complaints are similar to the facts of Caparo.
Both concerned claims brought by shareholders against auditors for losses allegedly
sustained by reason of the dissemination of an audit report provided to the shareholders
as a body.

9.

Mr. Lowe does not refer to any authority for shareholders being owed a duty of care by a
company's auditors.

10.

The Consolidated Complaints appear to acknowledge that to establish that a duty of
care was owed by EY Cayman to the Plaintiffs a "special relationship" must be shown
to exist as they attempt, in my opinion without success, to plead that a "special

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relationship" existed between the Plaintiffs and EY Cayman.! However, the only factor

relied on in support of the "special relationship" is the fact that the Funds (not the
auditors) were obliged to circulate the audited accounts to all shareholders in
compliance with the provisions of the Amended Primeo Articles, the Primeo OM, the
Herald Articles and the Herald OM. In my opinion, as a matter of Cayman law, this is
insufficient to establish an owed duty of care by the auditors to the shareholders.
11.

In circumstances where:
(il

it is acknowledged that a duty of care is not in general owed by auditors to
shareholders who receive a company's annual audited accounts; and

(ij)

there is nothing pleaded in the Consolidated Complaints that would in my
opinion be sufficient to demonstrate that a "special relationship" existed
between the Plaintiffs and EY Cayman to displace this general rule;

I remain of the view that a Cayman court would likely find that the Plaintiffs are unable
to establish a sufficient proximity of relationship between themselves and EY Cayman to
give rise to a duty of care for both the reasons set forth below and in my First
Declaration.

I deal with the specific matters raised by Mr. Lowe in support of his

opinions below.

CASE LAW CITED BY MR. LOWE DOES NOT SHOW THAT AUDITORS OWE A DUTY OF CARE
1=0 SHAREHOLDERS
12.

Mr. Lowe has relied primarily on three cases to try to show that an auditor owes a duty
of care to the shareholders of a company who receive the company's audited accounts.
For the reasons set out below none of these cases turn on facts which are similar to the
facts in this case, and none support his proposition that such a duty is owed.

13.

Mr. Lowe at paragraph 63 refers to Customs and Excise Commissioners v Barc/ays
Bank pic which considered two of the tests for a duty of care: (j) the "assumption of
responsibility" test and (ij) the three-pronged test in Caparo namely, foreseeability,

proximity and whether it is fair, just and reasonable.

According to Mr. Lowe, Lord

1 Paragraphs 260 and 268 of the Proposed Primeo Complaint, Counts 8 and 9 respectively; and paragraphs 713 and
721 of the Proposed Herald Complaint, Counts 10 and 11 respectively.

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Hoffmann in that case said that these "labels or slogans" do not assist. With all due
respect to Mr. Lowe that does not give an accurate description of what Lord Hoffmann
had to say about those tests in his judgment. At paragraph 35 he had this to say:"There is a tendency, which has been remarked upon by many judges, for phrases like
"proximate", "fair, just and reasonable" and "assumption of responsibility" to be used
as slogans rather than practical guides to whether a duty should exist or not. These
phrases are often illuminating but discrimination is needed to identify the factual
situations in which they provide useful guidance."

14.

The Barclays Bank case raised a novel question of law on facts which were entirely
different to the facts in this case; namely whether a bank having been served with a
freezing injunction granted to a third party against one of the bank's customers owes a
duty to the third party to take reasonable care to comply with the terms of the
injunction. The court at first instance decided that no such duty was owed following a
trial of a preliminary issue and that decision was overturned by the Court of Appeal.
Barclays Bank then appealed that decision to the House of Lords. So it was against the
background of a novel situation that the Learned Law Lords were considering the
applicability of the two tests described above.

15.

The House of Lords overturned the decision of the Court of Appeal and the
commissioners' claim against the bank was dismissed. The House of Lords held that
having been served with the injunction the bank was obliged to comply with its terms
and would be exposed to the risk of punishment for contempt if it did not do so. In the
circumstances, the bank had not voluntarily assumed responsibility for its actions so as
to give rise to a duty of care to the commissioners; its duty was to the court to comply
with the terms of the injunction.

The House of Lords in its holding concluded, inter

alia, that it would not be "fair, just and reasonable" to recognise a duty of care to the

third party in those circumstances.

In the result the commissioners had failed to

establish the third limb of the three-pronged test.

As Lord Bingham observed at

paragraph 15 of the judgment:"It is common ground that the foreseeability element of the threefold test is satisfied
here. The bank obviously appreciated that, since risk of dissipation has to be shown to
obtain a freezing injunction, the commissioners were liable to suffer loss if the
injunction were not given effect. It was not contended otherwise. The concept of
proximity in the context of pure economic loss is notoriously elusive. But it seems to
me that the parties were proximate only in the sense that one served a court order on
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the other and that other appreciated the risk of loss to the first party if it was not
obeyed. I think it is the third policy, ingredient of the three-fold test which must be
determinative. "
16.

The Lord Justices found the "assumption of responsibility" test to be of little assistance
and thus went on to consider the three-fold test in Caparo. As Lord Walker observed at
paragraph 74:-

"In this case the appellant bank has not, in any meaningful sense, made a voluntary
assumption of responsibility. It has by the freezing order had responsibility thrust
upon it. But in any case it is not proximity that is the respondents' problem in this
case. The duty of care for which the respondents contended successfully in the Court
of Appeal, and which they seek to maintain in this House, is not a duty leading to
"liability in an indeterminate amount for an indeterminate time to an indeterminate
class" (in the very well-known words of Cardozo CJ in Ultramares Corpn v Touche
(1931) 174 NE 441, 444). It would be a liability in a known maximum sum (in
respect of a precisely identified account), for a brief period, to a single known body
corporate. The respondents' problem is whether it is fair, just and reasonable to
impose on a bank a novel and substantial liability (on top of its potential liability for
contempt of court) if it carelessly fails to comply with a freezing order."

17.

It will be seen from the foregoing that the House of Lords applied the Caparo test in
reaching its decision that there was no duty of care owed by the bank to the
commissioners.

18.

At paragraph 63 Mr. Lowe infers that the three-fold test in Caparo provides little more
than a series of labels which do not assist.

general framework"

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I disagree; they provide a "convenient

against which a plaintiff's pleaded case can be analysed to

establish whether or not a duty of care is owed in respect of negligence. Indeed Smellie
C.J in Re Omni Securities, a case upon which Mr. Lowe seeks to rely and which
approved and followed Caparo, stated:

"In my view, this is an issue which can only go to the liability in tort, i.e. whether in
tort the applicants may be liable for economic loss due to the negligent misstatements
given to the plaintiff as the known recipient of the audit report for the specific purpose
of reliance upon it for the management of its affairs and upon which the plaintiff in
fact relied to its detriment. That is the tripartite test - knowledge, reliance, detrimentlaid down by the House of Lords in Caparo Indus. PLC v. Dickman (6) in delineating
the circumstances under which liability may be incurred by accountants or auditors to
third parties in respect of negligence, especially that arising from the performance of
the audit function. It is a delineation which narrows the scope of liability to third
parties (which was first defined in Hedley Byrne & Co. Ltd v. Heller & Partners Ltd.

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per Lord Bingham in Barc/ays Bank at paragraph 93

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(11)) by the requirement of proof of knowledge on the part of the auditor that his
report will be received and relied upon by the third party, as distinct from the mere
foreseeability that it might be so used." 3 (emphasis added)
He went on to state:'
"I intend to be guided by the test as laid down in Caparo Indus. PLC v. Dickman as
providing the definitive modern test in the context of an auditors' negligence claim .... "
19.

In Re Omni Securities the plaintiff company in liquidation brought proceedings against
its auditors DH&S (Zurich) and one of its affiliated firms DH&S (Cayman) and partners
in DH&S (Cayman) for damages for breach of contract and negligent misstatement.
DH&S (Cayman) and the partners in that firm made an application to strike out the
proceedings which was dismissed by the court. The court found that on the basis of the
pleaded facts it could not be shown that there was no reasonable prospect of success at
trial. The facts in the Re Omni Securities case can be distinguished from the claims in
the Consolidated Complaints here because the claims in Re Omni Securities were made
by the company in liquidation through its liquidators -

not by the company's

shareholders - and the facts pleaded were sufficient in Omni Securities for there to be
an arguable case in support of there being a sufficient proximity of relationship between
the company and the defendants to arguably give rise to a duty of care.

It is also

important to note that in this case Smellie CJ when considering the potential liability of
the defendants in tort, was able to identify the specific recipient of the audit report (i.e.
the company) and a "specific purpose" for which the audit report had been provided to
the company.
20.

The Court of Appeal decision in Coulthard v Neville Russell (a firm) [1998] BCC 359
("Coulthard") which is also relied on in the Lowe Affidavit at paragraph 66 also turns on
very different facts to the case pleaded by the Plaintiffs in their Consolidated
Complaints.

21.

In the Coulthard case the directors of a company, which went into liquidation, brought a
claim against the company's auditors for damages for negligence in failing to advise
them properly in relation to the treatment of certain monies as a loan which was found
to be in breach of section 151 of the Companies Act 1985 and which rendered the loan

31998 CILR 275 @ pg 6
4 1998 CILR 275 @pg 7

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illegal and unenforceable. The auditors sought an order striking out the claim against
them. The application was dismissed at first instance and the auditors appealed. The
statement of claim set out specific details of the advice which had been given by the
auditors to the directors including details of meetings which took place and their dates
and details of allegations that on three separate occasions discussions took place
between the directors and the auditors regarding the loan. Chadwick U stated: 5

"It would save in exceptional circumstances, be unwise for the directors of a company
to approve a balance sheet in a form which gave the auditors concern; so that the
auditors would find themselves unable to express the opinion that the balance sheet,
in that form, showed a true and fair view of the state of the affairs of the financial
year. A fortiori, if that balance sheet was to be used to demonstrate solvency in some
regulatory context. It is for this reason that discussions between directors and auditors
as to the proper treatment in the balance sheet of any item likely to be controversial
will, almost invariably, take place before the accounts were approved and the audit
report signed. "
22.

Whilst of course each case must turn on its own facts, it is unsurprising in light of the
directors' pleaded case that the Court of Appeal was not persuaded that the directors'
claim was bound to fail. In the Coulthard case the auditors dealt with the directors in
respect of a known specific transaction, whereas in this case no such specific contact is
alleged.

Indeed, the only allegation Mr. Lowe makes is at paragraph 70 of the Lowe

Affidavit where he makes reference to a document described as an Information
Memoranda, which refer to valuations of the Funds and which contained "statements
that the auditors had consented to the inclusion of their name and report in the
Information Memoranda".

However, this allegation is unsupported by any documents

exhibited by the Plaintiffs to their Consolidated Complaints or evidenced by any factual
allegations made by the Plaintiffs in the Consolidated Complaints.
23.

In my opinion the facts pleaded in the Consolidated Complaints do not establish any
"special relationship" such as to give rise to a duty of care owed by EY Cayman to the
Plaintiffs. As stated in my First Declaration, a "special factor" or "extra ingredient" is
required to establish that EY Cayman and the Plaintiffs had such a special relationship.

24.

Mr. Lowe does not agree that a "special factor" or an "extra ingredient" is required (see
paragraph 64 of the Lowe Affidavit) to establish a duty of care owed by company

5

[1998] 1 BCLC 143 @pg 7

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auditors to shareholders who receive the annual accounts to which audit reports are
attached; but he must accept that there has to be something extra present (however you
may wish to describe it) in order to displace the general rule that no such duty is owed
although he does not state what that extra factor is. The "special factor" or "extra
ingredient" is a reference to the presence of those facts and circumstances required to
be able to show that a proximate relationship existed so as to create a special
relationship between the auditor and the third party, in this case shareholders, which is
one of the criteria which must be proven to establish that a duty of care is owed by EY
Cayman to the Plaintiffs."
25.

The English courts identified that there are essentially three tests which may be
considered in establishing whether a duty of care is owed to a third party. Those three
tests were all considered in Caparo and the House of Lords determined that the threefold test -foreseeability, proximity and fairness justice and reasonableness -was the most
appropriate given the facts and circumstances of the case. The first of those tests is, as
the Lowe Affidavit states (at paragraph 65) the "assumption of responsibility" test
where the question is asked did the defendant voluntarily assurne a responsibility for
what he said or did to the plaintiff. In Caparo, the facts of which are similar to the facts
here, the House of Lords concluded that in the context of an auditor owing a duty of
care to a third party, the three-fold test was the most appropriate test.'

26.

The third test is the incremental test which was referred to by Lord Bridge in Caparo at
page 618D where he referred to the judgment of Brennan J in the High Court of
Australia in the case of Sutherland Shire Council v Heyman 8 where he stated that;
"The law should develop novel categories of negligence incrementally and by analogy
with established categories, rather than by a massive extension of a prima facie duty
of care restrained only by indefinable 'considerations which ought to negative, or
reduce or limit the scope of the duty or the class of person to whom it is owed"'.
So if there is a sufficient compelling analogy with a previously decided case, the
incremental test will be a useful starting point. Prior to Caparo the incremental test was
of no assistance when considering whether an auditor owes a duty of care to

" See in particular paragraph 14 of my First Declaration
'See Lord Roskill's judgment [1990] 2 A.C. 505@ 528G
B (1985) 50 A.L.R. 1,43-44
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shareholders who receive their audited accounts as there were no cases which had
considered this issue.

However, following Caparo, in cases like this which present

similar facts, the incremental test can be applied.
27.

With the exception of the fact that Caparo involved the preparation of audited accounts
in compliance with a statutory provision, the facts of Caparo are similar to the facts set
out in the Plaintiffs' Consolidated Complaints.

Both concerned claims brought by

shareholders against auditors for losses allegedly sustained

by reason of the

dissernination of an audit report provided to the shareholders as a body. The Lowe
Affidavit seeks to distinguish the Plaintiffs' claim against EY Cayman from Caparo on the
basis that the obligation of the company to disseminate the audited accounts in Caparo
was derived from a statute, whereas here, the obligation derives from the Funds'
governing documents. In my opinion Caparo turned on what the House of Lords found
to be the purpose of the statutory requirement for the audited accounts.

In the

judgment of Lord Oliver' he stated:"In my judgment, accordingly, the purpose for which the auditors' certificate is made
and published is that of providing those entitled to receive the report with information
to enable them to exercise in conjunction those powers which their respective
proprietary interests confer upon them and not for the purposes of individual
speculation with a view to profit. Same considerations as limit the existence of a duty
of care also, in my judgment, limit the scope of that duty and I agree with O'Connor U
that the duty of care is one owed to the shareholders as a body and not to individual
shareholders.
To widen the scope of the duty to include loss caused to an individual by reliance upon
the accounts for a purpose for which they were not supplied and were not intended
would be to extend it beyond the limits which are so far deducible from the decisions
of this House."
28.

As stated in my First Declaration, the basis upon which the Funds were obliged to
provide the Plaintiffs with the audited accounts was that both the Amended Primeo
Articles and the Herald Articles contain similar provisions, which provide that the
auditors shall if so required by the directors, make a report on the accounts of the
company at the next annual general meeting following their appointment in the case of
the company registered as an ordinary company and at the next extraordinary general
meeting in the case of a company which is an exempt company and at any time during

9

[1990] 2 A.C. 605 at page 6548
9

their term of office upon the request of the directors at any general meeting of the
members.]O The Offering Memoranda for both Funds also provide that in each year the
directors will cause to be prepared an annual report and audited accounts for the Funds
which the Funds are to send to shareholders within a specified period of time after each
financial year.
29.

In these circumstances it is apparent that the purpose for which the Funds' audited
accounts were prepared was not for any particular transaction or transactions of a
particular kind under contemplation by any particular shareholder.

In my opinion, the

position is analogous to the purpose of the statutory requirement for which the audited
accounts were prepared in Caparo, namely to provide information regarding the financial
affairs of the Funds to enable the general population of shareholders to undertake the
informed exercise of those powers which their respective proprietary interest conferred
upon them in the articles for both Funds." In this context, it is worth noting that the
Canadian case of Hercules Managements Ltd v Ernst & Young relied on by Mr. Lowe at
paragraph 33 of the Lowe Affidavit recognised the need to establish that the audited
report had been provided to the shareholders for a "specified purpose" before a duty of
care will arise. La Forest J stated:-

"The facts of Haig, supra, provide the basis for an example of where such a claim
might arise. Had the investors in that case been shareholders of the corporation, and
had a similarly negligent report knowingly been provided to them by the auditors for a
specified purpose, a duty of care separate and distinct from any duty owed to the
audited corporation would have arisen in their favour... " (emphasis added).
In this case it is not alleged by the Plaintiffs that EY Cayman knew that the audited
accounts would be provided to any specific shareholders for a specific purpose or
transaction.

30.

Accordingly, if one were to apply the incremental test here a compelling analogy can be
drawn between this case and Caparo, such that in my view a Cayman court would be
likely to conclude that no duty of care is owed by EY Cayman to the Plaintiffs.

See paragraphs 20- 22 inclusive of my First Declaration.
]] See paragraphs 25 to 28 of my First Declaration.

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31.

For the reasons set out in my First Declaration and above I remain of the opinion that
the Consolidated Complaints do not establish that EY Cayman owed a duty of care to
the Plaintiffs in respect of any losses which they may have suffered as a result of any
transactions they may have entered into in purported reliance upon the audited accounts
which were delivered by the Funds to the general body of shareholders.

Dated this 28 th day of October 2011

ER RITCHIE Q.C.

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