## Facts

- AUSA Life Insurance Company and other institutional insurers purchased long-term notes issued by JWP, Inc. through private placements from 1988 to 1992, investing about $149 million.
- Ernst & Young (E&Y) served as JWP’s independent outside auditor from 1985 through the 1992 audit period and issued audit opinions and certifications used in JWP’s annual reports and financial statements.
- The note purchase arrangements required JWP to provide GAAP-compliant audited financial statements and required auditor communications addressing covenant compliance.
- AUSA alleged JWP’s management manipulated financial statements to overstate earnings and net worth and to present a false picture of financial strength.
- AUSA alleged E&Y’s audits and certifications were materially false and not in accordance with GAAP, and that E&Y either participated in the fraud, deliberately concealed it, or acted recklessly in failing to disclose it.
- JWP’s 1991 acquisition of Businessland, Inc. was unsuccessful; JWP entered involuntary bankruptcy in December 1993.
- AUSA alleged it lost roughly $100 million due to reliance on the audited financial statements and related auditor certifications in purchasing and holding the notes.

## Issues

1. Whether AUSA produced sufficient evidence of loss causation (proximate cause), as distinct from transaction causation, to survive summary judgment on its § 10(b) and Rule 10b-5 claims against an outside auditor.
2. Whether AUSA raised triable issues of reliance and causation under New York common-law fraud and negligent misrepresentation based on alleged GAAP-deficient audit opinions and certifications.
3. Whether intervening business events, including the failed Businessland acquisition and later bankruptcy, necessarily broke the causal chain or limited recoverable damages as a matter of law.

## Decision

- The Second Circuit reversed the grant of summary judgment for E&Y in substantial part and remanded for further proceedings.
- The court held that the district court erred in concluding, as a matter of law, that AUSA failed to show loss causation on the federal securities claims.
- The court held that AUSA also raised triable issues on reliance and causation for New York fraud and negligent misrepresentation claims, subject to limits narrowing the scope of recoverable losses to those fairly traceable to the alleged misstatements.
- The court rejected the view that the failed acquisition and ensuing bankruptcy automatically severed causation; a factfinder could conclude the alleged audit-related misstatements concealed financial weaknesses and risks that later materialized.

## Legal Principles

- Securities fraud under § 10(b) and Rule 10b-5 requires both transaction causation (the misstatement induced the transaction) and loss causation (the misstatement proximately caused the economic loss).
- Loss causation may be shown where the alleged misrepresentation or omission concealed the company’s true financial condition or risk profile and the later loss resulted when the concealed weaknesses materialized; it is not required that the defendant separately misrepresent the specific triggering event.
- On summary judgment, evidence that audited financial statements and auditor certifications were required by contract and were actually relied upon by investors can create a jury question on materiality and reliance.
- Under New York law, fraud requires a material misrepresentation, scienter at least amounting to recklessness, justifiable reliance, and causation; negligent misrepresentation requires, at minimum, negligence plus reliance and causation.
- Even where liability questions proceed to trial, damages may be limited to losses fairly attributable to the alleged misstatements rather than to unrelated business declines or other non-attributable causes.

## Conclusion

The Second Circuit held that institutional investors alleging that an outside auditor’s GAAP-deficient audit opinions and certifications misstated an issuer’s financial condition presented triable issues of reliance and loss causation under Rule 10b-5 and New York law, and that later business failures did not automatically defeat proximate cause as a matter of law.


AUSA Life Ins. Co. v. Ernst & Young, 206 F.3d 202 (2d Cir. 2000)