## Facts

- InterFirst Corporation issued notes in 1982, maturing in 1989.
- In 1986, InterFirst pursued a merger with RepublicBank Corporation; Arthur Young & Co. (later Ernst & Young, L.L.P.) audited RepublicBank’s financial statements for merger-related purposes.
- Ernst & Young’s audit report stated RepublicBank’s financial statements fairly presented its financial condition and complied with applicable accounting standards; the report appeared in public filings and merger materials.
- After the merger, Pacific Mutual Life Insurance Company bought some of the 1982 InterFirst notes on the open market in 1987.
- Pacific alleged it relied in part on Ernst & Young’s audit report and that the report materially misstated RepublicBank’s financial condition.
- The merged entity later suffered severe financial distress and filed for bankruptcy, rendering the notes nearly worthless.
- Pacific sued Ernst & Young for fraudulent misrepresentation and related claims premised on the same alleged fraud.

## Issues

1. Whether Texas fraud’s intent-to-induce-reliance element is satisfied when an auditor merely could foresee that public investors might rely on an audit report, or instead requires that the auditor had reason to expect reliance by a particular person or limited class in a substantially similar transaction.
2. Whether Pacific raised a fact issue that Ernst & Young had reason to expect Pacific (or a limited class including Pacific) would rely on the merger audit report when purchasing InterFirst notes in a later secondary-market transaction.

## Decision

- The Texas Supreme Court reversed the court of appeals and rendered judgment that Pacific take nothing.
- The court held that Texas fraud law is consistent with a Restatement (Second) of Torts § 531 “reason to expect” approach and does not require strict privity.
- Applying that approach, the court concluded Ernst & Young negated intent to induce reliance as a matter of law because it had no reason to expect Pacific’s reliance in the transaction at issue.
- Pacific’s evidence (industry-practice expert affidavits and the audit’s presence in SEC filings) showed only general foreseeability, not the required “especial likelihood” that a particular person or limited group would rely in a similar transaction.
- Because the remaining claims were premised on the same alleged fraudulent misrepresentation, they failed with the fraud claim.

## Legal Principles

- Texas fraudulent misrepresentation requires proof that the defendant intended the plaintiff to rely on the statement or had reason to expect the plaintiff would rely on it.
- A “reason to expect” standard permits liability to some non-clients, but it requires more than generalized foreseeability that the public might read and rely on the statement.
- The defendant must have information indicating an especial likelihood that a particular person or a limited group will receive and rely on the representation in the same or a substantially similar transaction.
- An audit report prepared for a specific transactional purpose (such as a merger) does not, without more, establish intent to induce reliance by remote investors in later secondary-market purchases of outstanding securities.
- The mere inclusion of an audit report in public regulatory filings does not alone establish the requisite intent-to-induce reliance for all later market transactions.

## Conclusion

The court limited fraud-based auditor liability to cases where the auditor had reason to expect reliance by a particular person or a limited, specifically contemplated group in a substantially similar transaction, and held that generalized market reliance on public filings was insufficient to defeat summary judgment.


Ernst & Young, L.L.P. v. Pac. Mut. Life Ins. Co., 51 S.W.3d 573 (Tex. 2001)