In 1982, in the case of Cenco Inc, v. Seidman & Seidman, 686 F.2d 449 (7th Cir. 1982), the Seventh Circuit Court of Appeals held that the "imputation doctrine" should prohibit all shareholder lawsuits against auditors who were allegedly negligent in performing their auditing duties for a corporate client, where fraud resulted in losses to the shareholders. This case was decided under Illinois law and sought to protect outside auditors against fraud committed by the client, even though a more thorough examination may have disclosed the fraud or at least certain improprieties. This same issue of auditor liability was last addressed in New Jersey in 1990 in the Appellate Division case of In re Integrity Trust, 240 N.J. Super. 480 (App. Div. 1990) where the Court ruled that an outside auditor could be held liable in a fraud case where the auditor actually helped in the fraud.
The New Jersey Supreme Court was recently faced with a similar issue in the case of NCP Litigation Trust v. KPMG, LLC., A-19 September Term 2004, decided June 28, 2006. In the NCP case, the New Jersey Supreme Court held that auditor responsibility was not limited to only auditors who actively participated in the corporate fraud. The Court found that independent auditors can be held liable for a corporate client’s fraud, even if they did not participate in or have direct knowledge of the misconduct. The New Jersey Supreme Court expressly declined to follow the Illinois decision in Cenco Inc. stating that Cenco was decided more than 20 years before and that "events since then suggest that auditors must be more alert to corporate fraud and, where appropriate, courts should take steps to protect and safeguard the public from that fraud". The New Jersey Supreme Court indicated that it was writing "…under a clean slate in addressing the issue under New Jersey law. "
The NCP case involved a fraud committed by the chief financial officer and chief executive officer who provided the auditor with fake numbers to artificially inflate the company’s stock value and thereby bolster the CFO’s financial stake in the business. The company eventually filed bankruptcy and it’s shareholders sued the auditor for malpractice claiming that the auditors knew or should have known of the CFO-CEO’s fraudulent activities.
The auditor defended the suit on the basis of the "imputation doctrine", which generally protects third parties from suits involving corporate wrongdoers. The Court held that the auditor may have had an independent contractual obligation to detect the fraud, which it allegedly failed to do. The "imputation doctrine" was designed to protect the innocent and the Court found that relieving the auditor of liability would not promote the purpose of the doctrine.
Justices Jaynee laVecchia and Roberto-Soto wrote dissenting opinions stating that the "imputation doctrine" should apply, especially because the auditors in this case were not aware of and did not participate in the creation of fraudulent financial data.