Although I cannot pretend to know for certain what policy reason motivated the majority of the Supreme Court in their decision in Hercules Management, I believe the decision can be amply supported on a policy of avoiding the imposition of unintended, unknown, and unnecessary liability-and also maintaining caveat emptor.
Consider the implications of Hercules, if the court had decided to impose a liability on Ernst & Young. In so doing, the court would have imposed a duty upon people who create purpose-driven audits to consider and respond to the uses to which the audit’s audience might put it beyond the use for which the audit had been requested. This would create a large level of indeterminacy of liability on auditors, in that despite their best efforts, it will likely not be commercially possible for any auditor to fully canvas and consider the range of possible uses some particular shareholder might put the audit to. Relatedly then, the cost of preparing audits will rise, possibly drastically, because the increased liability will mean either that auditors will demand (justifiably, in view of the risk they assume) more money for audit preparation, or auditors will begin to buy expansive litigation insurance, which will increase their costs-and thus result in an indirect increase of costs to consumers.
In deciding that an auditor’s liability is limited by the specified purpose of the auditing work for which they have been contracted, the court in Hercules avoids the above scenario. Additionally, the decision of Hercules has the policy benefit of making shareholders maintain their personal liability for their own investment decisions, and not (by assigning liability for personal investment loss to the auditors of corporations) force corporations which are the subjects of investment bear the cost of insuring investment quality. In short, Hercules ensures that individual investors remain subject to caveat emptor vis a vie their investments, while allowing for the corporations they invest in to benefit from the proper management that those shareholders are supposed to be exercising by fully informing them of the corporation’s financial situation by periodic auditing.
I’d be interested to hear what other people think-am I being too dire in the potential consequences of finding personal shareholder liability on Ernst & Young? Do people think corporations should bear the brunt of the cost of providing shareholders comparative investment advice? Lemme know
Nice post Noah. I agree that shareholders should maintain personal liability for their own investment decisions. Presumably, E&Y was hired to prepare audits for NGH and NGA in order to satisfy regulatory requirements. If shareholders wanted to have the ability to sue the auditor, they should have commissioned their own audits (if that’s possible? I don’t know.). Shareholders should not be able to sue E&Y, as they were wearing the wrong hat!