Robert R. Bily v. Arthur Young & Company

834 P.2d 745 (1992)

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Nature of the Case

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Facts

Osborne Computer Corporation manufactured the first portable personal computer for the mass market. In just one short year, sales of the company's sole product, the Osborne I computer, had reached $10 million per month, making the company one of the fastest growing enterprises in the history of American business. The company began planning for an early 1983 initial public offering of its stock, engaging three investment banking firms as underwriters. That was postponed because of uncertainties caused by the company's employment of a new chief executive officer and its plans to introduce a new computer to replace the Osborne I. In order to obtain 'bridge' financing needed to meet the company's capital requirements until the offering, the company issued warrants to investors in exchange for direct loans or letters of credit to secure bank loans to the company. The warrants entitled their holders to purchase blocks of the company's stock at favorable prices that were expected to yield a sizable profit if and when the public offering took place. Ps were the investors who included individuals as well as pension and venture capital investment funds. One plaintiff, P, who was also a director of the company, purchased 37,500 shares of stock from company founder Adam Osborne for $1.5 million. The company retained D to perform audits and issue audit reports on its 1981 and 1982 financial statements. D issued unqualified or 'clean' audit opinions on the company's 1981 and 1982 financial statements. D stated that the statements had been prepared in accordance with 'Generally Accepted Accounting Principles' (GAAP); and the statements 'present[ed] fairly' the company's financial position. The 1981 financial statement showed a net operating loss of approximately $1 million on sales of $6 million. The 1982 financial statements included a 'Consolidated Statement of Operations' which revealed a modest net operating profit of $69,000 on sales of more than $68 million. As the warrant transaction closed on April 8, 1983, the company's financial performance began to falter. Sales declined sharply because of manufacturing problems with the company's new 'Executive' model computer. When the Executive appeared on the market, sales of the Osborne I naturally decreased but were not being replaced because Executive units could not be produced fast enough. In June 1983, the IBM personal computer and IBM- compatible software became major factors in the small computer market, further damaging the company's sales. The public offering never materialized. The company filed for bankruptcy on September 13, 1983. P ultimately lost their investments. (Now a little bit of time for the truth related to these facts. This author used to sell semiconductors to Osborne and knew many of the key players, personally and even warned them outright of their problems related to obtaining all the parts they needed to make their new computer. Those morons decided to announce the new computer before it was ready for the market or before they could handle the demand and to get all the parts they needed to make the new computer. They needed sole source semiconductor chips that just were not available at that time in the quantities they wanted them. As such, the sales of the computer they could make went to zero extremely fast because everyone wanted the new one which was much better than the Osborne I. That faux paus was a classic and extremely idiotic marketing screw-up. They did it for the hype of an upcoming computer show and their public offering. D, for the most part, had nothing to do with the failure of the company nor were any of D’s failures responsible for any wrongly made investment decisions). Ps in search of anyone with deep pockets sued D for its failings. P's expert witness, William J. Baedecker, reviewed the 1982 audit and offered a critique identifying more than 40 deficiencies in D's performance amounting, in Baedecker's view, to gross professional negligence. D did not perform its examination in accordance with GAAP. He found the liabilities on the company's financial statements to have been understated by approximately $3 million. As a result, the company's supposed $69,000 operating profit was, in his view, a loss of more than $3 million. He also determined that Arthur Young had discovered material weaknesses in the company's accounting controls, but failed to report its discovery to management. At the close of the evidence, the jury received instructions and special verdict questions including three theories of recovery: fraud, negligent misrepresentation, and professional negligence. The fraud instructions required proof of an intentional misrepresentation made by D 'with intent to defraud the plaintiff or a particular class of persons to which plaintiff belonged.' Similarly, the negligent misrepresentation instructions required a negligent misrepresentation made 'with the intent to induce plaintiff or a particular class of persons to which plaintiff belongs to rely on it.' The negligence instructions stated in part that an independent auditor has a duty to have the degree of skill and learning possessed by reputable, certified public accountants in the same community and to use 'reasonable diligence and its best judgment in the exercise of its professional skill.' D got the verdict on intentional fraud and negligent misrepresentation. P got the verdict on professional negligence. The jury awarded compensatory damages of approximately $4.3 million, representing approximately 75 percent of each investment made by P. The Court of Appeal affirmed.