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NCP Litigation Trust v. KPMG LLP

June 28, 2006

NCP LITIGATION TRUST, PLAINTIFF-RESPONDENT,
v.
KPMG LLP, DEFENDANT-APPELLANT.



On certification to the Superior Court, Appellate Division.

SYLLABUS BY THE COURT

(This syllabus is not part of the opinion of the Court. It has been prepared by the Office of the Clerk for the convenience of the reader. It has been neither reviewed nor approved by the Supreme Court. Please note that, in the interests of brevity, portions of any opinion may not have been summarized).

In this appeal, the Court must determine whether the imputation doctrine, which holds that knowledge of an agent is generally attributable to its principal, bars the suit of a litigation trust, acting as a corporation's successor and representing the corporation's shareholders, against the corporation's auditor for negligently failing to discover the intentional misrepresentation by corporate officers of details concerning the corporation's financial status.

Physician Computer Network (PCN) retained defendant KPMG LLP (KPMG) as its independent auditor from mid-1993 to mid-1998. John Mortell and Thomas Wraback, officers of PCN who were KPMG's primary contacts, had orchestrated a series of fraudulent transactions to inflate PCN's reported revenues and reduce its reported expenses. They intentionally misrepresented PCN's financial status to KPMG, which KPMG did not detect for several years.

In April 1996, PCN filed its annual report with the Securities and Exchange Commission (SEC) for the 1995 fiscal year, reporting a 104% increase in revenues over 1994 and a 584% increase over 1993. The 1995 financial statements were accompanied by an audit opinion by KPMG, which stated that KPMG had conducted its audit "in accordance with generally accepted auditing standards" (GAAS), requiring them "to obtain reasonable assurance about whether the financial statements are free of material misstatement" and examine, "on a test basis, evidence supporting the amounts and disclosures in the financial statements." The opinion stated that PCN's financial statements "present fairly, in all material respects, the financial position" of PCN as of December 31, 1995 and the results of its operations and cash flows for 1993, 1994 and 1995 "in conformity with generally accepted accounting principles" (GAAP). In two registrations statement filings with the SEC, PCN included its 1995 audited financial statements and KPMG's audit report. In 1997, PCN filed its annual report for 1996 with the SEC, which included its audited financial statements and an unqualified audit opinion by KPMG stating that its audit was conducted in accordance with GAAS and GAAP. The financial statements reported revenues for PCN that had more than doubled the revenues reported for 1995. Throughout 1997, PCN continued to report increased revenues and income as compared to corresponding periods in 1996.

Beginning with its audit for the 1997 fiscal year, KPMG discovered and reported to PCN several accounting irregularities in prior financial statements. PCN appointed a Special Committee of its Board to investigate. Upon discovering the officers' fraud, PCN was forced to acknowledge previously unreported losses of tens of millions of dollars and restate previous financial results. KPMG withdrew its audit opinions for 1994, 1995 and 1996. PCN ultimately declared bankruptcy and its assets were acquired by Medical Manager Corporation.

Thereafter, a consolidated class action in federal court against PCN was settled for $21,150,000 on behalf of persons who acquired PCN common stock from February 1996 to April 1998. The same group later settled claims against Mortell and Wraback. In 2001, a shareholder class filed suit against KPMG in federal court alleging securities fraud violations in connection with the 1995 and 1996 audits. The court granted KPMG's motion to dismiss the plaintiffs' claims, finding that they had failed to state a claim. Later, six former officers and managers of PCN, including Mortell and Wraback, settled an SEC suit charging them with accounting fraud.

In the present case, NCP Litigation Trust (the "Trust"), acting as PCN's successor-in-interest and representing PCN's shareholders, filed suit against KPMG alleging that KPMG committed negligence, negligent misrepresentation, breach of contract, and breach of fiduciary duty. The Trust asserts that KPMG failed to perform its audits in conformity with GAAS and GAAP, the professional guidelines that auditors must adhere to while conducting an audit. According to the Trust, PCN's 1995 financial records, which KPMG certified, were in such disarray that the successor auditor could not reconstitute them. The Trust also alleged that KPMG failed to verify PCN's receipt and deposit of a $3.5 million check that was part of a fraudulent asset purchase arranged by Mortell and Wraback. According to the Trust, a simple examination of PCN's bank records would have revealed that this amount was never deposited. KPMG also allegedly allowed for the improper reversal of an approximate $1.8 million liability, thereby offsetting an increase in PCN's accounts receivable reserve, even though KPMG allegedly knew that the reversal of that obligation "was not supported by GAAP." The complaint further alleges that KPMG failed to discover PCN's improper recognition of income on its software maintenance agreements, which resulted in PCN reporting nearly $1.5 million in revenue in 1996 that was not actually earned until 1997. The Trust also maintains that KPMG violated GAAS by failing to require PCN to accrue liabilities of approximately $1.5 million in vacation and bonus pay expenses. Finally, the complaint asserts that individual audit team members were distracted and deficient in the performance of their duties.

The trial court granted KPMG's motion to dismiss based on the imputation doctrine. The court concluded that the officers' fraud was imputable to the Trust and that the Trust cannot sue KPMG unless KPMG "materially participated" in the fraud. The trial court found no record evidence such fault of KPMG sufficient to overcome the rule of imputation.

In an unreported decision, the Appellate Division reversed in part, concluding that the imputation defense was not available to KPMG because the Trust's complaint, fairly read, alleges that KPMG committed equitable fraud independent of any legal fraud committed by PCN's officers.

The Supreme Court granted certification. 181 N.J. 286 (2004). The Court also granted amicus curiae status to the American Institute of Certified Public Accountants and to the New Jersey Society of Certified Public Accountants.

HELD: The imputation doctrine does not bar corporate shareholders who were not engaged in or aware of the wrongdoing of corporate agents from recovering through a litigation trust against an auditor who was negligent within the scope of its engagement by failing to uncover or report the fraud of corporate officers and directors.

1. On a R. 4:6-2(e) motion to dismiss, the trial court should assume that the opposing party's allegations are true and give that party the benefit of all reasonable inferences. That liberal standard has particular relevance in imputation cases because deciding whether to permit an auditor to use the defense requires a detailed factual analysis. (pp. 14-16)

2. A principal is deemed to know the facts known to its agent. The purpose of that doctrine (that the principal has "constructive" notice or knowledge of, or is "imputed" with, the agent's knowledge) is to protect innocent third parties from suits by corporations whose agents have engaged in malfeasant behavior against those third parties. (pp. 16-18)

3. The rationale for imputation begins to break down in the context of a corporate audit where the allocation of risk and liability among principals, agents, and third parties becomes more complicated. In this case, if the misconduct of PCN's officers is imputed to PCN, PCN as their principal can be said to have committed the fraud, and the wrongdoing may be imputed to the Trust, as PCN's successor-in-interest, who then would be estopped from suing the allegedly negligent third-party auditor, KPMG. Because it is difficult to justify absolving negligent corporate auditors, courts have struggled to determine what circumstances permit an auditor to invoke the imputation defense. (pp. 18-19)

4. The parties' arguments require the Court to consider whether this State's jurisprudence permits the Trust to maintain an action for negligence. Application of the imputation doctrine is a matter of state law. In the only New Jersey decision to address the issue, In re Integrity Insurance Company, the auditor allegedly actively participated in the fraud of the company's directors and officers, thus enabling managerial misconduct to bankrupt the company. The Appellate Division in Integrity held that the "doctrine of constructive notice to the principal is not available to one who contributed to the misconduct sought to be imputed." The panel reasoned that the auditor should not be able to avoid responsibility for its own misdeeds, if established, because imputation "is invocable to protect the innocent, never to promote an injustice." The Supreme Court rejects the assertion that only an auditor who actively participated in the corporate fraud can bebarred from raising the imputation defense. The court in Integrity was careful not to establish "active participation" as the standard, but instead stated that the defense is not available "to one who contributed to the misconduct." (pp. 19-23)

5. This matter does not present the typical circumstance for which the imputation defense was designed. PCN's agents allegedly defrauded the corporation and its creditors; KPMG is not a victim of the fraud in need of protection. Further, KPMG had an independent contractual obligation to detect the fraud, which it allegedly failed to do. Allowing KPMG to avoid liability for its allegedly negligent conduct would not promote the purpose of the imputation doctrine. (pp. 24-25)

6. The federal court decision in Cenco, Inc. v. Seidman & Seidman (Seventh Circuit Court of Appeals) is the seminal case on the issue of who may bring a claim for negligence against an auditor. Applying Illinois law, the Cenco court held that allegedly negligent auditors could invoke imputation as a defense to bar a shareholder suit when corporate management committed fraud that benefited the corporation. The court looked to tort law principles designed to compensate the victims of wrongdoing and deter future wrongdoing, and determined that allowing the corporation to recover would provide compensation to the culpable corporate officers who owned stock, and would reduce shareholders' incentives to hire honest managers and monitor their behavior. Concluding that management's fraudulent acts benefited the company (the stockholders were beneficiaries, not victims, of the fraud), the court barred the corporation's suit against the auditor. Later, the same court in Schacht v. Brown, distinguished Cenco and reached a different result. In Schacht, the bankruptcy liquidator sued the auditor for negligently failing to discover the fraud of the corporation's officers and directors which led to its insolvency. The court rejected the argument that the fraud benefited the corporation because of the damage allegedly inflicted by the diminution of its assets and income. Further, any recovery would benefit the corporation's creditors and policyholders who were innocent parties; the wrongdoing officers would not benefit. Other jurisdictions have distinguished Cenco and not applied the imputation defense in cases where recovery against allegedly negligent third parties would inure to the benefit of creditors of the insolvent corporation. Those courts have reasoned that allowing creditors to recover against a negligent auditor would serve the objectives of tort liability. (pp. 26-32).

7. The Court declines to hold that the imputation defense should prohibit all shareholder lawsuits against allegedly negligent auditors. It is unfair to allow the impropriety of some shareholders to bar all from recovery. However, imputation may be asserted against shareholders who engaged in the fraud or who, by way of their role in the company, should have been aware of the fraud. Application of New Jersey's comparative negligence standard will ensure that an auditor is liable only for as much of a plaintiff's losses as are directly attributable and proportionate to the auditor's negligence. Further, any alleged benefit to the corporation would be a factor in apportioning damages. (pp. 32-40).

8. KPMG's liability must be defined by the scope of the engagement it entered into with PCN. Any negligence suit against KPMG must be based on the scope of the parties' contractual agreements and understandings to determine whether KPMG violated any duty. In this case, the issues to be resolved are whether KPMG was negligent in performing its agreed duties and to what extent such negligence proximately contributed to the damages suffered by plaintiff. In so providing, the Court effectuates the parties' agreement. (pp. 40-44).

9. In conclusion, when an auditor is negligent within the scope of its engagement, the imputation doctrine does not prevent corporate shareholders who are innocent of corporate wrongdoing from seeking to recover. The complaint in this matter presents a colorable claim that KPMG, by negligently failing to discover inaccuracies in PCN's financial records, contributed to the misconduct that led to PCN's bankruptcy. Until discovery occurs, KPMG does not deserve the same protection as an innocent third party. (pp. 44-45)

The judgment of the Appellate Division is AFFIRMED AS MODIFIED and the matter is REMANDED to the trial court for further proceedings consistent with this opinion.

JUSTICE LaVECCHIA has filed a separate, DISSENTING opinion, expressing the view that she does not endorse the adoption of simple negligence as the basis for permitting a carve-out from application of the imputation defense, and that in the absence of any credible claim of recklessness, gross negligence or other similar culpable conduct by the auditor that contributed to the wrongdoing, defendants were entitled to a dismissal.

JUSTICE RIVERA-SOTO has filed a separate, DISSENTING opinion, expressing the view that the imputation defense should protect a third party who reasonably relies on the representations of a corporate officer, when the third party does not actively participate in that corporate officer's wrongdoing; that the imputation defense should be applied to bar liability to the Trust because the fraud of PCN's officers was knowledge imputed to PCN, the Trust stands in the shoes of PCN itself, and the complaint cannot fairly be construed as alleging that KPMG actively participated in the fraud; that KPMG was retained to provide garden-variety audit report services and, thus, the scope of its engagement with PCN did not require KPMG to guarantee that PCN's financial statements were entirely accurate; that the Court should have followed the federal court opinion in the shareholder action against KPMG, which found that plaintiffs' complaint alleging federal securities fraud violations had failed to state a claim; and that the majority ignores the public policy considerations behind the Legislature's limitation on the liability of accountants for third-party claims.

CHIEF JUSTICE PORITZ and JUSTICES LONG, ALBIN and WALLACE join in JUSTICE ZAZZALI's opinion. JUSTICES LaVECCHIA and RIVERA-SOTO have filed separate, dissenting opinions.

The opinion of the court was delivered by: Justice Zazzali

Argued January 3, 2005

In the mid-1990s, two officers of a corporation intentionally misrepresented details concerning the corporation's financial status to an independent auditing firm. That firm in turn failed to detect those misrepresentations for several years. After subsequent audits revealed the officers' fraud, the corporation was forced to acknowledge previously unreported losses of tens of millions of dollars and to declare bankruptcy. A litigation trust, acting as the corporation's successor-in-interest and representing the corporation's shareholders, filed suit against the auditor for negligently conducting the audit. The trial court granted the auditor's motion to dismiss based on the imputation doctrine, which holds that knowledge of an agent generally is attributed to its principal. The trial court concluded that the fraud was imputable to the litigation trust, as the corporation's successor, and that the litigation trust cannot sue the auditor unless the auditor intentionally and "material[ly] participat[ed]" in the fraud. The Appellate Division reversed, concluding that the trust's complaint alleged sufficient facts to support an equitable fraud claim against the auditor.

In this matter, we therefore must decide whether the imputation doctrine bars the litigation trust's action. We hold that the imputation doctrine does not bar corporate shareholders from recovering through a litigation trust against an auditor who was negligent within the scope of its engagement by failing to uncover or report the fraud of corporate officers and directors. Imputation, however, may be raised as a defense by auditors to bar such claims against corporate shareholders who engaged in or were aware of the wrongdoing of corporate agents. In light of our holding, and for the reasons set forth below, we affirm the Appellate Division decision, as modified, and remand this matter to the trial court for reinstatement of the complaint.

I.

A.

Physician Computer Network, Inc. (PCN), a publicly traded New Jersey corporation with offices in Morris Plains, was engaged in the business of developing and marketing software to assist doctors in communicating with hospitals, insurers, laboratories, and group health care providers. From mid-1993 until mid-1998, PCN retained defendant KPMG LLP, an international accounting firm with a regional office in Short Hills, as its independent auditor. During that time, two PCN officers, John Mortell and Thomas Wraback, served as the primary contacts with KPMG. John Mortell was a director of PCN during all relevant times and PCN's President from January 1998 until March 1998, when he was removed from his position. Mortell also served as the corporation's Chief Financial Officer from May 1992 to March 1995 and as its Executive Vice President and Chief Operating Officer from March 1995 to December 1997. Thomas Wraback was PCN's Senior Vice President and Chief Financial Officer from September 1996 until August 1998, when PCN terminated his employment.

During the mid-to-late 1990s, Mortell and Wraback orchestrated a series of fraudulent transactions to inflate PCN's reported revenues and reduce its reported expenses. On April 1, 1996, PCN filed its annual report on Form 10-K with the Securities and Exchange Commission (SEC) for the fiscal year ending on December 31, 1995. In that filing, PCN reported revenues of over $41 million for 1995, a 104% increase over revenues of approximately $20 million in 1994, and a 584% increase over revenues of approximately $6 million in 1993. Despite that increase, the corporation also reported a net loss before extraordinary items of over $11 million. The 1995 financial statements were accompanied by an unqualified audit opinion by KPMG directed to PCN's Board and stockholders, stating:

We have audited the consolidated financial statements of the Physician Computer Network, Inc. and subsidiaries as of December 31, 1995 and 1994, and the related consolidated statements of operations, changes in shareholders' equity (deficiency), and cash flows for each of the years in the three-year period ended December 31, 1995. These consolidated financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedule based on our audits.

We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Physician Computer Network, Inc. and subsidiaries as of December 31, 1995 and 1994, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1995, in conformity with generally accepted accounting principles.

Also in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, and in all material respects, the information set forth therein.

The following day, April 2, 1996, PCN issued a press release announcing that it had filed a registration statement and prospectus with the SEC to offer seven million shares of PCN's common stock for sale to the public. PCN later filed an amended statement with the SEC, lowering that amount to 5.6 million shares. With KPMG's express consent, each SEC registration statement and prospectus included a copy of the corporation's audited financial statements for 1995 and KPMG's accompanying audit report.

Two months later, PCN issued another press release, this time announcing that PCN had signed an agreement with WismerMartin Inc., another provider of practice management systems, for PCN to acquire that company, by merger, subject to WismerMartin shareholder approval. The agreement provided that PCN was to obtain all of Wismer-Martin's issued and outstanding stock in exchange for approximately $2 million in cash and 935,000 shares of PCN common stock. In connection with that merger, PCN filed a form S-4 registration statement with the SEC, which, with the express consent of KPMG, included PCN's audited financial statements for 1995 and KPMG's corresponding audit report. Wismer-Martin merged with PCN in September 1996.

In 1997, PCN filed its annual report for 1996 with the SEC, which included its audited financial statements for the year ending on December 31, 1996, and an unqualified audit opinion by KPMG, stating that KPMG's audit was conducted in accordance with Generally Accepted Auditing Standards (GAAS) and Generally Accepted Accounting Principles (GAAP). According to those financial statements, PCN's 1996 revenues were almost $96 million, more than double that of 1995. Throughout 1997, PCN continued to report increased revenues and income as compared to corresponding periods in the prior year.

During the course of its audit work for the fiscal year ending on December 31, 1997, KPMG discovered several accounting irregularities. In February 1998, KPMG raised those concerns with Mortell, Wraback, and PCN's outside counsel. As a result, on March 3, 1998, the corporation issued a press release announcing that it would restate its previously reported financial results for each of the first three quarters of 1997 and instead report a loss from operations for each of those quarters. The corporation also announced that it would report a loss for the fourth quarter of 1997, yielding a total expected loss of between $27 and $31 million for the year. In that same announcement, the corporation stated that Mortell had "taken a temporary leave of absence" pending completion of the corporation's 1997 audit. Following those disclosures, the price of PCN stock fell seventy percent, hitting a record low.

In April 1998, PCN announced both that KPMG was withdrawing its auditor's report for 1996 and that PCN had appointed a Special Committee of its Board to conduct an investigation into the matter. From April 1998 to June 1998, KPMG continued its audit procedures and found additional irregularities in the 1996 consolidated statements. At the end of August, PCN filed a Form 8-K with the SEC, disclosing that KPMG had withdrawn its audit opinion for the 1994 and 1995 fiscal years and had discovered that the financial statements for the 1995 and 1996 fiscal years would need to be restated. PCN also disclosed that KPMG was no longer acting as independent auditor for the corporation, although the parties dispute whether PCN dismissed KPMG or KPMG resigned. PCN subsequently retained the accounting firm of Arthur Anderson to complete the audit of its 1997 financial statements and to restate its fiscal results for 1995 and 1996.

The effect of PCN's announcements and disclosures was disastrous for the corporation. Thereafter, PCN continually operated at a cash flow deficit and was in default on its bank debt. The corporation ultimately filed a petition for bankruptcy on December 7, 1999. As part of the bankruptcy plan, the corporation's assets were acquired by Medical Manager Corporation. PCN no longer operates as a public corporation.

B.

Beginning in 1998, several class action lawsuits were filed against PCN on behalf of various shareholder groups and consolidated in the United States District Court for the District of New Jersey. The consolidated action, which eventually settled for $21,150,000, was comprised of persons who purchased or otherwise acquired PCN common stock from February 1996 to April 1998. The settlement expressly denoted that it did not preclude claims against KPMG, Mortell, or Wraback. Nine months later, the same group settled their claims against Mortell and Wraback for $45,000, to "be used to fund the investigation and prosecution of claims the Class may have against KPMG."

Then, in 2001, a class of plaintiffs, consisting of shareholders for the period of April 1996 through April 1998, filed suit against KPMG in the United States District Court for the District of New Jersey. The complaint alleged securities fraud violations under Section 10(b) of the Securities Exchange Act of 1934 in connection with KPMG's 1995 and 1996 audits and Section 11 of the Securities Act of 1933 in connection with the 1995 audit. KPMG filed a motion to dismiss. In an unpublished opinion, Judge Dickinson Debevoise dismissed the plaintiffs' claims with prejudice, finding that they had failed to state a claim and failed to plead fraud with particularity.

In 2002, the SEC filed a complaint in the United States District Court for the District of Columbia, charging six former officers and mangers of PCN, including Mortell and Wraback, with accounting fraud. The SEC also filed a notice of settlement, indicating that all defendants had consented to the entry of "a permanent injunction enjoining [each person] from violating or aiding or abetting violations of the anti-fraud, periodic reporting, record-keeping, internal controls and lying to the auditors provisions of the federal securities laws." As part of the settlement, Mortell agreed to be permanently barred from acting as an officer or director of a public company, and Wraback agreed to be barred for ten years.

C.

The present action against KPMG was filed in May 2002 by plaintiff NCP Litigation Trust (Trust). The Trust was created pursuant to PCN's confirmed bankruptcy plan, approved by the United States Bankruptcy Court for the District of New Jersey. The formal agreement creating the Trust provides:

[T]he Debtors [PCN and related entities] have agreed to contribute to the Litigation Trustee in trust . . . all of their interests in any Causes of Action (the "Litigation Claims") . . . [and] have requested that the Litigation Trustee enforce the Litigation Claims, if any, for the benefit of all holders of Allowed Class 7B Equity Interests. . . .

The record reflects that the term "Allowed Class 7B Equity Interests" refers to shareholders of the debtor corporation.

The Trust's amended complaint alleges that KPMG committed negligence, negligent misrepresentation, breach of contract, and breach of fiduciary duty. As part of those allegations, the Trust asserts that KPMG failed to perform its audits in conformity with GAAS and GAAP, the professional guidelines that auditors must adhere to while conducting an audit. In essence, the Trust claims that

KPMG negligently failed to exercise due professional care in the performance of its audits and in the preparation of the financial statements and audit reports. Had KPMG not performed negligently, and had it instead exercised due care, it would have detected PCN's fraud and prevented the losses PCN suffered.*fn1

According to the Trust, PCN's 1995 financial records, which KPMG certified, were in such disarray that the successor auditor, Arthur Anderson, was unable to reconstitute them. The Trust also cites an investigation by the Special Committee of PCN's Board that found that the corporation's 1995 fiscal results had been overstated. PCN's 1996 financial records also are alleged to have suffered from substantial irregularities. For example, KPMG purportedly failed to verify PCN's receipt and deposit of a $3.5 million check that was part of a fraudulent asset purchase arranged by Mortell and Wraback. According to the Trust, a simple examination of PCN's bank records would have revealed that this amount --- the largest single source of PCN's 1996 income --- was never deposited. KPMG also allegedly allowed for the improper reversal of an approximate $1.8 million liability, thereby offsetting an increase in PCN's accounts receivable reserve, even though "KPMG knew that the reversal of [that] obligation was not supported by GAAP."

The complaint further alleges that KPMG failed to discover PCN's improper recognition of income on its software maintenance agreements. Specifically, PCN entered into maintenance service contracts with its software customers that required customers to pay the fees for the entire maintenance contract when the contract was executed. The Trust alleges that KPMG neglected to comply with GAAP because, although PCN received payment up front for the full amount of the maintenance contracts, GAAP requires that revenue be recognized over time as the services are provided, not at the time of the initial sale. As a result, PCN reported nearly $1.5 million in 1996 that was not actually earned until 1997. The Trust also maintains that KPMG violated GAAS by failing to require PCN to accrue liabilities of approximately $1.5 million in vacation and bonus pay expenses, which were incurred in 1996 but that would not be paid until the following year.

Finally, the complaint asserts that individual audit team members were distracted and deficient in the performance of their duties:

The KPMG audit team assembled for the 1996 audit was not a strong one. Upon information and belief, the partner on the PCN audit for years was distracted by another client which was having substantial trouble which required him to spend a lot of time away from PCN during the audit. The audit manager was new to the PCN audit and was therefore unfamiliar with the Company.

Also, the audit senior, who was also new to the PCN audit, was so preoccupied about leaving KPMG to attend law school that he spent substantial time asking Wraback about apartment-hunting in New York rather than performing the necessary audit work; his audit work suffered as a result.

KPMG moved to dismiss, contending that the fraud of Mortell and Wraback, as agents of PCN, should be imputed to the Trust, as PCN's successor-in-interest, thereby barring the Trust's action against KPMG. The trial court agreed and granted the motion. The court reasoned that to defeat the imputation defense the Trust would have to show "that there has been a material participation by the third party, a material form of culpability." After reviewing the record, the court concluded that it found "no evidence of any material fault, accounting irregularity, [or] participation of the defendants in the fraudulent conduct of these senior participants that would in any way be deemed sufficient to estop the rule of imputation as the case was in [In re Integrity Insurance Co., 240 N.J. Super. 480 (App. Div. 1990),]" New Jersey's only decision addressing application of the imputation defense in the corporate auditing context.

In an unreported decision, the Appellate Division reversed in part, concluding that "Integrity supports the sufficiency of [the Trust's] complaint." In the panel's view, "[n]egligence, negligent misrepresentation, and breach of contract, as well as legal fraud, surely can be culpable conduct that 'contributed to the misconduct of another.'" As such, the Appellate Division found that "[t]he trial court read Integrity too narrowly when it essentially held that only legal fraud by the third party would constitute sufficiently culpable conduct to defeat the imputation defense." The panel concluded that the imputation defense was not available to KPMG because the Trust's complaint, fairly read, alleges that KPMG committed equitable fraud independent of any legal fraud committed by PCN's officers. The panel, however, upheld the trial court's dismissal of the Trust's claim for breach of fiduciary duty.

KPMG appealed, and we granted certification. 181 N.J. 286 (2004). We also granted amicus curiae status to the American Institute of Certified Public Accountants and to the New Jersey Society of Certified Public Accountants.

II.

At the outset, we observe that this matter is before us on a Rule 4:6-2(e) motion to dismiss. On such motions, a trial court should grant a dismissal "in only the rarest of instances." Printing Mart-Morristown v. Sharp Elecs. Corp., 116 N.J. 739, 772 (1989). A court's review of a complaint is to be "undertaken with a generous and hospitable approach," id. at 746, and the court should assume that the non-movant's allegations are true and give that party the benefit of all reasonable inferences, Smith v. SBC Communications Inc., 178 N.J. 265, 282 (2004). If "the fundament of a cause of action may be gleaned even from an obscure ...


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