New Mexico State Investment Council v. Ernst & Young LLP
2011 U.S. App. LEXIS 7680
| 9th Cir. | 2011Background
- Broadcom engaged in a large stock option backdating scheme causing a $2.2B restatement for 1998–2005.
- EY audited Broadcom and issued a 2005 unqualified opinion covering 2003–2005.
- Plaintiffs allege EY knew or was reckless about backdating and still issued clean opinions.
- Key alleged red flags include a May 2000 grant with no documentation and other irregular grants.
- Complaint asserts EY’s knowledge/recklessness caused misstatements in Broadcom’s financials and their restatement.
- EY’s alleged involvement in 2003 corrective reforms is cited as evidence of awareness.
- District court dismissed for lack of scienter; Ninth Circuit reverses and remands for further proceedings.
Issues
| Issue | Plaintiff's Argument | Defendant's Argument | Held |
|---|---|---|---|
| Whether EY's alleged scienter is sufficiently pled | EY knew or recklessly ignored backdating indicators | Auditors lack sufficient information and context; no strong inference of fraud | Yes, strong inference supported |
| May 2000 backdated grant as a red flag | May 2000 grant with no documentation signals intent to misstate | Possibility of innocent explanation or insufficient evidence | Yes, supports scienter |
| Undermanned compensation committee and subsequent approvals | Grants dated while quorum absent show improper oversight | Documentation and processes could be misinterpreted; not conclusive | Yes, supports scienter |
| EY's role in 2003 corrective reforms | EY participated in reforms but did not reveal prior misstatements | Reforms reflect compliance with SOX; not indicative of fraud | Yes, supports scienter when viewed with broader context |
Key Cases Cited
- Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308 (2007) (plaintiff must show a strong inference of scienter)
- In re Countrywide Fin. Corp. Sec. Litig., 588 F.Supp.2d 1132 (C.D. Cal. 2008) (red flags/GAAS line of inquiry; auditor scienter standards)
- In re Software Toolworks Inc. Sec. Litig., 50 F.3d 615 (9th Cir. 1994) (helpful standard for assessing scienter, especially auditor cases)
- In re Homestore.com, Inc. Sec. Litig., 252 F.Supp.2d 1018 (C.D. Cal. 2003) (logical inference of scienter from audit failures)
- In re Daou Sys., Inc., 411 F.3d 1006 (9th Cir. 2005) (GAAP/GAAS violations and scienter inference)
- In re Oxford Health Plans Inc. Sec. Litig., 51 F.Supp.2d 290 (S.D.N.Y. 1999) (holistic scienter evaluation recognizing in-your-face facts)
- Public Employees' Ret. Ass'n of Colo. v. Deloitte & Touche, 551 F.3d 305 (4th Cir. 2009) (limited reliance on missing documentation; context-specific)