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Standard Chartered PLC v. Waterhouse11/7/1996
United, then the fourth largest bank in Arizona.
PW had functioned as United's independent auditor since 1970. As an auditor, PW annually examined United's books and records to investigate and verify the accuracy of its financial statements. United's financial statements, including balance sheets and income statements, were a primary source of information, both for United itself and for others outside the company, concerning the actual condition of United's operations, assets, and liabilities.
PW audited United for fiscal years 1985 and 1986 for an annual fee of approximately $140,000, and each year issued unqualified opinions supporting the accuracy, completeness, and regularity of United's financial statements. An auditor's "unqualified" opinion on a company's financial statements is an opinion without reservations or qualifications and amounts to a representation that the contents are reasonably accurate with no material exceptions.
In September 1985, Union and United entered into a merger agreement by which Union would purchase all of United's capital stock. PW was not a party to the agreement. The agreement did not require an audit or certification of United as a condition of closing, and neither took place. The agreement did require, however, that Union be given all United financial statements audited by PW, other United financial information reviewed by PW, and "management letters" prepared by PW describing any weaknesses that it found in United's internal controls. Within the agreement, United also consented for Union to receive from PW any information about United that Union might request. The agreement conditioned Union's obligation to perform on the absence of a material adverse change in United's financial condition and on receipt of certification that United's shareholders' equity was at least $135 million as of the merger's effective date.
United's "loan portfolio" consisted of the aggregated short-term and long-term debts that United's loan customers owed the bank. The loan portfolio was a significant component of United's assets, comprising $1.4 billion of United's total assets of $2.1 billion in 1985. As United's independent auditor, one of PW's functions was to periodically evaluate the loan portfolio, the individual customer accounts that comprised the loan portfolio, and United's internal lending controls in order to predict what proportion of the loans would ultimately be repaid. This evaluation in turn tested the accuracy of United's allowance for uncollectible loans, which United showed on its financial statements as a charge against income.
In November of 1985, PW representatives met with Union's chief financial officer, Jack Frazee, and others to solicit the retention of PW as United's auditor. One subject they addressed was the public financings that Union would undertake to raise money to fund the purchase of United. Frazee later met individually with PW's lead audit partner, Karl Almquist, to discuss PW's working relationships with United's managers and directors. Before the holidays in 1985, Frazee decided to rely on PW for ongoing financial information about United through the closing, and he communicated that decision to PW, to representatives of United, and to PW's competitor, Peat Marwick.
In early 1986, PW issued an unqualified audit opinion on United's 1985 financial statements. PW stated that it had conducted its audit in accordance with generally accepted auditing standards and that the information in the financial statements was fairly presented in accordance with generally accepted accounting principles. Based on the audited financial statements, Union bought United stock in the open market and proceede
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