Central District Of California Sustains Putative Class Action Against Canadian Silver Company And Its Auditor For Failing To Disclose Major Potential Tax Liability In Its Public Financial Statements
On March 25, 2019, Judge Christina A. Snyder of the United States District Court for the Central District of California denied a motion to dismiss a class action filed against a Canadian silver company (the “Company”), current and former executives of the Company, and its auditor and tax consultant (the “Auditor”), alleging violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5. In Re Silver Wheaton Corp. Secs. Lit., No. 2:15-cv-05146; 2:15-cv-5173 (C.D. Cal. Mar. 25, 2019). Plaintiffs allege defendants failed to disclose USD$207 million in Canadian tax liabilities and that the Auditor wrongfully issued clean audit opinions. The Court held that plaintiffs sufficiently pleaded claims against all defendants. Of particular note, while the Court acknowledged several hurdles that generally result in the dismissal of claims against auditors, it held that those hurdles had been surmounted by plaintiffs given the unique circumstances of the case.
Headquartered in British Columbia, the Company and its subsidiaries purchase and sell silver by entering into “streaming agreements” under which it makes large up-front payments for the right to purchase a portion of a mine’s future silver output and then reselling the silver at market prices. On July 6, 2015, the Company revealed that the Canada Revenue Agency (“CRA”) proposed reassessing its tax liability for several years. According to the CRA, the Company and a Cayman Islands-based subsidiary violated Canada’s transfer pricing rules by improperly pricing transactions between them. The Company’s financial statements, which the Company certified as complying with Generally Accepted Accounting Principles (“GAAP”) and/or International Financial Reporting Standards (“IFRS”), did not disclose this potential tax liability.
The Court previously denied a motion to dismiss a first amended complaint. The second amended complaint, which adds the Auditor as a defendant and removes earlier allegations that the Company hid information from its independent auditors, was filed after some discovery had taken place. The second amended complaint alleges that the Auditor turned a blind eye to the flaws in the Company’s transfer pricing and wrongfully issued clean audit opinions. The Company and individual defendants again moved to dismiss, arguing that plaintiffs’ allegations of scienter are insufficient and that the audit opinions demonstrated that defendants believed that the Company’s transfer pricing and financial statements complied with the applicable accounting standards. The Auditor also moved to dismiss on the grounds that plaintiffs failed to adequately allege the falsity of its opinions, scienter, and a causal connection between plaintiffs’ alleged losses and its alleged violations of accounting standards.
The Court again declined to dismiss the complaint. In particular, the Court noted that plaintiffs set forth additional facts showing how the Company’s tax position was indefensible and the extent to which the Company and its executives and officers were aware of the CRA’s audit plans and the substantial risk that the Company would be required to pay back taxes. The absence of allegations that the Company hid information from its auditors was held not to negate an inference of scienter, and the Court rejected defendants’ argument that plaintiffs have not sufficiently alleged scienter because the Auditor issued clean opinions, reiterating that many courts have found allegations of scienter to be sufficient even when companies had “clean” audit opinions.
Likewise, the Court declined to dismiss the claims against the Auditor. The Court held that the Auditor’s statement that the Company’s financial statements complied with applicable accounting standards was a statement of opinion and that plaintiffs therefore had to plead that the statement was subjectively false. Though the opinion is redacted because it rests on allegations that incorporate confidential material disclosed during discovery, the Court appears to have held that plaintiffs had sufficiently alleged for purposes of a motion to dismiss that the Auditor at least was aware of a risk that the Company could incur additional tax liability.
In addition, while the Court acknowledged that pleading sufficient facts to support a strong inference of scienter as to an outside auditor is often difficult because it typically has less access to information than the company it is auditing, the Court also found plaintiffs’ allegations give rise to a strong inference that the Auditor was aware of the “precariousness” of the Company’s tax position and of the progress and extent of the CRA’s audit. And while the Court acknowledged that a desire to continue to receive fees is typically insufficient to support a strong inference of scienter as against an auditor, here, the Court ruled that such an inference was warranted because the Auditor also was receiving nearly half a million dollars in fees for tax advisory work. The Court observed that a strong inference of scienter was further supported by the size of the alleged omission. Finally, with respect to causation, the Court found that the Auditor’s purported auditing violations are inextricably linked with the concealment of the Company’s tax liability, and whether the alleged misrepresentations were a proximate cause of plaintiffs’ harm is a question of fact.