Deloitte LLP v. Flanagan: Big Four Partner Breaches Fiduciary Duty

In Deloitte LLP v. Flanagan, No. 4125-VCN, 2009 WL 5200657 (Del. Ch. Dec. 29, 2009), plaintiffs Deloitte LLP and Deloitte & Touche LLP (collectively “Deloitte” or the “Partnerships”) accused defendant Thomas P. Flanagan (“Flanagan”), a partner in the international accounting firm partnership Deloitte, of trading in the securities of some of the firm’s clients in breach of his partnership agreement and the general fiduciary duties he owed his partners.  The plaintiffs also accused Flanagan of misrepresenting this trading activity in annual representations to the firm.  Deloitte sued to recover damages caused to the firm and sought partial summary judgment on the question of liability.  The court granted the plaintiffs' motion for partial summary judgment as to liability.  Vice Chancellor John Noble left the determination of damages for a later hearing.

Plaintiff Deloitte LLP is a Delaware limited liability partnership that provides audit, consulting, financial advisory, risk management, and tax services to clients.  Plaintiff Deloitte & Touche LLP is a Delaware limited liability partnership that provides audit and risk management services to clients.  Defendant Flanagan, a Certified Public Accountant, was a partner of one or both of the Partnerships for 30 years until his resignation on September 5, 2008.  As a partner of Deloitte, Flanagan was required to sign a Memorandum of Agreement with each of the Partnerships (“MOAs”) setting forth his rights and obligations as a fiduciary.  The MOAs require that partners not engage in any activities inconsistent with Deloitte’s rules and policies, one of which prohibits partners and employees of Deloitte from owning any securities in the firm’s “Attest Clients.”  Deloitte defines Attest Clients as clients for whom Deloitte performs audits, reviews of financial statements, or other “agreed upon procedures or engagements.”  The policies also require partners to disclose all information regarding investments held by them so that Deloitte can track any unauthorized holdings.  The policies further require that partners make annual representations to the Partnerships that they complied with these policies.   

Flanagan consistently made annual representations that he was familiar with the policies, that he had accurately and completely disclosed all investments he held, and that at no time did he have a financial interest in a restricted entity.  Deloitte’s Complaint asserted that, notwithstanding Flanagan’s representations, he did in fact trade in the shares of Deloitte clients in more than 300 instances over several years.  Deloitte requested partial summary judgment as to the question of liability on its claims for breach of fiduciary duty, breach of contract, common law fraud, and equitable fraud. 

The court focused on a subset of trades for which Flanagan did not offer a defense and which appeared to violate Deloitte’s policies.  According to the complaint, Flanagan received an 85% gain from trading call options of Allstate Corporation shortly after he reviewed a draft of the insurer's upcoming earnings release.  Flanagan then purchased and sold call options of Best Buy Company for a 31% return, after he directly provided audit services and learned of the company’s earnings prior to their public announcement.  Lastly, Flanagan received a 1,400% return by improperly trading in options of Motorola Corporation, another of Deloitte’s clients with whom he had worked, not long after receiving an e-mail that included a statement from the company's CEO about the Corporation’s recent performance. 

The court held that Flanagan’s misrepresentations with respect to his holdings constituted a breach of his duty to be “just and faithful to the Partnership,” therefore the court granted Deloitte’s motion for summary judgment on its breach of fiduciary duty claim.  For the breach of contract claim, the court stated that Flanagan was on actual notice that these three entities were clients of Deloitte since he personally provided them audit services.  As a result, his trading in these entities and his failure to report his trades to Deloitte constituted a breach of the MOAs.   The court also granted summary judgment for the equitable fraud claim because the court stated that Flanagan had an obligation to accurately report his trading on the Annual Representation form and to maintain an accurate and complete list of his holdings in Deloitte’s Tracking and Trading system.  Flanagan failed to fulfill either of these obligations.

Lastly, the court granted Deloitte’s motion for summary judgment on liability with respect to the common law fraud claim.  The standard for scienter in common law fraud requires committing the misstatement recklessly or with intent.  The court found that the magnitude of Flanagan’s unauthorized trades, the discerning trading in those clients for which Flanagan had material nonpublic information, and his misuse of the Tracking and Trading system established that Flanagan acted with requisite scienter. 

In summary, the court granted Deloitte’s motion for partial summary judgment as to liability.  Vice Chancellor John Noble left the determination of damages for a later hearing.

The primary materials for this case may be found on the DU Corporate Governance website.