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Merrimack College v. KPMG LLP (Lawyers Weekly No. 12-054-17)

COMMONWEALTH OF MASSACHUSETTS
SUFFOLK, ss. SUPERIOR COURT.
1484CV02098-BLS2
____________________
MERRIMACK COLLEGE
v.
KPMG LLP
____________________
MEMORANDUM AND ORDER ALLOWING DEFENDANT’S MOTION FOR SUMMARY JUDGMENT
Merrimack College incurred substantial financial losses because its former financial aid director, Christine Mordach, deliberately approved fake Perkins loans for many students without their knowledge.1 For years Mordach awarded far more financial aid than she was authorized to spend. She made the college’s financial aid budget appear balanced by replacing grants and scholarships with fake Perkins loans, the proceeds of which were used to pay tuition owed to Merrimack. Ms. Mordach pleaded guilty to federal criminal charges of mail and wire fraud.
Merrimack seeks to recover its losses from its former auditor, KPMG LLP. Merrimack claims that KPMG noticed but did not follow up on discrepancies in some student loan accounting and deficiencies in internal controls for such loans, and as a result failed to discover Mordach’s fraud. Merrimack asserts that KPMG was negligent, breached its contract, and violated G.L. c. 93A.
KPMG has moved for summary judgment on several grounds, including that Merrimack’s claims are barred under the equitable doctrine known as in pari delicto because Mordach committed fraud to benefit her employer and her deliberate wrongdoing on behalf of Merrimack was far worse than KPMG’s alleged negligence.
The Court agrees that, in light of the undisputed material facts, Merrimack’s claims are barred by the in pari delicto doctrine. Under these circumstances, Merrimack is legally responsible for Mordach’s misconduct. Merrimack is also
1 The Perkins Loan program provides “low-interest loans to financially needy students” at institutions of higher education that are funded with federal monies, matching contributions by each participating school, and repayment of prior loans. De La Mota v. United States Dept. of Educ., 412 F.3d 71, 74 (2d Cir. 2005). “The schools independently determine eligibility, advance funds, collect payments[,] and make decisions concerning loan forgiveness.” Id.; see also 20 U.S.C. §§ 1070 et seq.
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bound by the allegations in its complaint that Mordach engaged in intentional fraud. That deliberate misconduct by Merrimack’s employee was far more serious than KPMG’s purported negligence. Finally, the Court is not persuaded that Massachusetts should recognize, on public policy grounds, an exception to this doctrine for claims against an allegedly negligent outside auditor. The Court will therefore allow KPMG’s motion and dismiss this action.
1. Legal Background. “The doctrine of in pari delicto bars a plaintiff who has participated in wrongdoing from recovering damages for any loss resulting from the wrongdoing.” Choquette v. Isacoff, 65 Mass. App. Ct. 1, 3 (2005). It reflects an equitable and policy judgment that courts should “not lend aid to parties who base their cause of action on their own immoral or illegal acts.” Id. at 4. This doctrine does not create an absolute bar to recovery. If both sides may have engaged in misconduct, the “less guilty” party may be able to recover damages or obtain equitable relief, notwithstanding its own misconduct. Id., quoting Council v. Cohen, 303 Mass. 348, 354 (1939), and Berman v. Coakley, 243 Mass. 348, 350 (1923).
“In pari delicto” is a phrase of legal Latin that “means ‘in equal fault.’ ” Baena v. KPMG LLP, 453 F.3d 1, 6 (1st Cir. 2006), quoting Black’s Law Dictionary 791 (6th ed. 1990). It comes from a long-standing equitable maxim, “in pari delicto potior est conditio defendentis,” that can be translated as “[i]n a case of equal or mutual fault, the position of the [defending party] is the better one.” Id. n.5, quoting Black’s Law Dictionary.
The practical import of this principle, where it applies, “is simply that the law leaves the parties exactly where they stand; not that it prefers the defendant to the plaintiff, but that it will not recognize a right of action” based on inequitable conduct. Atwood v. Fisk, 101 Mass. 363, 364 (1869).
This principle was developed and originally applied to bar a plaintiff who engaged in wrongdoing from obtaining purely equitable relief (such as an order that someone specifically perform a contract or some other injunctive relief) to remedy its own misconduct (such as entering into an illegal contract or engaging in fraud). Choquette, 65 Mass. App. Ct. at 4.
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More recently, this doctrine has also been applied to bar a plaintiff from asserting legal claims seeking monetary compensation for an injury that was in part self-inflicted. In Choquette, for example, the plaintiff filed a bankruptcy petition and was then sued by the bankruptcy trustee for fraudulently conveying property and filing a false statement of his assets. The plaintiff turned around and sued his attorney for legal malpractice on the theory that the lawyer had prepared the false schedule of assets. The Appeals Court affirmed summary judgment in favor of the defendant lawyer on the ground that the in pari delicto doctrine barred all claims because the plaintiff had knowingly signed the false asset schedule and then lied about it under oath during his bankruptcy hearing. Id. at 3-8.
The in pari delicto doctrine applies with full force against a corporation or other legal entity, such as Merrimack College, that has been injured as a result of misconduct by an employee or other agent acting on its behalf and then seeks compensation from some third party for that injury. Arcidi v. National Association of Government Employees, Inc., 447 Mass. 616, 621-62 (2006).
2. Application to the Undisputed Facts. Whether particular claims are barred because the plaintiff is at least as culpable as, and thus in pari delicto with, the defendant can be resolved on a motion for summary judgment where the material facts are not in dispute. See Choquette, 65 Mass. App. Ct. at 2-8.
2.1. Imputing Misconduct to Merrimack. Under the circumstances of this case, Mordach’s fraudulent conduct must be imputed to Merrimack, meaning that Merrimack is legally responsible for Mordach’s fraud.
The rules describing when an employer is responsible for wrongdoing by its employee can be summarized as follows. Any misconduct by employee that is “committed within the scope of his employment” is imputed to the employer, which is “vicariously liable” for the employee’s misdeeds. E.g., Kourouvacilis v. American Fed’n of State, Cty. & Mun. Employees, 65 Mass. App. Ct. 521, 534 (2006). Conduct by an employee is deemed to be “within the scope of employment if it is of the kind he [or she] is employed to perform, … if it occurs substantially within the authorized time and space limits, … and if it is motivated, at least in part, by a purpose to serve the employer” (citations omitted). Wang Laboratories, Inc. v.
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Business Incentives, Inc., 398 Mass. 854, 859 (1986). “[A]n employer need not control the details of an employee’s tasks in order to be held liable [or responsible] for the employee’s tortious acts.” Dias v. Brigham Med. Assocs., Inc., 438 Mass. 317, 320 (2002).
These same “agency-based imputation rules” for deciding whether an employer will be held vicariously liable for its employee’s wrongdoing apply with full force in this case, because they also determine whether an employee’s misconduct is imputed to the employer when applying the in pari delicto doctrine. Baena, 453 F.3d at 8 (applying Massachusetts law); accord Kirschner v. KPMG LLP, 938 N.E.2d 941, 950-952 (N.Y. 2010) (applying New York law).
All three prongs of the test reiterated in Wang Laboratories are satisfied here, which means that Mordach’s fraud must be imputed or attributed to Merrimack. Mordach served as Merrimack’s Director of Financial Aid. She was responsible for approving all Perkins loans awarded to Merrimack students. Doling out Perkins loan funds was part of Mordach’s job, something that Merrimack paid her to do, and something she did during regular working hours and using Merrimack’s facilities and equipment. Furthermore, the factual record makes clear that Mordach approved fraudulent Perkins loans in order to improve Merrimack’s finances by allowing it to spend additional federal Perkins funds on its operations. Mordach did not perpetrate this fraud in order to profit from it personally; none of the funds that Mordach improperly released by approving false loans without a student’s consent went into her pocket or bank account.
Merrimack makes several arguments as to why, in its view, the imputation of Mordach’s misconduct to Merrimack turns on disputed issues of fact and thus cannot be resolved on a motion for summary judgment. None has merit.
First, the argument that Merrimack should not be held to account for misdeeds by a lower-level employee has no basis in law and cannot be squared with the facts.
There is no “low-level employee” exception to the legal rule that an employer is vicariously liable for misconduct committed by employee within the scope of her employment. What matters is whether an employee’s negligent or intentional
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misconduct involved something within the scope of their employment responsibilities, not whether they are a senior executive or a junior staffer. See generally Wang Laboratories, supra.
In any case, the undisputed facts show that Mordach was a relatively high-level staffer. She was responsible for managing Merrimack’s entire financial aid program, including the award of Perkins loans. As Director of Financial Aid, from 1999 to 2004 Mordach oversaw the award and distribution of almost $ 150 million in financial aid. For eight different years Mordach, together with the other members of Merrimack’s senior management, signed management representation letters to KPMG. Merrimack points to no appellate decision in which a corporate entity was not held responsible for misconduct committed within the scope of employment by someone with similar management responsibilities.
Second, Merrimack’s further argument that in the long run the college was hurt, not helped, by Mordach’s fraud also misses the point. Whether an employer is vicariously liable for an employee’s misconduct turns on whether the employee’s actions were motivated at least in part by a desire to benefit her employer. See Wang Laboratories, 398 Mass. 859. It is irrelevant whether “in retrospect” the employee’s actions “were ill-advised” and actually hurt the employer’s interests. Kourouvacilis, 65 Mass. App. Ct. at 535.
Third, Merrimack’s assertion that Mordach’s subjective intent was to protect her own job, not to help Merrimack, is also unavailing. Even if Mordach’s “predominant motive” was to benefit herself, Merrimack is still responsible for Mordach’s misconduct so long as her actions were undertaken within the scope of her authority as financial aid director. See Wang Laboratories, 398 Mass. at 859-860. As in Wang, “[t]here can be no serious claim” that Mordach’s approval of Perkins loans “was not the kind of conduct [she] was employed to perform.” Id. at 860. As a result, Mordach’s misconduct must be imputed to Merrimack.
This is not a case in which an employee engaged in fraud against her employer with the intent to profit personally at the employer’s expense.
Merrimack correctly notes that an employer or other principal is not responsible for misconduct by or credited as having knowledge of an agent that “has
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acted fraudulently toward the principal and is engaged in an independent fraudulent act from which the principal does not benefit.” Sunrise Properties, Inc. v. Bacon, Wilson, Ratner, Cohen, Salvage, Fialky & Fitzgerald, P.C., 425 Mass. 63, 67 (1997). An agent who commits a “fraudulent act … against the principal” is sometimes called a “faithless agent;” since such a person is not working on behalf of the principal, but instead is trying to harm the principal, it would not be appropriate to impute their knowledge or misconduct to the principal. See Lawrence Sav. Bank v. Levenson, 59 Mass. App. Ct. 699, 705-706 (2003).
In the context of the in pari delicto doctrine, this same concept is referred to as an “adverse interest” exception to the doctrine. See, e.g., Baena, 453 F.3d at 7. This exception only applies where the agent has “totally abandoned his principal’s interests and [is] acting entirely for his own or another’s purposes. It cannot be invoked merely because he has a conflict of interest or because he is not acting primarily for his principal.” Kirschner, 938 N.E.2d at 952, quoting Center v. Hampton Affiliates, Inc., 488 N.E.2d 898, 900 (N.Y. 1985). This “most narrow of exceptions” is reserved for cases such as “outright theft or looting or embezzlement” where a “fraud is committed against a corporation rather than on its behalf.” Id.
The adverse interest exception to the in pari delicto doctrine does not apply here because Mordach was approving false Perkins loans in order to allow Merrimack to spend additional federal monies, not in order to profit personally at Merrimack’s expense. “A fraud that by its nature will benefit the corporation,” at least in the short run, “is not ‘adverse’ to the corporation’s interests, even if it was actually motivated by the agent’s desire for personal gain.” Kirschner, supra at 952. “To allow a corporation to avoid the consequences of corporate acts simply because an employee performed them with his personal profit in mind would enable the corporation to disclaim, at its convenience, virtually every act its officers undertake. ‘[C]orporate officers, even in the most upright enterprises, can always be said, in some meaningful sense, to act for their own interests.’ ” Id., quoting Grede v. McGladrey & Pullen LLP, 421 B.R. 879, 886 (N.D.Ill. 2009).
The fact that Mordach concealed her misconduct from others at the college does not insulate Merrimack from responsibility for her wrongdoing. Concealment
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does not implicate a “faithless agent” or “adverse interest” exception to the normal imputation rules in the absence of proof that the agent was acting completely against the interests of its principal. GTE Products Corp. v. Broadway Elec. Supply Co., Inc., 42 Mass. App. Ct. 293, 299-300 (1997); National Credit Union Admin. v. Ticor Title Ins. Co., 873 F.Supp. 718, 726-727 (D.Mass. 1995) (applying Massachusetts law). As one commentator has explained:
A principal is liable for many frauds by the agent, although committed for the agent’s own purposes. In fact, most unauthorized frauds by agents are committed because of the strong conflicting interests of the agent. In such cases, the innocent principal is liable because the agent has knowledge which makes his representations deceitful. The fact that the agent has every reason to conceal the facts from the principal is immaterial….
W.A. Seavey, Agency § 102, at 185-186 (1964).
In sum, in deciding whether the in pari delicto doctrine applies, the Court must treat Mordach’s fraud as misconduct committed by and for Merrimack.
2.2. Mordach’s Fraud Outweighs KPMG’s Alleged Negligence. The intentional misconduct by Merrimack’s agent in authorizing fraudulent Perkins loans is far more serious than KPMG’s failure to ferret out that fraud when auditing Merrimack’s finances. Merrimack’s claims against KPMG are therefore barred by the doctrine of in pari delicto. See, e,g., Baena v. KPMG, supra (applying Massachusetts law); Peterson v. McGladrey LLP, 792 F.3d 785, 788 (7th Cir. 2015) (applying Illinois law); Christians v. Grant Thornton, LLP, 733 N.W.2d 803, 814-815 (Minn. Ct. App. 2007); Kirschner v. KPMG, supra (applying New York law).
Merrimack cannot avoid summary judgment on the ground that there is a disputed issue as to whether Mordach committed intentional fraud. Merrimack points to deposition testimony in which Mordach insisted that although improper loans sometimes just “slipped by,” she did not intentionally approve fraudulent loans. This testimony cannot be squared with Merrimack’s own binding allegations.
In its complaint, Merrimack alleges that Mordach approved Perkins loans “for imaginary students who never existed,” for current students who never signed any promissory notes, for prior students who had graduated or died and thus were not eligible for a Perkins loan, using fake social security numbers, or listing Mordach’s own home address as the address for the purported loan application.
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When it responded to KPMG’s statement of undisputed material facts, Merrimack understandably admitted that these facts demonstrate that Mordach had engaged in deliberate fraud. More specifically, Merrimack admitted that Mordach “created false paperwork and issued Perkins loans to students without the students’ knowledge or consent.” Deliberately processing and approving loans for dead or otherwise departed students, using made up social security numbers, putting down Mordach’s own address in lieu of the students, approving loans for students who never signed any promissory note, and otherwise obligating current and former students to repay a loan they never knew about is fraudulent.
Merrimack cannot avoid summary judgment on the ground that facts admitted by Merrimack in its complaint have arguably been contradicted by Mordach’s deposition testimony.2 To the contrary, Merrimack is bound by its own, detailed allegations that Mordach engaged in intentional fraud. See G.L. c. 231, § 87 (allegations “[i]n any civil action pleadings … shall bind the party marking them”). This statute provides that “facts admitted in pleadings” are “conclusive upon” the party making them. Adiletto v. Brockton Cut Sole Corp., 322 Mass. 110, 112 (1947). Since no “[f]indings contrary to facts admitted in pleadings” may be made, judgment should be entered against a party if the facts admitted in its pleading demonstrate that it cannot prevail as a matter of law. Id.
2.3. No Auditor Exception. Merrimack urges the Court to recognize an exception to the in pari delicto doctrine, on public policy grounds, for claims that an auditor of an organization’s finances negligently failed to discover that an employee had engaged in fraud.
Since this doctrine is equitable in nature, considerations of public policy are always relevant. See generally Arcidi, 447 Mass. at 620. Courts should not dismiss claims on in pari delicto grounds “where the public interest requires” that a party
2 KPMG’s further argument that Mordach’s guilty plea in federal court conclusively establishes that she engaged in fraud is without merit. Under Massachusetts law guilty pleas may be evidence of wrongdoing, but they “are not conclusive of the underlying facts.” Costa v. Fall River Housing Auth., 453 Mass. 614, 632 (2009). Mordach’s plea would not bar Merrimack from offering evidence at trial in an attempt to explain away the plea. Id. n.27; accord Aetna Cas. & Sur. Co. v. Niziolek, 395 Mass. 737, 747-750 (1985).
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be allowed to enforce an illegal contract or seek compensation for some injury. Choquette, 65 Mass. App. Ct. at 4, quoting Berman, 243 Mass. at 354; accord Bernhardt v. Atlantic Finance Corp., 311 Mass. 183, 188 (1942).
The public policy exception sought by Merrimack, however, would be inconsistent with existing Massachusetts law. In Choquette, the Appeals Court was asked to exempt legal malpractice claims from the doctrine of in pari delicto on the ground that the public policy of holding lawyers accountable for giving “competent legal advice” concerning “complex areas of the law” should outweigh any equitable concern about a client seeking be compensated by someone else for injuries caused by the client’s own wrongdoing. See 65 Mass. App. Ct. 7-8. The Appeals Court rejected that argument.
This case is indistinguishable from Choquette. Merrimack argues that “an auditor’s important role in identifying irregularities in financial documents” should outweigh the equitable concerns underlying the in pari delicto doctrine. But there is no good reason why the public interest in holding independent auditors like KPMG responsible for their negligence is any stronger than the very similar public interest at stake in Choquette in holding attorneys responsible for any legal malpractice.
New Jersey appears to be the only state that has recognized an “auditor exemption” to the doctrine of in pari delicto. See NCP v. KPMG LLP, 901 A.2d 871, 882 (N.J. 2006); Thabault v. Chait, 541 F.3d 512, 526-529 (3d Cir. 2008) (applying New Jersey law).
Every other court to consider the issue has rejected the New Jersey approach and declined to create a blanket “auditor exception” to the doctrine of in pari delicto. See Official Committee of Unsecured Creditors of Allegheny Health Educ. and Research Foundation v. PriceWaterhouseCoopers LLP, 989 A.2d 313, 325-335 (Pa. 2010) (“AHERF”); Kirschner, 938 N.E.2d at 955-959 (N.Y. 2010); Stewart v. Wilmington Trust SP Svcs., Inc., 112 A.3d 271, 315-318 (Del. Ct. Chancery), aff’d, 126 A.3d 1115 (Del. 2015).
Other courts have instead held that the doctrine of in pari delicto bars a corporation from suing its outside auditor for professional malpractice based on the auditor’s failure to detect fraud committed by a corporate officer, where the fraud
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benefited the corporation at least in part and auditor is not accused of aiding or participating in the fraud. See Baena v. KPMG, 453 F.3d 1 (1st Cir. 2006) (applying Massachusetts law); Peterson v. McGladrey LLP, 792 F.3d 785, 788 (7th Cir. 2015) (applying Illinois law); Christians v. Grant Thornton, LLP, 733 N.W.2d 803, 814-815 (Minn. Ct. App. 2007); USACM Liquidating Trust v. Deloitte & Touche LLP, 764 F.Supp.2d 1210, 1222-1223 (D.Nev. 2011) (applying Nevada law); (applying Minnesota law); Kirschner, supra (applying New York law); AHERF, supra, at 335-336 (applying Pennsylvania law).3 Those decisions are consistent with Massachusetts law.
The Court is compelled by Choquette to reject Merrimack’s advocacy for an auditor exemption to in pari delicto. If Choquette did not control, then the Court would be convinced by the New York Court of Appeals’ thoughtful explanation of why it would not be appropriate to recognize such an exemption. Merrimack’s proposal would “creat[e] a double standard whereby the innocent stakeholders” of the outside auditor “are held responsible for the sins of their errant agents while the innocent stakeholders of” the entity injured by its employee’s fraud “are not charged with knowledge of their wrongdoing agents.” Kirschner, 938 N.E.2d at 958. As in Kirschner, Merrimack has not shown that there is a compelling public policy justification for letting entities that were injured by the deliberate fraud of their employees sidestep the in pari delicto doctrine and shift responsibility to an independent auditor that negligently failed to discover the fraud.
ORDER
Defendant’s motion for summary judgment is ALLOWED. Final judgment dismissing all claims with prejudice shall enter forthwith.
May 15, 2017
___________________________
Kenneth W. Salinger
Justice of the Superior Court
3 In contrast, several courts have held that an auditor that actively participates in an alleged fraud is not protected by the in pari delicto doctrine. See AHERF, 989 A.2d at 336-339; Stewart, 112 A.3d at 319-320. There is no evidence in this case that KPMG knowingly aided or abetted Mordach’s fraudulent scheme.
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