This post was also written by Terence Healy.

On April 8, 2013, District Judge Shira Scheindlin (S.D.N.Y.) dismissed Deloitte Touche Tohmatsu CPA Ltd. (“Deloitte”) from a securities fraud class action brought by investors in Longtop Financial Technologies, Ltd. (“Longtop”), a Chinese company which was delisted from the NYSE in 2011. The plaintiffs alleged auditing giant Deloitte committed securities fraud by issuing unqualified audit opinions during a time when Longtop was engaged in pervasive accounting fraud. Deloitte approved Longtop’s financials even though it had identified risk factors within the company and was otherwise aware of “red flags” suggesting potential fraud.

In a 70-page opinion found here, Judge Scheindlin reiterated the high bar for pleading securities fraud against auditors. The court clarified that an auditor’s failure to uncover problems with a company’s internal controls and accounting practices does not constitute recklessness. To plead recklessness under the securities laws, a complaint must allege facts that approximate an actual intent to aid in the fraud perpetrated by the company, or that support an inference that the accounting practices were so deficient that the audit conducted amounted to no audit at all. The court found the theory of liability against Deloitte – that, in effect, it had identified risk factors at a company that was later discovered to have engaged in fraud – was “tainted by hindsight.” The court warned of the harmful policy implications for allowing fraud claims on that basis.

The decision, coming after two earlier attempts to have the case dismissed, is a big win for Deloitte – and will come in handy for other firms seeking to challenge claims of securities fraud related to the audits they conduct. The dismissal will also allow Deloitte to avoid some of the thorny discovery issues that arise when adversaries seek documents and workpapers from China.

The case is In re Longtop Financial Technologies Limited Securities Litigation, Case No. 11-cv-3658 (SAS) (U.S.D.C. S.D.N.Y.).