One of the most annoying things about the aftermath of the 2008 credit crisis has been the almost total absence of remedies, either for institutional investors or ordinary people. Sure, there are plenty of villains if you troll the Internet, but in the real world, it boils down to a small cast of characters: a handful of investment banks, mortgage firms, credit ratings agencies, and, not least, the auditors that accepted the adequacy of the bankers’ financial reports.

The ability of investors to obtain redress has just gotten a whole lot harder, thanks to the U.S. Third Circuit Court of Appeals in Philadelphia. In a decision that has received little publicity outside of legal circles, the court essentially ruled that investors are helpless when they’re buying stocks or bonds or—as in this instance—a portfolio of subprime securities. You’re in the same position as you’d be in a use-car lot, except that you aren’t able to get your own mechanic to give the wreck a once-over. You can forget about what auditors say about a security you’re thinking of buying. As a matter of fact, after reading that decision, I began to seriously wonder if there’s any point in a company hiring an independent auditor before it goes out and sells securities to the public.

This ruling is only binding in the Third Circuit, which covers New Jersey, Pennsylvania, and Delaware, and other courts have ruled differently, but it’s likely to have an impact on court rulings nationwide. In January, I described how securities class-action suits are on the wane, and this ruling isn’t going to help reverse that trend.

To get to the heart of this decision, you have to comb through a lot of legalese. This article in the Legal Intelligencer sets forth the issues about as well as you can find. But you have to read the decision itself to grasp the problem here from the investor perspective. The case involved a suit against BDO Seidman, one of the nation’s largest accounting firms. An investor named John Malack purchased notes issued by American Business Financial Services, a subprime mortgage lender, between 2002 and 2005. The notes became worthless during the mortgage meltdown, and ABFS went bankrupt. Malack and other investors sued Seidman, which had been the mortgage company’s independent auditor.

It’s the kind of story that has been repeated many times during the financial crisis, and the role of the auditors has been controversial. In this case, which is being vigorously defended by Seidman, Malack contended that if Seidman had been doing its job, it wouldn’t have granted those notes a clean audit opinion. He went on to allege that “without clean audit opinions, American Business would not have been able to register the notes with the SEC, the notes would not have been marketable, and Malack and the other investors would not have purchased the notes.”

In other words, what the plaintiffs were contending was that this was no ordinary instance of securities fraud, that the process was fubar from top to bottom—a point of view that is hardly earth-shattering, considering the events of the past two years. In legal terminology, they were advancing the view, which is accepted in some jurisdictions, that “fraud created the market.”

That was huffily rejected by the appellate panel. Were that legal theory to apply, the court unanimously ruled, “any investor who purchases any security could point to the security's availability on the market to satisfy the reasonable reliance element of a Section 10(b) [securities fraud] claim."

But that position, the court felt, lacks common sense. And this is where the court’s ruling gets interesting, even for people whose eyes glaze over at legal terminology. “For a security’s availability on the market to be an indication of its genuineness there must be some entity involved in the process of taking the security to market that acts as a bulwark against fraud,” the judges pointed out. “Yet the entities most commonly involved in bringing a security to market do not imbue the security with any guarantee against fraud.” [emphasis added]

That’s honest, if nothing else. In fact, it sounds like the kinds of things I write—except that the judges were using this as bludgeon against investors seeking justice. Just to drive home the point, the court went on to say that “the security’s promoter and other entities involved in the issuance, such as the underwriter, the auditor, and legal counsel—the very entities often charged with fraud—cannot be reasonably relied upon to prevent fraud.” OK, I can understand the underwriter, the lawyers, and the stock promoters. I’m not naive. But the auditors?

Evidently I’m a wild-eyed idealist. To count on the auditors to actually identify fraud, the judges pointed out, is to “believe that an initial investor may reasonably rely on clearly self-interested (perhaps dishonest) parties to make decisions that are at least burdensome and at most economically irrational.” Oh, dear. We certainly don’t want to make life inconvenient for clearly self-interested and perhaps dishonest people.

As I said, the courts are not unanimous on this subject. The Seventh Circuit, covering Illinois and Wisconsin, agrees with its brethren in Philadelphia. The Fifth Circuit, in Louisiana, Mississippi, and Texas has accepted the plaintiff’s theory in the past. If this inconsistency is to be rectified, it needs to go either before the (gulp) U.S. Supreme Court, or Congress has to pass a law clarifying the situation. Whoever or whatever eventually gets to resolve this mess, will need knowledge of the real world, and a solid appreciation of Dickens. Reading the Third Circuit decision, I am reminded of Mr. Bumble: “The law is an ass.”