Auditor Ernst and Young LLP must face a lawsuit over its role in a $2.2 billion stock options backdating scheme at Broadcom Corp , a U.S. appeals court ruled.

In a proposed class-action, Broadcom investors alleged Ernst knew of, or recklessly disregarded, fraudulent backdating but still attested to the validity of the communications chip maker's financial statements.

Improper backdating occurs when a company ties stock options to a past date when the share price was low but fails to properly account for it.

A lower court granted Ernst's motion to dismiss the lawsuit. But the U.S. 9th Circuit Court of Appeals ruled that the lawsuit alleged enough facts showing Ernst's state of mind for it to survive dismissal.

The complaint is loaded with specific allegations of how and why EY should have investigated deficient or missing documentation, the court wrote on Thursday.

An Ernst representative, Charlie Perkins, said the company would continue to defend itself vigorously.

We believe our audit work was conducted professionally and appropriately, and that this claim has no merit, Perkins said.

In one of the biggest backdating cases on record, Broadcom acknowledged it improperly accounted for $2.2 billion, and it restated income for fiscal years 1998 to 2005.

A lawyer for the plaintiffs, Thomas Dubbs, said he believes this is the first backdating case against an auditor where a motion to dismiss was ultimately denied. He added that the size and magnitude of Broadcom's restatement must give Ernst and Young pause as to how the case will develop.

We believe this decision underscores the role of major auditing firms as gatekeepers for the system, Dubbs said.

The case in the 9th Circuit is New Mexico State Investment Council v. Ernst & Young, 09-55632.

(Reporting by Dan Levine; Editing by John Wallace, Bernard Orr and Steve Orlofsky)

Lawsuit