A corporation can be held responsible for an executive's wrongdoing, even if the corporation itself is hurt by the official's actions, a federal appeals court ruled.

The exception to the general legal rule occurs if innocent third parties relied on the executive's authority, said the 9th U.S. Circuit Court of Appeals in San Francisco in a ruling last week in In re ChinaCast Education Corporation Securities Litigation that overturned a lower court ruling.

In 2011, the auditors for Hong Kong –based ChinaCast, an education and e-learning services provider, revealed that it had “serious internal control weaknesses,” according to the ruling.

Soon after, its founder and CEO, Ron Chan Tze Ngon, looted the company's coffers, including proceeds from its U.S. stock offering, transferring $120 million of corporate assets to outside accounts, among other activities, court papers say.

During this time, Mr. Chan and another executive emphasized the company's financial health and stability in communications with investors, according to the ruling.

Mr. Chan was fired in March 2012. In September 2012, a group of shareholders sued ChinaCast, Mr. Chan and others.

The U.S. District Court in Pasadena, California, dismissed the case holding that because Mr. Chan had acted against the company's interests, ChinaCast could not be held responsible for his actions.

However, a three-judge appeals court panel unanimously overturned that ruling saying that the so-called adverse interest rule “doesn't apply in every instance where there is a faithless fraudster within the corporate ranks.”

“In other words, there is an exception to the exception: the adverse interest rule collapses in the face of an innocent third party who relies on the agent's apparent authority,” said the ruling.

That is the case here, said the ruling. “The complaint alleges that third-party shareholders understandably relied on Chan's representations, which were made with the imprimatur of the corporation that selected him to speak on its behalf and sign (Securities and Exchange Commission) filings.”

Furthermore, ChinaCast learned from its auditor in 2011 of the company's internal control weaknesses, “yet the company failed to take significant action or heighten oversight. Had they done so, they may have prevented much of the decimation of ChinaCast's bottom line and share value,” said the ruling.