ACCT400 Chapter 4
The 1933 Act requires _____ to prove a loss and misleading financial statements
third parties
1933 Act
Auditors must prove due diligence
The third party user approach revolves around auditor_____
liability
Under the 1934 Act, third parties must prove _____
scienter
The 1934 Act protect any person buying or _____ the security
selling
The _____ requires registration of an initial stock sale
1933 Act
Item (a) relates to what a plaintiff who purchased securities must prove in a civil liability suit against a CPA. a. The plaintiff security purchaser must prove material misstatements were included in a filed document.
Applies to both acts
Item (b) relates to what a plaintiff who purchased securities must prove in a civil liability suit against a CPA. b. The plaintiff security purchaser must prove a monetary loss occurred.
Applies to both acts
Failure of one or both parties to a contract to perform in accordance with the contract's provisions
Breach of contract
If the CPAs provided negligent tax advice to a public company, the client would bring suit under:
Common law
Under common law, the CPAs who were negligent may mitigate some damages to a client by proving:
Contributory negligence
The most significant result of the Continental Vending case was that it:
Created a more general awareness of the possibility of auditor criminal prosecution
Which of the following cases reaffirmed the principles in the Ultramares case?
Credit Alliance Corp. V. Arthur Andersen & Co.
A landmark case in which the auditors were held liable under Section 11 of the Securities Act of 1933
Escott V. BarChris Construction Corp.
Dandy Container Corporation engaged the accounting firm of Adams and Adams to audit financial statements to be used in connection with an interstate public offering of securities. The audit was completed, and an unqualified opinion was expressed on the financial statements that were submitted to the Securities and Exchange Commission along with the registration statement. Two hundred thousand shares of Dandy Container common stock were offered to the public at $11 a share. Eight months later the stock fell to $2 a share when it was disclosed that several large loans to two "paper" corporations owned by one of the directors were worthless. The loans were secured by the stock of the borrowing corporations, which was owned by the director. These facts were not disclosed in the financial statements. The director involved and the two corporations are insolvent. Required: State whether the following statement is true or false relating to original purchasers of the stock. c. An insider who had knowledge of all the facts regarding the loans to the two paper corporations could nevertheless recover from the accounting firm.
False
Misrepresentation by a person of a material fact, known by that person to be untrue or made with reckless indifference as to whether the fact is tru with intent to deceive and with the result that another party is injured
Fraud
If a CPA performs an audit recklessly, the CPA will be liable to third parties who were unknown and not foreseeable to the CPA for:
Gross negligence
A case that established that auditors should not be held liable under the Securities Exchange Act of 1934 unless there was intent to deceive
Hochfelder V. Ernst
Assume that in a particular audit the CPAs were negligent but not grossly negligent. Indicate whether they would be "liable" or "not liable" for the following loss proximately caused by their negligence and determine that liability under the various theories discussed and followed by different states: a. Loss sustained by client; suit brought under common law.
Liable
Assume that in a particular audit the CPAs were negligent but not grossly negligent. Indicate whether they would be "liable" or "not liable" for the following loss proximately caused by their negligence and determine that liability under the various theories discussed and followed by different states: c. Loss sustained by a bank known to the auditors to be relying on the financial statements for a loan; suit brought in a state court that adheres to the Credit Alliance v. Arthur Andersen precedent.
Liable
Assume that in a particular audit the CPAs were negligent but not grossly negligent. Indicate whether they would be "liable" or "not liable" for the following loss proximately caused by their negligence and determine that liability under the various theories discussed and followed by different states: d. Losses to stockholders purchasing shares at a public offering; suit brought under the Securities Act of 1933.
Liable
Assume that in a particular audit the CPAs were negligent but not grossly negligent. Indicate whether they would be "liable" or "not liable" for the following loss proximately caused by their negligence and determine that liability under the various theories discussed and followed by different states: e. Loss sustained by a bank named as a third-party beneficiary in the engagement letter; suit brought under common law.
Liable
Assume that in a particular audit the CPAs were negligent but not grossly negligent. Indicate whether they would be "liable" or "not liable" for the following loss proximately caused by their negligence and determine that liability under the various theories discussed and followed by different states: f. Loss sustained by a lender not in privity of contract; suit brought in a state court that adheres to the Rosenblum v. Adler precedent.
Liable
Violation of a legal duty to exercise a degree of care that an ordinary prudent person would exercise under similar circumstances
Negligence
Assume that in a particular audit the CPAs were negligent but not grossly negligent. Indicate whether they would be "liable" or "not liable" for the following loss proximately caused by their negligence and determine that liability under the various theories discussed and followed by different states: b. Loss sustained by trade creditor, not in privity of contract; suit brought in a state court that adheres to the Ultramares v. Touche Co. precedent.
Not liable
Assume that in a particular audit the CPAs were negligent but not grossly negligent. Indicate whether they would be "liable" or "not liable" for the following loss proximately caused by their negligence and determine that liability under the various theories discussed and followed by different states: g. Losses sustained by stockholders; suit brought under Sections 18(a) and 10(b) of the Securities Exchange Act of 1934.
Not liable
Under the Securities and Exchange Act of 1934, auditors and other defendants are generally faced with:
Proportionate liability
Match the established precedent to the correct Third Party Liability Approach: Auditors must prove due diligence (foreseen user)
Restatement approach
The _____ approach includes responsibility toward any foreseeable users of the financial statements
Rosenblum
Match the established precedent to the correct Third Party Liability Approach: Third part must prove existence of scienter (foreseeable user)
Rosenblum Approach
Written law created by state or federal legislative bodies
Statutory law
In cases of breach of contract, plaintiffs generally have to prove all of the following, except:
The CPAs made a false statement
Which of the following approaches to auditors' liability is least desirable from the CPA's perspective?
The Rosenblum approach
A CPA issued an unqualified opinion on the financial statements of a company that sold common stock in a public offering subject to the Securities Act of 1933. Based on a misstatement in the financial statements, the CPA is being sued by an investor who purchased shares of this public offering. Which of the following represents a viable defense?
The false statement is material in the overall context of the financial statements
Which statement best expresses the factors that purchasers of securities registered under the Securities Act of 1933 need to prove to recover losses from the auditors?
The purchasers of securities must prove that the financial statements were misleading; then, the burden of proof is shifted to the auditors to show that the audit was performed with "due diligence"
Dandy Container Corporation engaged the accounting firm of Adams and Adams to audit financial statements to be used in connection with an interstate public offering of securities. The audit was completed, and an unqualified opinion was expressed on the financial statements that were submitted to the Securities and Exchange Commission along with the registration statement. Two hundred thousand shares of Dandy Container common stock were offered to the public at $11 a share. Eight months later the stock fell to $2 a share when it was disclosed that several large loans to two "paper" corporations owned by one of the directors were worthless. The loans were secured by the stock of the borrowing corporations, which was owned by the director. These facts were not disclosed in the financial statements. The director involved and the two corporations are insolvent. Required: State whether the following statement is true or false relating to original purchasers of the stock. f. The accountants could avoid or reduce the damages asserted against them if they could establish that the drop in the stock's market price was due in whole or in part to other causes.
True
1934 Act
Third party must prove existence of scienter Auditors must prove good faith
The _____ approach assigns responsibility by the auditor to the narrowest category of financial statement users
Ultramares
The _____ approach requires auditors to be responsible to known financial statement users
Ultramares
A landmark case establishing that auditors should be held liable to third parties not in privity of contract for gross negligence, but not for ordinary negligence
Ultramares V. Touche & Co.
Match the established precedent to the correct Third Party Liability Approach: Auditors must prove due diligence (known user)
Ultramares approach
A case in which auditors were held liable for criminal negligence
United States V. Simon (Continental Vending)
Item (c) relates to what a plaintiff who purchased securities must prove in a civil liability suit against a CPA. c. The plaintiff security purchaser must prove lack of due diligence by the CPA.
Applies to neither of the acts
Item (d) relates to what a plaintiff who purchased securities must prove in a civil liability suit against a CPA. d. The plaintiff security purchaser must prove privity with the CPA.
Applies to neither of the acts
Unwritten law that has developed through court decisions; it represents judicial interpretation of a society's concept of fairness
Commons law
Performing duties with such recklessness that persons believing the duties have been completed carefully are being misled. The person performing the duties does not have knowledge of misrepresentations within the financial statements
Constructive fraud
A common law case in which the court held that auditors should be held liable for ordinary negligence only to third parties they know will use the financial statements for a particular purpose
Credit Alliance V. Arthur Andersen & Co.
Which of the following elements is most frequently necessary to hold a CPA liable to a client?
Failed to exercise due care
Dandy Container Corporation engaged the accounting firm of Adams and Adams to audit financial statements to be used in connection with an interstate public offering of securities. The audit was completed, and an unqualified opinion was expressed on the financial statements that were submitted to the Securities and Exchange Commission along with the registration statement. Two hundred thousand shares of Dandy Container common stock were offered to the public at $11 a share. Eight months later the stock fell to $2 a share when it was disclosed that several large loans to two "paper" corporations owned by one of the directors were worthless. The loans were secured by the stock of the borrowing corporations, which was owned by the director. These facts were not disclosed in the financial statements. The director involved and the two corporations are insolvent. Required: State whether the following statement is true or false relating to original purchasers of the stock. g. The Securities and Exchange Commission would defend any action brought against the accountants in that the SEC examined and approved the registration statement.
False
Damage to another is attributable to a wrongdoer's act. This issue may be raised as a defense in litigation - that is the defense may argue that some other factor caused the loss
Proximate cause
Item (e) relates to what a plaintiff who purchased securities must prove in a civil liability suit against a CPA. e. The plaintiff security purchaser must prove reliance on the document.
Only applies to Section 10(b) of the Securities Exchange Act
Item (f) relates to what a plaintiff who purchased securities must prove in a civil liability suit against a CPA. f. The plaintiff security purchaser must prove the CPA had scienter.
Only applies to Section 10(b) of the Securities Exchange Act
A case that established the precedent that auditors should be held liable under common law for ordinary negligence to all foreseeable third parties
Rosenblum V. Adler
A case in which the court used the guidance of the Second Restatement of the Law of Torts to decide the auditors' liability to third parties under common law
Rusch Factors, Inc. V. Levin
Intent to deceive, manipulate or defraud. This concept is used in the 1934 Securities Exchange Act to establish auditor liability.
Scienter
A federal securities statute covering registration statements for securities to be sold to the public
Securities Act of 1933
Dandy Container Corporation engaged the accounting firm of Adams and Adams to audit financial statements to be used in connection with an interstate public offering of securities. The audit was completed, and an unqualified opinion was expressed on the financial statements that were submitted to the Securities and Exchange Commission along with the registration statement. Two hundred thousand shares of Dandy Container common stock were offered to the public at $11 a share. Eight months later the stock fell to $2 a share when it was disclosed that several large loans to two "paper" corporations owned by one of the directors were worthless. The loans were secured by the stock of the borrowing corporations, which was owned by the director. These facts were not disclosed in the financial statements. The director involved and the two corporations are insolvent. Required: State whether the following statement is true or false relating to original purchasers of the stock. a. The Securities Act of 1933 applies to the above-described public offering of securities.
True
The 1136 Tenants' case was important because of its emphasis upon the legal liability of the CPA when associated with:
Unaudited financial statements
A method of allocating damages to each group that is liable according to that groups pro-rata share of any damages recovered by the plaintiff.
Proportionate liability
Dandy Container Corporation engaged the accounting firm of Adams and Adams to audit financial statements to be used in connection with an interstate public offering of securities. The audit was completed, and an unqualified opinion was expressed on the financial statements that were submitted to the Securities and Exchange Commission along with the registration statement. Two hundred thousand shares of Dandy Container common stock were offered to the public at $11 a share. Eight months later the stock fell to $2 a share when it was disclosed that several large loans to two "paper" corporations owned by one of the directors were worthless. The loans were secured by the stock of the borrowing corporations, which was owned by the director. These facts were not disclosed in the financial statements. The director involved and the two corporations are insolvent. Required: State whether the following statement is true or false relating to original purchasers of the stock. b. The accounting firm has potential liability to any person who acquired the stock.
True
Dandy Container Corporation engaged the accounting firm of Adams and Adams to audit financial statements to be used in connection with an interstate public offering of securities. The audit was completed, and an unqualified opinion was expressed on the financial statements that were submitted to the Securities and Exchange Commission along with the registration statement. Two hundred thousand shares of Dandy Container common stock were offered to the public at $11 a share. Eight months later the stock fell to $2 a share when it was disclosed that several large loans to two "paper" corporations owned by one of the directors were worthless. The loans were secured by the stock of the borrowing corporations, which was owned by the director. These facts were not disclosed in the financial statements. The director involved and the two corporations are insolvent. Required: State whether the following statement is true or false relating to original purchasers of the stock. d. In court, investors who bought shares in Dandy Container need only show that they sustained a loss and that failure to explain the nature of the loans in question constituted a false statement or misleading omission in the financial statements.
True
Dandy Container Corporation engaged the accounting firm of Adams and Adams to audit financial statements to be used in connection with an interstate public offering of securities. The audit was completed, and an unqualified opinion was expressed on the financial statements that were submitted to the Securities and Exchange Commission along with the registration statement. Two hundred thousand shares of Dandy Container common stock were offered to the public at $11 a share. Eight months later the stock fell to $2 a share when it was disclosed that several large loans to two "paper" corporations owned by one of the directors were worthless. The loans were secured by the stock of the borrowing corporations, which was owned by the director. These facts were not disclosed in the financial statements. The director involved and the two corporations are insolvent. Required: State whether the following statement is true or false relating to original purchasers of the stock. e. The accountants could avoid liability if they could show they were not negligent.
True
The 1933 and 1934 acts include provisions for civil and _____ charges against CPAs
criminal
The Restatement approach requires responsibility towards _____ users of the financial statements
foreseen