Audit Ch 4

Securities Act of 1933

Regulates initial issuance of registered securities to the investing public Registrants required to file registration statement with SEC (that includes F/S) Plaintiffs must prove 1. Loss 2. F/S contained a material misstatement No need to prove that audit was performed with due diligence or causation (burden of proof on auditor)

What types of damages are allowed?

1. Auditor's fee 2. Compensatory damages 3. Punitive damages **Many courts have applied the doctrine of comparative negligence which allows for allocation of damages among plaintiffs (in contrast to joint and several liability)

what can auditors be sued for under common law?

1. Breach of contract 2. Ordinary negligence (lack of reasonable care) 3. Gross negligence (lack of minimal care) 4. Fraud (scienter)

Who are auditors responsible to?

1. Clients (through engagement letter) 2. Known users (Ultramares): 3. Foreseen users (2nd Restatement of the Law of Torts) 4. Forseeable users (rosenblum)

What must plaintiffs prove for a charge of negligence?

1. The auditor had a duty to the plaintiff to exercise due care 2. The auditor failed to act in accordance with that duty (i.e., follow GAAS) 3. The plaintiff suffered a loss 4. The auditor's lack of due care was the cause of the plaintiff's loss (aka causation or proximate cause) *** Defendant considered innocent until proven guilty

Under common law, the CPAs who were negligent may mitigate some damages to a client by proving: A. Contributory negligence. B. The CPAs' fee was not material. C. The CPAs were not competent to accept the engagement. D. The CPAs' negligence was caused by the fact that they had too much work.

A

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: A. Strict liability for all damages incurred. B. Gross negligence. C. Either ordinary or gross negligence. D. Breach of contract.

B

In cases of breach of contract, plaintiffs generally have to prove all of the following, except: A. The CPAs had a duty. B. The CPAs made a false statement. C. The client incurred losses related to the CPAs' performance. D. The CPAs breached their duty.

B

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. A. Only applies to Section 11 of the 1933 Securities Act. B. Only applies to Section 10(b) of the Securities Exchange Act. C. Applies to both acts. D. Applies to neither of the acts.

B

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. A. Only applies to Section 11 of the 1933 Securities Act. B. Only applies to Section 10(b) of the Securities Exchange Act. C. Applies to both acts. D. Applies to neither of the acts

B

Statutory Law

Based on violations of WRITTEN statutes -shareholders

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. A. Only applies to Section 11 of the 1933 Securities Act. B. Only applies to Section 10(b) of the Securities Exchange Act. C. Applies to both acts. D. Applies to neither of the acts.

C

Under the Securities and Exchange Act of 1934, auditors and other defendants are generally faced with: A. Joint liability. B. Joint and several liability. C. Proportionate liability. D. Limited liability.

C

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? A. The investor has not proved fraud or negligence by the CPA. B.The investor did not actually rely upon the false statement. C. The CPA detected the false statement after the audit date. D. The false statement is immaterial in the overall context of the financial statements.

D

If the CPAs provided negligent tax advice to a public company, the client would bring suit under: A. The Securities Act of 1933. B. The Securities Exchange Act of 1934. C. The federal income tax law. D. Common law

D

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. A. Only applies to Section 11 of the 1933 Securities Act. B. Only applies to Section 10(b) of the Securities Exchange Act. C. Applies to both acts. D. Applies to neither of the acts.

D

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

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: 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

Foreseeable users (Rosenblum):

Liable to any third party the auditors could reasonable "foresee" as relying on the financial statements for routine business purposes (this precedent has not commonly been followed)

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

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

Foreseen users (2nd restatement of the Law of Torts)

Third parties who the auditors knows will rely on the financial statements (can be part of a group) even if exact identity is not known

Known users (ultramares)

Third party that has been disclosed to the auditor

Common Law

Uses legal precedent to identify fault and responsibility -clients -non-shareholder 3rd parties

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. A. Only applies to Section 11 of the 1933 Securities Act. B. Only applies to Section 10(b) of the Securities Exchange Act. C. Applies to both acts. D. Applies to neither of the acts.

C

Which of the following elements is most frequently necessary to hold a CPA liable to a client? A. Acted with scienter or guilty knowledge. B. Was not independent of the client. C. Failed to exercise due care. D. Did not use an engagement letter.

C

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? A. The purchasers of securities must prove ordinary negligence by the auditors and reliance on the audited financial statements. B. The purchasers of securities must prove that the financial statements were misleading and that they relied on them to purchase the securities. C. 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." D. The purchasers of securities must prove that the financial statements were misleading and the auditors were negligent.

C

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

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

Securities Exchange Act of 1934

Regulates daily trading of securities (requires periodic filing of F/S with SEC) Plaintiffs must prove 1. Loss 2. F/S contained a material misstatement 3. They relied upon the financial statement 4. Intent to deceive

Which of the following approaches to auditors' liability is least desirable from the CPA's perspective? A. The Ultramares approach. B. The Rosenblum approach. C. The Restatement of Torts approach. D. The Foreseen User approach.

B

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. A. Only applies to Section 11 of the 1933 Securities Act. B. Only applies to Section 10(b) of the Securities Exchange Act. C. Applies to both acts. D. Applies to neither of the acts.

D

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

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