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