R5 BLAW Flashcards
CPA Legal Liability
can arise from:
- Breach of Contract
- Tort (negligence, fraud, or constructive fraud)
- Violation of Statute (33 and 34)
Breach of Contract
If CPA doesn’t fulfill terms of engagement
- generally requires privity (client and named 3rd parties)
- if CPA breach is material, not entitled to payment
- defenses mentioned in contract apply
(e. g. client’s failure to let CPA see acct records if failure to cooperate and valid)
Ordinary Negligence
Tort
- must show: duty of care, breach, caused injury, and damages
- majority rule: duty to client and limited forseeable class of persons whom CPA knows will rely on work
- minority ultramares decision: duty to privity so clients and named third party beneficiaries
- defense: neither client nor person who CPA knows will rely on audit (gen public/creditors) NO PRIVITY
Breach- failure to act w due care (ordinary negligence)
- perform w skill and care expected of ordinarily prudent CPAs under the circumstances
- defense: due diligence, followed GAAS or GAAP
Fraud and Constructive Fraud
Tort
Actual Fraud MAIDS
- misrepresentation of material fact
- actual reliance on misrepresentation
- intent to induce reliance
- damages
- scienter: intent to deceive
Constructive Fraud/Gross Negligence
- MAIDS but instead of scienter, reckless
CPA can be liable to anyone
- privity is not a defense to fraud
- best defense: lack of scienter (had good faith)
Securities Laws
Section 11 of 1933 Act
Rule 10b-5 of 1934 Act
Private Securities Litigation Reform Act
Sarbanes-Oxley Act
Section 11 of 1933 Act
IPO "LAM" CPA who signs on FSs in a registration statement can be held liable to a plantiff who "LAM" - loss suffered - acquired the stock - material misrepresentation in FS
defense: due dilligence
no intent, negligence, or reliance required
Rule 10b-5 of 1934 Act
Fraud “MAIDS”
CPA can be held criminally or civilly liable if proven:
- loss suffered
- acquired the stock
- material misrepresentation (LAM same as section 11)
- scienter
- reliance on misrepresentation
Private Securities Litigation Reform Act
CPA has certain duties in an audit under 1934 Securities Exchange Act
Audit Requirements
- designed to detect illegal acts
- designed to identify related party transactions
- evaluate the ability of issuer to continue as a going concern
Detection Procedure
- if illegal acts found, inform issuer’s audit committee
- if AC doesnt take action, report directly to board of directors
Notification to SEC
- board is to report to SEC within 1 day
- if CPA fails to receive copy of notice w/i 1 day, CPA is to furnish SEC w copy of report within 1 day
- CPA may resign from the audit before notifying SEC
Not liable for breach of confidentiality
Sarbanes-Oxley Act
under SOX, it is a crime:
- to knowingly alter, destroy, falsify, etc document to impede federal investigation,
- not keep audit workpapers for 7 years
- defraud
Audit Workpapers
- workpapers belong to the accountant or accountant’s firm, not the client
prohibited from showing papers to anyone w/o client’s permission EXCEPT:
- subpoenaed
- shown to prospective purchaser of CPA’s practice as long as they don’t disclose confidential information (but not given)
- CPA society voluntary quality control review
- defense of a lawsuit
- official investigation by AICPA/state trial board
- GAAP/GAAS requires disclosure
Security Definition
If investor is passive, the investment is most likely a security
include: stocks, bonds, debentures, oil well interest, stock options, collateral trust certificates, warrants, and limited parternship interests
excluded: certificates of deposit and general partnership interests
Securities Act of 1933
regulates original issuance of securities (IPO)
purpose: provide investors w sufficient investment info
- requires most issuers to register new issues of securities w SEC and provide prospectuses containing material info regarding securities
- SEC doesn’t guarantee accuracy of this info, just evaluates completeness
Required to Register: Issuers, Underwriters, and Dealers
Registration Statement
Securities Act of 1933
most securities can’t be sold unless registered w SEC
Part 1- The Prospectus
- a written, radio, or television offer to sell securities
- summarizes info about securities
- each investor must receive a copy of the prospectus before or contemporaneous w every sale of security
Part 2- Info about securities being issued must include
- Audited BS and profit and loss statement from a certified public accounting firm registered w PCAOB*
- names and addresses of directors, officers, underwriters, and shareholders w >10%
- amount of stock and debt issuer has outstanding
- principal purpose offering proceeds will be used for
- anything that might affect value of the securities
Shelf Registrations- just 1 registration statement for all securities they will offer in the future
- GR prohibited, but permitted if issuer has filed under 1934 act for a year and info is continuously updated
SEC reviews the registration statement to ensure completion of both parts
Effective 20 days after filing
Blue Sky Laws- state laws governing stock sales
Timetable of Sales Activity
Securities Act of 1933
30 days before Registration- No Sales Activity Allowed
- permitted to negotiate w an underwriter
After Registration but Before Effectiveness (20 days)- sales GR prohibited but these are allowed:
- oral offers to sell (but no written)
- tombstone ads
- preliminary (red herring) prospectus
After Effective Date
- can be sold, all investors must receive a prospectus
Special Rules for Some 1934 Act Reporting Companies (large private company now going public)
- seasoned issuers have reported under 1934 for >12 months and have been good
- well-known seasoned issuers also have 700 million equity outstanding worldwide
- WKSIs can make oral or written offers at any time and also have a special form of shelf registration effective immediately
Exemptions from Registration
Securities Act of 1933
1933 has 2 types of exemptions
- Securities Exemptions “BRINGS”
- banks and savings and loans (CDs)
- railroads/common carriers
- insurance policies (not companies)
- not for profit orgs
- government
- short term commercial paper (maturity date 9 months or less) - Transaction Exemptions
- non issuer, underwriter or dealer (casual sales)
- exchanges w existing holders and corporate reorganizations
- intrastate sales
- private offering exemption- regulation D*
- regulation A*
Regulation D
Securities Act of 1933
3 private offering exemptions, general conditions that apply:
- prohibiting general advertising of securities sold under regulation D, but exceptions under 504 and 506
- purchasers must hold for 2+ years
- SEC must be informed w/i 15 days of first sale
Rule 504
- 1 million limit in 12 month period
- no limit on number or type of purchaser
- no specific disclosures required
Rule 505
- 5 million limit in 12 month
- any number of accredited investors, but only 35 or less unaccredited
- accredited: 1 million in net worth or 200,000 annual income
- if only accredited purchase, no disclosure required
- if any unaccredited investors, all investors must be given an annual report w audited financial statements
Rule 506
- unlimited dollar amount
- any # of accredited, but only 35 unaccredited, but sophisticated
- if only accredited, no disclosure; if any unaccredited, annual report for all
Regulation A- Simplified Filing
Securities Act of 1933
- modified regulation often referred to as Reg A+
- not a registration exemption, but rather a simplified form of registration to allow SMALL companies to make IPOs quicker and less cost
- file an offering statement with a offering circular
- companies may “test the waters” to determine interest
up to 5 mill
who can NOT use reg A? GAS
- gas, oil, minerals
- acquire or merge an unidentified company
- SEC reporting companies
- companies disqualified by SEC
2 Tiers Under Reg A
- Tier 1
- up to 20 million
- no investor limits
- general solicitation allowed
- financials don’t have to be audited
- filing doesn’t have to be updated - Tier 2
- up to 50 million
- unaccredited investors can’t invest >10% of their income
- general solicitation allowed
- financials must be audited
- filing must be updated
Liability Under 1933 Act
Section 11 - civil
- “LAM”
- need not prove intent to deceive, negligence, or reliance
- anyone who signs a registration statement is liable, privity not required
- defense: due diligence
Section 12- Civil Antifraud
- if required registration was not made, if prospectus not given, or if materially false statements made or omitted
- purchaser may sue for damage, no need for scienter or reliance
Section 17- Criminal Antifraud
- anyone who uses fraud
- enforced by SEC and prosecuted by Justice Department
Securities Exchange Act of 1934
- exchanges (sales and purchases) after securities are issued
- registration and reporting provisions
- antifraud provisions
1934 Act Registration Requirements*
2 companies must register w SEC:
- shares traded on a national exchange or
- more than $10 million in assets and >2,000 shareholders or 500 non accredited shareholders
- national stock exchanges, brokers and dealers must also register
1934 Act Reporting Requirements
Companies Required to Report– Reporting Companies
- all companies required to register under 1934 Act
- any issuer that must register under 1933 Act
must file periodic business reports & 5% TIP
Periodic Business Reports- 10K, 10Q, 8K
- 10K annually within 60 days (90 for large corps) from fiscal year end; must be certified by independent accts
- 10Q quarterly filed w/i 40 days (45 for small); contain reviews of interim financial info by independent CPAs
- 8K filed w/i 4 days after major change in company
5% TIP
- 5%+ Owners Must Report: bg info about purchaser, source of funds, purpose in buying
- Tender Offers: any party making tender off to purchase 5%+; report must include bg info
- Insiders: officers, directors, >10% stockholders; disclose holdings in monthly updates; + absolute liability on insiders who make profits wi 6 month period
- Proxy Solicitations and Statements: written request for permission to vote a shareholder’s shares at a shareholder meeting
- more R5-54
Rule 10b-5– Antifraud Provisions
1934 Act
- Rule 10b applies even if registration not required
- prohibits fraud in connection w purchase or sale of any security
- LAM + scienter + reliance (MAIDS)
- Interstate Commerce- thus federal laws apply
- Insider Trading = Fraud
- SEC can impose fines and seek criminal penalties, but does not prosecute themselves
Section 18
1934 Act
liability for false or misleading information in the registration statement or other required reports (periodic business reports and 5%TIP)
-defense: lack of scienter
