REG 10 - Accountant Liability Flashcards
What are three areas where Accountant Liability may arise?
(Why might accountants get sued? 3 sources)
- Common Law
- Federal Securities Laws (1933/1934 Acts)
- Violating Accountant-Client privileged information
What are the three types of Common Law Liability?
- Breach of Contract
- Negligence (Forseen User)
- Fraud/Gross Negligence (1934)
Breach of Contract
(Who can sue, Plaintiff prove, Defense)
Breach of Contract - an accountant who does not fulfil the terms of the contract or engagement will be held liable for Breach of Contract as a result of non-compliance & accountant will be held liable to the client (in privity) & any intended 3rd party beneficiaries for compensatory damages.
Who can sue?
- Anyone in Privity - Anyone who hired you or in the contract
- Intended 3rd party beneficiaries (donee or creditor)
Plaintif must prove? (MILE):
- Material misstatement or omission (FS must contain)
- Info - in the FS was the proximate cause of the harm to the plaintiff
- Loss (damages) - plaintiff must have suffered a financial loss as a result of the above
- Error - caused by breach or non-performance
Defense by accountant?
- Did NOT breach the contract
- Fully performed contract terms
Negligence
(Who can sue, Plaintiff prove, Defense)
Negligence (Forseen User) - failure to excercise due professional care in the performance of an engagement.
Who can sue?
- Privity (client)
- Intended 3rd party beneficiaries (donee or creditor)
- Known or Forseen User by CPA
Plaintif must prove? (MIL-E):
- Material misstatement or omission (FS must contain)
- Info - in the FS was the proximate cause of the harm to the plaintiff
- Loss (damages) - plaintiff must have suffered a financial loss as a result of the above
-
Error - Absence of Due Professional Care (NEGligent)
-
Non-disclosure of information to client
- Ex: Internal control weakness
- Errors previously discovered but NOT corrected
- GAAS/GAAP NOT followed
-
Non-disclosure of information to client
Defense by accountant?
- NOT NEGligent (Performed w/ Due Care)
- Disclosed ALL information
- Errors previously discovered ARE corrected
- GAAS/GAAP Standards ARE followed
- Plaintiff Lacks Privity
Fraud/Gross Negligence (& 1934 Act)
(Who can sue, Plaintiff prove, Defense)
Fraud/Gross Negligence - Ineffective performance with intent to deceive making the auditor liable to those with or without privity, which may be actual fraud or constructive fraud.
Who can sue?
- Anyone
- Unforseen or “Unknown”
Plaintif must prove? (MILE):
- Material misstatement or omission (FS must contain)
- Info - in the FS was relied upon which caused harm to the plaintiff
- Loss (damages) - plaintiff must have suffered a financial loss as a result of the above
-
Error - reckless or intentional misconduct
- Actual Fraud - Intent to deceive; scienter
- Constructive Fraud - reckless disregard
Defense by accountant?
- Not Gross Negligent
- Not Material
Privity
Being a “party to the contract” &, as a result, being entitled to remedies in the form of compensatory damages for the non-performance by other parties to the contract.
Actual Fraud
&
Constructive Fraud
Actual Fraud - making false statement with scienter or the knowledge of their falsity, such as expressing an unmodified opinion on FS that the auditor knows to be materially misstated.
Constructive Fraud - making false statements as a result of gross negligence or recklessness disregard for the truth, not knowing if the statements are true or false, such as an auditor expressing an opinion in the report on FS of which an audit was not actually performed.
Scienter
The intent to mislead, decieve, manipulate, or defraud with the accountant’s knowledge of the falsity.
NOTE: Correct! Acting without good faith constitutes scienter under the 1934 Act and would result in liability if the other elements of proof are satisfied.
Liability under 1933 Act
(Who can sue, Plaintiff prove, Defense)
1933 Securities Act - Law requires that the audited FS be included in the prospectus & registration statement required when puclic offers (IPO) fall within the law. Section 11 makes anoyone who signs the registration statement liable for all damages caused by any mistatement of material fact in the registration statement.
Who can sue?
- Anyone
- NO Privity Needed
Plaintif must prove? (MiLe):
- Material misstatement or omission (FS must contain)
- Loss (damages) - plaintiff must have suffered a financial loss as a result of the above
- FS must be included in the prospectus
Accountant/Auditor is GUILTY until he/she proves?
- Investor knew of error (prove investor did not rely)
- Due Diligence (Without NEGligence)
- Non-disclosures aren’t present
- Errors were corrected
- GAAS/GAAP were followed
Liability under 1934 Act
(Who can sue, Plaintiff prove, Defense)
1934 Securities Act - Ineffective performance with intent to deceive making the auditor liable to those with or without privity, which may be actual fraud or constructive fraud.
Who can sue?
- Anyone
- NO Privity Needed
Plaintif must prove? (MILE):
- Material misstatement or omission (FS must contain)
- Info - in the FS was relied upon which caused harm to the plaintiff
- Loss (damages) - plaintiff must have suffered a financial loss as a result of the above
-
Error - reckless or intentional misconduct
- Actual Fraud - Intent to deceive; scienter
- Constructive Fraud - reckless disregard
Accountant/Auditor is GUILTY until he/she proves?
- Not Gross Negligent
- Not Material
NOTE: Correct! Acting without** **good faith constitutes scienter under the 1934 Act and would result in liability if the other elements of proof are satisfied.
NOTE: Correct! Under the Securities Exchange Act of 1934, both civil and criminal penalties could be assessed against a CPA who intentionally violates the provisions of Section 10(b), Rule 10b-5.
1995 Private Securities Litigation Reform Act
(RIG)
This law places into the code several responsibilities already considered part of an effective audit under GAAS, including (RIG):
- Related-party Transactions - auditor must include substatntive tests desgined to identify all significant/material related-party transactions
- Illegal Acts - auditor should attempt to identify illegal acts with a direct & material effect on the FS
- Going Concern - auditor should perform tests to determine if there is substantial doubt as to the ability of the client to continue in existence throughout the following fiscal year.
NOTE: The board of directors has 1 day to report to the SEC of these illegal acts & must provide proof that it did to the auditor. If auditor did not receive proof, the auditor has 1 business day to either:
- Resign from the engagement
- Notify the SEC of the board’s failure to make the appropriate filing
Paid Tax Preparers
Penalty may be assessed if? (3)
Paid tax preparers of federal income tax returns are subject to federal statutory liability as well. A penalty may be assessed by the IRS against a preparer who:
- Fails to sign the return, & provide appropriate Federal ID#
- Fails to provide a copy of the return to the client & retain a copy for the time specified by the law
- Negotiates or endorses a client’s tax refund check
NOTE: Incorrect! A tax preparer may rely on the information provided by the taxpayer without seeing documentation, as long as the preparer has made reasonable inquiries that satisfy the preparer that any necessary documentation exists. Under these circumstances, the preparer has no liability to the IRS.
Working Papers (4)
(Audit Documentation)
The accountant, not the client, owns the working papers. The accountant must maintain confidentiality, & cannot provide the working papers obtained during the engagement to other parties without the permission of the client. Some exceptions are:
- Valid subpeona
- IRS administrative subpeona
- Court Order
- Quality Control Peer Review
- “State CPA Society Quality Control Panel”
Racketeer Influenced & Corrupt Organizations Act
(RICO)
An act passed by congress with the intent of punishing those engaged in racketeering by extending criminal liability to those ordering the commitment of racketeering or assisting in those involved in racketeering.
Racketeering - an illegal activity carried out on behalf of an organization, such as the use of organized crime to commit illegal acts like extortion, or the use of a legitimate business to perfom illegal acts like money laundering. Examples are:
- extortion
- any act or threat involving murder
- kidnapping
- gambling
- arson
- robbery
- dealing with controlled substance
Ultramares vs. Touche Ruling
Correct! Under the Ultramares vs. Touche ruling, only parties in privity of contract with the auditor can successfully sue for negligence; and since Hark was not told that the specific purpose of the audit was to submit statements to Third Bank, Third lacks privity.
Correct! Under the Ultramares vs. Touche ruling, only parties in privity can sue the auditor for negligence. A foreseen party that does not meet the standard of privity of contract cannot sue for negligence.
