STUDY UNIT TWO CPAs AND THE LAW

Question 1

Fact Pattern: While conducting an audit, Larson Associates, CPAs, failed to detect material misstatements included in its client’s financial statements. Larson’s unmodified opinion was included with the financial statements in a registration statement and prospectus for a public offering of securities made by the client. Larson knew that its opinion and the financial statements would be used for this purpose.
Which of the following statements is true with regard to a suit against Larson and the client by a purchaser of the securities under Section 11 of the Securities Act of 1933?

A. The purchaser must prove that Larson was negligent in conducting the audit.
B. Larson will not be liable if it had reasonable grounds to believe the financial statements were accurate.
C. The purchaser must prove that Larson knew of the material misstatements.
D. Larson will be liable unless the purchaser did not rely on the financial statements.

Answer 1

B. Larson will not be liable if it had reasonable grounds to believe the financial statements were accurate.
Answer (B) is correct.
To recover under Section 11, the plaintiff need only prove that (s)he acquired securities subject to a registration statement, (s)he suffered a loss, and a part of the registration statement for which the defendant was responsible contained a misstatement or omission of a material fact. The plaintiff and the defendant need not have been in privity of contract, the plaintiff need not have relied on the misstatement or omission, and the defendant need not have been negligent. An auditor who proves (s)he was not negligent by showing (s)he acted with “due diligence” is then relieved of liability under Section 11.
(2.3.103)

Question 2

Quincy bought Teal Corp. common stock in an offering registered under the Securities Act of 1933. Worth & Co., CPAs, expressed an unmodified opinion on Teal’s financial statements that were included in the registration statement filed with the SEC. Quincy sued Worth under the provisions of the 1933 act that deal with omission of facts required to be in the registration statement. Quincy must prove that

A. There was a material misstatement in the financial statements.
B. Quincy relied on Worth’s opinion.
C. Quincy was in privity with Worth.
D. There was fraudulent activity by Worth.

Answer 2

A. There was a material misstatement in the financial statements.
Answer (A) is correct.
Section 11 is the most frequently invoked basis for suit under the Securities Act of 1933. Under Section 11, the investor need only prove that (1) (s)he suffered losses in a transaction involving the particular securities covered by the registration statement, and (2) the registration statement contained a material misstatement or omission of a fact for which the CPAs were responsible, e.g., in the audited financial statements. Proof of negligence is not required.
(2.3.102)

Question 3

Which one of the following, if present, would support a finding of constructive fraud on the part of a CPA?

A. Ordinary negligence.
B. Reckless disregard.
C. Intent to deceive.
D. Privity of contract.

Answer 3

B. Reckless disregard.
Answer (B) is correct.
Whether an accountant is liable for fraud depends on whether (s)he acted with scienter. Scienter means that the person making a representation knew that it was false at the time of making it or acted with a reckless disregard for the truth. The difference between actual and constructive fraud is that the scienter requirement for the latter is met by gross negligence (reckless disregard). Hence, the following four elements are necessary to prove constructive fraud: (1) misrepresentation of a material fact, (2) reckless disregard for the truth, (3) reasonable reliance by the injured party, and (4) injury. Thus, the presence of reckless disregard for the truth would support a finding of constructive fraud on the part of a CPA.
(2.4.179)

Question 4

Corporations that are exempt from registration under the Securities Exchange Act of 1934 are subject to the act’s

A. Proxy solicitation provisions.
B. Antifraud provisions.
C. Provisions dealing with the filing of annual reports.
D. Provisions imposing periodic audits.

Answer 4

B. Antifraud provisions.
Answer (B) is correct.
The antifraud provisions of the act apply to any person who performs a prohibited act in connection with the purchase or sale of any security, whether or not the security is registered.
(2.3.121)

Question 5

Which of the following is incorrect regarding an engagement letter?

A. The engagement letter includes all necessary elements of a contract.
B. The engagement letter need not include specific descriptions of services to be performed.
C. The engagement letter should include a description of services to be performed beyond those required by professional standards.
D. The engagement letter is not a prerequisite to the formation of a personal service contract for audit services.

Answer 5

B. The engagement letter need not include specific descriptions of services to be performed.
Answer (B) is correct.
An engagement letter includes descriptions of the services contracted to be performed. For example, a provision for positive confirmation of all accounts receivable may be set forth in the engagement letter.
(2.4.186)

Question 6

Given evidence of a violation of the federal securities laws, the SEC lacks the power to

A. Subpoena witnesses.
B. Compel the production of books and records anywhere in the United States.
C. Prosecute criminal cases.
D. Determine responsibility for a violation in an administrative hearing and impose certain sanctions.

Answer 6

C. Prosecute criminal cases.
Answer (C) is correct.
The SEC is a federal administrative agency with both quasi-legislative and quasi-judicial authority. It promulgates rules and regulations under the securities laws, but it is also empowered to enforce these laws. Its powers include the ability to subpoena witnesses, books, and records and to conduct administrative hearings to adjudicate cases involving alleged breaches of the rules and regulations. It can also issue cease-and-desist orders directed against potential as well as actual violations. Because administrative agencies cannot impose criminal sanctions, the Justice Department must prosecute criminal cases involving violations of the securities laws.
(2.1.32)

Question 7

A requirement of a private action to recover damages for violation of the registration requirements of the Securities Act of 1933 is that

A. The securities were purchased from an underwriter.
B. A registration statement was filed.
C. The plaintiff acquired the securities in question.
D. The issuer or other defendants committed either negligence or fraud in the sale of the securities.

Answer 7

C. The plaintiff acquired the securities in question.
Answer (C) is correct.
The Securities Act of 1933 permits a civil action by an acquirer of securities if the required registration was not made, if a registered security was sold but a prospectus was not delivered, if a security was sold using a prospectus that was not current, or if an offer to sell was made before a required registration. Section 11 allows an acquirer to sue for misstatements or omissions of material facts in the registration statement.
(2.3.126)

Question 8

Anderson, LLC, is a large registered public accounting firm that is the continuing auditor of PubCo, an issuer of publicly traded securities subject to the Securities Exchange Act of 1934. Under the Sarbanes-Oxley Act of 2002, Anderson

A. Will be criminally liable for destroying its working papers 2 years after each audit.
B. Must rotate all partners off the PubCo audit every 5 years.
C. Is subject to inspections by the PCAOB every 3 years.
D. May provide internal auditing services to PubCo even though the work will be subject to audit procedures.

Answer 8

A. Will be criminally liable for destroying its working papers 2 years after each audit.
Answer (A) is correct.
Auditors must retain their audit working papers for at least 7 years. Under Title VIII of the act (also known as the Corporate and Criminal Fraud Accountability Act of 2002), it is a crime for auditors to fail to maintain all audit or review working papers for 5 years. Furthermore, tampering with records, for example, altering, destroying, or concealing audit working papers, for the purpose of impairing their integrity or availability for use in an official proceeding or to obstruct such a proceeding is a crime punishable by up to 20 years in prison.
(2.3.118)

Question 9

The reporting requirements of the Securities Exchange Act of 1934 and its rules

A. Require all corporations engaged in interstate commerce to file an annual report.
B. Apply to a corporation that registered under the Securities Act of 1933 but that did not register under the Securities Exchange Act of 1934.
C. Apply only to issuers, underwriters, and dealers.
D. Require all corporations engaged in interstate commerce to file quarterly audited financial statements.

Answer 9

B. Apply to a corporation that registered under the Securities Act of 1933 but that did not register under the Securities Exchange Act of 1934.
Answer (B) is correct.
The following must file periodic reports under the 1934 act: (1) national securities exchanges, (2) an issuer with more than $10 million in total gross assets and 500 or more shareholders of a class of equity securities traded in interstate commerce, (3) an issuer whose securities are traded on a national exchange, and (4) an issuer that has registered under the 1933 act. These issuers must file annual (10-K), quarterly (10-Q), and material events (8-K) reports and send similar reports to shareholders. However, an issuer that must report solely on the basis of registration under the 1933 act need not transmit an annual report to its shareholders.
(2.2.67)

Question 10

Fact Pattern: West & Co., CPAs, expressed an unmodified opinion on the financial statements of Pride Corp. These were included in Pride’s registration statement filed with the SEC. Subsequently, Hex purchased 500 shares of Pride’s preferred stock, which were acquired as part of a public offering subject to the Securities Act of 1933. Hex has commenced an action against West based on the Securities Act of 1933 for losses resulting from misstatements of facts in the financial statements included in the registration statement.
Which of the following elements must Hex prove to hold West liable?

A. West performed the audit negligently.
B. West expressed its opinion with knowledge of material misstatements.
C. The misstatements were material.
D. Hex relied on the financial statements included in the registration statement.

Answer 10

C. The misstatements were material.
Answer (C) is correct.
Section 11 is the most frequently invoked basis for suit under the Securities Act of 1933. Under Section 11, the investor need only prove that (s)he suffered losses in a transaction involving the particular securities covered by the registration statement and that the registration statement contained a material misstatement or omission of fact for which the CPAs were responsible, e.g., in the audited financial statements. Unless rebutted, such proof is sufficient to prevail in the lawsuit.
(2.3.112)

Question 11

ABC Construction Company hires Brown, LLP, to perform audit services as an independent contractor. Brown’s status as an independent contractor is inconsistent with

A. Hiring a staff accountant to assist in the completion of the required services.
B. Signing a contract to perform consulting services for Gator Construction, Inc., a similar-sized construction company in the same market.
C. Signing a contract to perform tax services for Gator Construction, Inc., a construction company in the same market.
D. Outsourcing some of the required audit services to Green, LLP, a well-respected local CPA firm. Brown did not consult ABC about this decision.

Answer 11

D. Outsourcing some of the required audit services to Green, LLP, a well-respected local CPA firm. Brown did not consult ABC about this decision.
Answer (D) is correct.
The accountant must consult the client and obtain the client’s permission when delegating responsibility for the engagement. The personal qualities of the auditors are an inducement to enter the contract. Thus, performance by Green was not bargained for by ABC.
(2.4.187)

Question 12

Under the provisions of Section 10(b) and Rule 10b-5 of the Securities Exchange Act of 1934, which of the following activities must be proven by a stock purchaser in a suit against a CPA?

I Intentional conduct by the CPA designed to deceive investors
II Negligence by the CPA

A II only.
B I only.
C Neither I nor II.
D Both I and II.

Answer 12

B I only.
This answer is correct.
Under Rule 10b-5, a plaintiff must prove a misstatement or omission of a material fact or other fraud, its connection with the purchase or sale of securities, an intent to deceive or defraud, reliance on the misstatement, and loss caused by the reliance. Thus, intentional misconduct, not negligence, must be proven

Question 13

Under the liability provisions of Section 11 of the Securities Act of 1933, an auditor may help to establish the defense of due diligence if

I The auditor performed an additional review of the audited statements to ensure that the statements were accurate as of the effective date of a registration statement.
II The auditor complied with GAAS or other applicable professional standards.

A I only.
B Both I and II.
C II only.
D Neither I nor II.

Answer 13

B Both I and II.
This answer is correct.
A CPA is strictly liable to investors under Section 11 but will not be liable if (s)he can prove due diligence. This defense requires proof that a reasonable investigation was conducted and that the CPA reasonably believed that the financial statements were accurate on the effective date of the registration statement. Proof of adherence to GAAP and the standards of the PCAOB for a public-company audit is the usual basis for such a due diligence defense. For example, PCAOB auditing standards require that subsequent events procedures be performed; that is, the auditor should extend his or her procedures from the date of the report up to the effective date of a 1933 act filing or as close thereto as is reasonable and practicable.

Question 14

According to the Securities Act of 1933, which of the following statements is correct regarding an issuer of securities?
A All securities issuers must provide potential investors with a prospectus containing specified information.
B An issuer is permitted to advertise an initial offering of securities only through distribution of the prospectus.
C If an issuer sells a security and fails to meet certain disclosure requirements, the purchaser may sell it back to the issuer and recover the price paid.
D All securities issuers must register the securities offering with the Securities and Exchange Commission (SEC).

Answer 14

C If an issuer sells a security and fails to meet certain disclosure requirements, the purchaser may sell it back to the issuer and recover the price paid.
This answer is correct.
A successful plaintiff is entitled only to monetary damages under Section 11. They are generally measured by the plaintiff’s loss, but resale is not required to prove loss. If the purchaser sells the security back to the issuer, the purchaser will recover the price paid.

Question 15

Which of the following securities are regulated by the provisions of the Securities Act of 1933?
A Securities guaranteed by domestic governmental organizations.
B Securities issued by insurance companies.
C Securities issued by not-for-profit, charitable organizations.
D Securities issued by savings and loan associations.

Answer 15

B Securities issued by insurance companies.
This answer is correct.
The 1933 act exempts certain types of securities and transactions from the registration requirements. These include securities issuances by not-for-profit organizations, domestic governments, banks, savings and loans associations, companies as part of an approved reorganization, common carriers regulated by the ICC, receivers or trustees in bankruptcy, and companies in exchange for existing securities if no commission is paid. Intrastate offerings, negotiable instruments (due within 9 months), and securities sold under Regulations A and D (small or limited offerings and private placements, respectively) are also exempt. Insurance policies and annuity contracts are regulated by the states, not by the federal government. However, other securities issued by insurance companies are regulated by the 1933 act.

Question 16

Under the liability provisions of Sec. 18 of the Securities Exchange Act of 1934, for which of the following actions would an accountant generally be liable?
A Intentionally failing to notify a reporting corporation’s audit committee of defects in the verification of accounts receivable.
B Negligently approving a reporting corporation’s incorrect internal financial forecasts.
C Intentionally preparing and filing with the SEC a reporting corporation’s incorrect quarterly report.
D Negligently filing a reporting corporation’s tax return with the IRS.

Answer 16

C Intentionally preparing and filing with the SEC a reporting corporation’s incorrect quarterly report.
This answer is correct.
Under Sec. 18(a), a person, including a corporation, responsible for any false or misleading statement in an application, document, or report filed with the SEC is civilly liable unless the defendant proves that the action was in good faith and was without knowledge that the statement was false or misleading. Criminal liability is imposed for willfully and knowingly making materially false and misleading statements in a document filed with the SEC. Thus, an accountant who intentionally prepares a false quarterly report on Form 10-Q (a required filing by an issuer) is liable civilly under Sec. 18 and criminally under Sec. 32.

Question 17

Insider trading under Rule 10b-5 of the Securities Exchange Act of 1934 is defined as company employees or their family members who trade the company’s securities while knowing nonpublic corporate information.

True.
False

Answer 17

False.
Your answer is correct.
Insider trading under Rule 10b-5 is the purchase or sale of any security by an individual who

Has access to material, nonpublic information;
Has not disclosed it before trading; and
Has a fiduciary obligation to the issuer, the shareholders, or any other source of the information.

Question 18

The legal standard for criminal prosecution for aiding and abetting securities law violations is knowledge.

True.
False.

Answer 18

False.
Your answer is correct.
The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 enlarged the scope of the SEC’s authority to prosecute those who aid and abet securities law violations. The legal standard is now “knowing or reckless” instead of merely knowing.

Question 19

Under Section 11 of the Securities Act of 1933, a successful plaintiff is only entitled to monetary damages.

True.
False.

Answer 19

True.
Your answer is correct.
A successful plaintiff is entitled only to monetary damages under Section 11. They are generally measured by the plaintiff’s loss, but resale is not required to prove loss. The loss equals the difference between the price paid for the security and one of the following:

Before Suit

After Suit
Security sold

Purchase price − sales price

Purchase price − (greater of market value or sales price)
Security not sold

Purchase price − market value

Purchase price – market value
The purpose of this measure of damages is to prevent unjust enrichment of the plaintiff.

Question 20

Under Section 10(b) of the Securities Exchange Act of 1934, liability is only to actual purchasers or sellers.

True.
False.

Answer 20

True.
Your answer is correct.
Section 10(b) is the antifraud provision of the 1934 act, which states liability is only to actual purchasers or sellers.

Question 21

The auditing firm must report directly to the audit committee, not to management.

True.
False.

Answer 21

True.
Your answer is correct.
According to the Sarbanes-Oxley Act of 2002, the audit committee must be directly responsible for appointing, compensating, and overseeing the work of the public accounting firm employed by the issuer. In addition, this firm must report directly to the audit committee, not to management.

Question 22

Fraud is the intentional lack of reasonable care and diligence.

True.
False.

Answer 22

False.
Your answer is correct.
Fraud is an intentional misrepresentation. An accountant is liable for losses that result from his or her commission of fraud. Punitive and compensatory damages are permitted.

Question 23

Under the Securities Exchange Act of 1934, a corporation whose common stock is listed on a national stock exchange
A Is subject to having the registration of its securities suspended or revoked.
B Is prohibited from making private placement offerings.
C Must submit Form 10-K to the SEC except in those years in which the corporation has made a public offering.
D Must distribute copies of Form 10-K to its shareholders.

Answer 23

A Is subject to having the registration of its securities suspended or revoked.
This answer is correct.
The SEC is authorized by the 1934 act to impose sanctions to enforce its provisions. The SEC may deny, suspend, or revoke registration or it may order a suspension of trading of the securities. These sanctions are in addition to civil and criminal liability imposed by the federal securities laws.
View Subunit 2.2 Outline

Question 24

Which of the following transactions is subject to registration requirements of the Securities Act of 1933?
A The public sale by a corporation of its negotiable 10-year notes.
B The issuance of stock by a publicly traded corporation to its existing shareholders because of a stock split.
C The public sale of stock of a trucking company regulated by the Interstate Commerce Commission.
D A public sale of municipal bonds issued by a city government.

Answer 24

A The public sale by a corporation of its negotiable 10-year notes.
This answer is correct.
The 1933 Act defines the term “security” to include almost any offering that constitutes an investment, including a corporation’s negotiable 10-year notes. Any offer or sale of a security to the public requires registration unless a specific exemption applies. A corporation’s negotiable 10-year notes are not exempt from registration under the 1933 Act.
View Subunit 2.1 Outline

Question 25

Which of the following transactions is subject to registration requirements of the Securities Act of 1933?
A The public sale by a corporation of its negotiable 10-year notes.
B The sale across state lines of municipal bonds issued by a city.
C Issuance of stock by a publicly traded corporation to its shareholders because of a stock split.
D The public sale by a charitable organization of 10-year bearer bonds.

Answer 25

A The public sale by a corporation of its negotiable 10-year notes.
This answer is correct.
Under the 1933 act, any offer or sale of a security to the public requires registration unless a specific exemption applies. Negotiable 10-year rates are securities because they provide evidence of indebtedness. Moreover, no exemption applies. For example, these notes are not commercial paper
View Subunit 2.1 Outline

Question 26

Under the common law, which of the following defenses, if used by a CPA, would best avoid liability in an action for negligence brought by a client?
A The accuracy of the CPA’s report was not guaranteed.
B The client was contributorily negligent.
C The client was comparatively negligent.
D The CPA’s negligence was not the proximate cause of the client’s losses.

Answer 26

D The CPA’s negligence was not the proximate cause of the client’s losses.
This answer is correct.
A plaintiff-client must prove all of the following elements of negligence: (1) the accountant owed the client a duty, (2) the accountant breached this duty, (3) the accountant’s breach actually and proximately caused the client’s injury, and (4) the client suffered damages. Proximate cause is a chain of causation that is not interrupted by a new, independent cause. Moreover, the injury would not have occurred without the proximate cause. However, actual causation is insufficient. The injury also must have been reasonably foreseeable. Thus, the concept of proximate cause limits liability to foreseeable damages. Accordingly, lack of proof of proximate cause precludes any recovery of damages.
View Subunit 2.4 Outline

Question 27

Which of the following statements concerning the prospectus required by the Securities Act of 1933 is true?
A The prospectus is prohibited from being distributed to the public until the SEC approves the accuracy of facts embodied therein.
B The prospectus should enable the SEC to pass on the merits of the securities.
C The prospectus is a part of the registration statement.
D The prospectus must be filed after an offer to sell.

Answer 27

C The prospectus is a part of the registration statement.
This answer is correct.
A prospectus is prepared as part of the registration statement. A prospectus is a written document proposing a sale of securities to potential investors. The prospectus contains most of the information in the registration statement. It must be furnished to each potential investor prior to the time of delivery of the securities.
View Subunit 2.1 Outline

Question 28

Which of the following statements is true with respect to ownership, possession, or access to a CPA firm’s audit working papers?
A Working papers are subject to the privileged communication rule, which, in most jurisdictions, prevents any third-party access to the working papers.
B Working papers may never be obtained by third parties unless the client consents.
C Working papers are not transferable to a purchaser of a CPA practice unless the client consents.
D Working papers are the client’s exclusive property.

Answer 28

C Working papers are not transferable to a purchaser of a CPA practice unless the client consents.
This answer is correct.
Transferring working papers to a purchaser of a practice constitutes communication of the information they contain and violates the AICPA’s Conduct Rule 301, Confidential Client Information. However, this rule does not prohibit review of the CPA’s practice, including a review in conjunction with the purchase, sale, or merger of the practice.
View Subunit 2.5 Outline

Question 29

On May 1, Apel purchased 7% of Stork Corp.’s preferred stock traded on a national securities exchange. After the purchase, Apel owned 9% of the outstanding preferred stock. Stork is registered under the Securities Exchange Act of 1934. With respect to the purchase, Apel

A. Is not required to file any report or information with the SEC because Apel owns less than 10% of the preferred stock.
B. Must file with the SEC, the issuer, and the national securities exchange information concerning the purpose of the acquisition.
C. Must file only with the SEC information concerning the source of the funds used to purchase the preferred stock.
D. Is not required to file any report or information with the SEC because the security purchased was preferred stock.

Answer 29

B. Must file with the SEC, the issuer, and the national securities exchange information concerning the purpose of the acquisition.
Answer (B) is correct.
As part of its regulation of tender offers, the Securities Exchange Act of 1934 requires any person who has acquired more than 5% of any registered equity security to file reports with the issuer, the exchange on which the security is traded, and the SEC. The information reported includes the identity of the purchaser, the source of funding, the purpose of the acquisition, and the number of shares owned.
(2.2.76)

Question 30

A main provision of the Securities Act of 1933, as amended in 1934, is the requirement that

A. New securities offered for sale in interstate commerce be registered with the SEC.
B. Public utility holding companies register with the SEC.
C. All security brokers be licensed by the SEC.
D. Bonds be issued only under a trust indenture approved by the Securities and Exchange Commission (SEC).

Answer 30

A. New securities offered for sale in interstate commerce be registered with the SEC.
Answer (A) is correct.
The Securities Act of 1933 was designed to provide complete and fair disclosure to potential investors. The 1933 act applies only to the initial issuance of securities. Disclosure is accomplished through the requirement that a registration statement be filed with the SEC. Once potential investors have complete disclosure, the assumption is that they can make a reasonable decision.
(2.2.71)

Question 31

Which one of the following is not a financial aspect covered in the management discussion and analysis (MD&A) section of the annual report?

A. Discussion of favorable or unfavorable trends concerning overall operations of management.
B. Analysis of liquidity using both hard and soft data.
C. Analysis of current-period profitability.
D. Discussion of any management disagreement with the auditor’s opinion.

Answer 31

D. Discussion of any management disagreement with the auditor’s opinion.
Answer (D) is correct.
Certain information must be disclosed in Form 10-K and the annual report to the shareholders. It includes management’s discussion and analysis (MD&A) of financial condition and results of operations. This discussion must address liquidity, capital resources, results of operations, and the effects of inflation and changing prices. Forward-looking information (a forecast) is encouraged but not required. Information about disagreements over accounting and disclosure matters is included in Form 10-K but not in MD&A.
(2.1.56)

Question 32

In which of the following situations is an accountant considered to have aided and abetted violations of the Securities Exchange Act of 1934?

I The accountant is generally aware of his or her participation in an improper activity OR knowingly aids the activity.
II The accountant is generally aware of his or her participation in an improper activity AND knowingly aids the activity.
III The accountant observes the activity and remains silent. This may constitute abetting.

A. I and II.
B. I, II, and III.
C. II only.
D. II and III.

Answer 32

C. II only.
Answer (C) is correct.
If the accountant is generally aware of his or her participation in an improper activity AND knowingly aids the activity, (s)he is liable for aiding and abetting. Silence may constitute aiding, not abetting.
(2.3.132)

Question 33

All the following are functions of the Securities and Exchange Commission except the

A. Setting of rules concerning the proxy process of large public companies.
B. Review of stock trades by corporate insiders.
C. Regulation of interstate offerings of new securities to the public.
D. Determination of fair trading prices for the common stock of large public companies.

Answer 33

D. Determination of fair trading prices for the common stock of large public companies.
Answer (D) is correct.
The SEC is charged with enforcement of federal securities laws. Under the Securities Act of 1933, the offer or sale of a security to the public requires registration with the SEC absent a specific exemption. However, the 1933 act is essentially a disclosure statute. The SEC does not evaluate the merits of securities. Its role is to enforce the laws ensuring the public availability of information to potential investors.
(2.1.30)

Question 34

The partnership of Rodgers & Higgs, CPAs, performed audits of Alt Corp., a publicly-traded company, for the past several years. After issuing the current year’s audit report, the CFO of Alt confessed to having committed fraud against Alt. Under which of the following statutes would the investors most likely bring suit against Rodgers & Higgs?

A. Securities Exchange Act of 1934, if they can prove scienter.
B. Securities Act of 1933, if they can prove gross negligence.
C. Securities Act of 1933, if they can prove ordinary negligence.
D. Securities Exchange Act of 1934, if they can prove ordinary negligence.

Answer 34

A. Securities Exchange Act of 1934, if they can prove scienter.
Answer (A) is correct.
The Securities Exchange Act of 1934 requires that the plaintiff prove there is (1) an oral or written misstatement or omission of a material fact or other fraud, (2) a connection with any purchase or sale of securities, (3) the defendant’s intent to deceive (scienter), (4) reliance on the misstatement or indirect reliance (fraud-on-the-market), and (5) loss caused by the reliance. If the investors have lost money and can prove scienter on the part of the CPAs, they will have satisfied all the requirements of the Securities Exchange Act of 1934.
(2.3.143)

Question 35

A CPA who fraudulently performs an audit of a corporation’s financial statements will

A. Probably be liable to any person who suffered a loss as a result of the fraud.
B. Be liable only to the corporation and to third parties who are members of a class of intended users of the financial statements.
C. Be liable only to third parties in privity of contract with the CPA.
D. Probably be liable to the corporation even though its management was aware of the fraud and did not rely on the financial statements.

Answer 35

A. Probably be liable to any person who suffered a loss as a result of the fraud.
Answer (A) is correct.
Because fraud involves moral corruption, the courts permit all reasonably foreseeable users of an accountant’s work product to bring suit. The distinctive feature of fraud is scienter, that is, intentional misrepresentation or reckless disregard for the truth (sometimes found in gross negligence).
(2.4.177)

Question 36

Bird Corp. made a $5 million exempt common stock offering under Rule 505 of Regulation D of the Securities Act of 1933. Thus, the shares were restricted securities. As the issuer of restricted securities, Bird must

A. Publicly advertise that the shares are not registered.
B. Make a reasonable effort to determine that purchasers are buying for themselves and not for others.
C. Apply to the SEC for contingent exemptions so that purchasers may resell their shares as exempt.
D. Provide information to all purchasers as to how they can register their shares so that resale will be permitted.

Answer 36

B. Make a reasonable effort to determine that purchasers are buying for themselves and not for others.
Answer (B) is correct.
Exemption from the 1933 act requirements under Rules 505 and 506 of Regulation D applies to particular transactions, not the securities offered and sold. Securities sold under one of these exemptions are restricted. An issuer of restricted securities is therefore required to make a reasonable effort to determine that purchasers are not underwriters and that they are purchasing strictly for their own investment purposes.
(2.1.36)

Question 37

The CPA firm of Knox & Knox has been subpoenaed to testify and produce its correspondence and working papers in connection with a lawsuit brought by a third party against one of its clients. Knox considers the subpoenaed documents to be privileged communication and therefore seeks to avoid admission of such evidence in the lawsuit. Which of the following is correct?

A. Federal law recognizes no such privilege.
B. The privileged communication rule as it applies to the CPA-client relationship is the same as that of attorney-client.
C. In the absence of a specific statutory provision, the law does not recognize the existence of privileged communication between a CPA and client.
D. The privilege is available regarding the working papers because the CPA is deemed to own them.

Answer 37

C. In the absence of a specific statutory provision, the law does not recognize the existence of privileged communication between a CPA and client.
Answer (C) is correct.
Nonstatutory law does not recognize privileged communication between a CPA and client. In some states and in some federal tax matters, however, the auditor may be protected by a privilege created by statute.
(2.5.210)

Question 38

If a CPA is engaged by an attorney to assist in the defense of a criminal tax fraud case involving the attorney’s client, information obtained by the CPA from the client after being engaged

A. Is not privileged because the matter involves a federal issue.
B. Will be deemed privileged communications under certain circumstances.
C. Will be deemed privileged communications provided that the CPA prepared the client’s tax return.
D. Is not privileged in jurisdictions that do not recognize an accountant-client privilege.

Answer 38

B. Will be deemed privileged communications under certain circumstances.
Answer (B) is correct.
The attorney-client privilege would protect the information. The defendant is the client of the attorney, and the CPA is the agent of the attorney. Hence, communications between the CPA and the defendant are, in effect, between the attorney and the defendant. However, if the defendant is the CPA’s client, their communications will not be privileged unless the case involves a state tax matter in a jurisdiction that has enacted a statute protecting accountant-client communications. The limited federal accountant-client privilege does not apply in criminal tax matters.
(2.5.205)

Question 39

Gold, CPA, expressed an unmodified opinion on the financial statements of Eastern Power Co. Silver purchased Eastern bonds in a public offering subject to the Securities Act of 1933. The registration statement filed with the SEC included the financial statements. Gold is being sued by Silver under Section 11 of the Securities Act of 1933 for the misstatements contained in the financial statements. To prevail, Silver must prove

Scienter?

Reliance?

Answer 39

Scienter No

Reliance No

Answer (C) is correct. The plaintiff’s case has the following elements: The plaintiff purchased securities subject to a registration statement, the plaintiff suffered a loss, and a part of the registration statement for which the defendant was responsible contained a misstatement or omission of a material fact. The plaintiff and the defendant need not have been in privity of contract; the plaintiff need not have relied on the misstatement or omission; and the defendant need not have intended to deceive, manipulate, or defraud anyone.

Question 40

West & Co., CPAs, was engaged by Sand Corp. to audit its financial statements. West expressed an unmodified opinion on Sand’s financial statements. Sand has been accused of making negligent misrepresentations in the financial statements that Reed relied upon when purchasing Sand stock. West was not aware of the misrepresentations and was not negligent in performing the audit. If Reed sues West for damages based upon Section 10(b) and Rule 10b-5 of the Securities Exchange Act of 1934, West will

A. Lose because Reed relied upon the financial statements.
B. Prevail because some element of scienter must be proved.
C. Prevail because Reed was not in privity of contract with West.
D. Lose because the statements contained negligent misrepresentations.

Answer 40

B. Prevail because some element of scienter must be proved.
Answer (B) is correct.
Rule 10b-5 is an antifraud provision that requires proof of scienter, that is, of an intent to deceive, manipulate, or defraud. In this context, even gross negligence probably does not satisfy the scienter requirement, although some courts have held that it does if the accountants had a fiduciary duty (such as that owed to a client) to the plaintiff. Thus, Reed cannot prove scienter, and West will prevail.
(2.3.107)

Question 41

Which of the following is least likely to be considered a security under the Securities Act of 1933?

A. Limited partnership interests.
B. Warrants.
C. Stock options.
D. General partnership interests.

Answer 41

D. General partnership interests.
Answer (D) is correct.
The term “security” is defined very broadly by the Securities Act of 1933, as interpreted by the U.S. Supreme Court. In general, a security is an investment through which one reasonably anticipates a financial return through the efforts of others. A general partner is entitled to participate directly in the management of the business. Thus, return on the investment in the partnership might be attributed to his or her own efforts.
(2.1.20)

Question 42

Hark, CPA, failed to follow generally accepted auditing standards in auditing the financial statements of Long Corp., a nonpublic company. Long’s management had told Hark that the audited statements would be submitted to several banks to obtain financing. Relying on the statements, Third Bank gave Long a loan. Long defaulted on the loan. In a jurisdiction applying the traditional doctrine, if Third sues Hark, Hark will

A. Lose because Hark was negligent in performing the audit.
B. Win because there was no privity of contract between Hark and Third.
C. Lose because Hark knew that banks would be relying on the financial statements.
D. Win because Third was contributorily negligent in granting the loan.

Answer 42

B. Win because there was no privity of contract between Hark and Third.
Answer (B) is correct.
An accountant is not liable to all persons who are damaged by his or her negligence. Lack of privity is still a defense in some states. For example, under the holding in the Ultramares case, an accountant is liable for negligence only if the plaintiff was in privity of contract with the accountant or a primary beneficiary of the engagement. Under the primary benefit test, the accountant must have been aware that (s)he was hired to produce a work product to be used and relied upon by a particular third party. Because Long’s management did not specifically name Third Bank to Hark, Hark will not be liable. However, most courts now extend a CPA’s liability to anyone in a class of foreseen (but not necessarily individually identified) third parties who the CPA knows will use the information.
(2.4.151)

Question 43

The SEC’s antifraud Rule 10b-5 prohibits trading on the basis of inside information of a business corporation’s stock by

A. Officers, directors, and beneficial holders of 10% of the corporation’s stock.
B. Officers and directors only.
C. Officers, directors, and shareholders only.
D. Anyone who bases his or her trading activities on the inside information.

Answer 43

D. Anyone who bases his or her trading activities on the inside information.
Answer (D) is correct.
Rule 10b-5 is the SEC rule under the Securities Exchange Act of 1934 that prohibits any person from engaging in manipulative or deceptive acts in the purchase or sale of any security. It prohibits trading on the basis of inside information and applies to anyone who has not made a full disclosure of the inside information. It applies not only to officers, directors, shareholders (and beneficial holders), but also to tippees, i.e., those who receive inside information from insiders.
(2.2.77)

Question 44

A CPA will be liable to a tax client for damages resulting from all of the following actions except

A. Refusing to sign a client’s request for a filing extension.
B. Neglecting to evaluate the option of preparing joint or separate returns that would have resulted in a substantial tax savings for a married client.
C. Failing to advise a client of certain tax elections.
D. Failing to timely file a client’s return.

Answer 44

A. Refusing to sign a client’s request for a filing extension.
Answer (A) is correct.
An accountant owes a general duty to exercise the skill and care of an ordinarily prudent accountant in the same circumstances. Moreover, Treasury Circular 230 states that diligence must be exercised in preparing, approving, and filing returns, documents, and other papers relating to IRS matters. Accordingly, the accountant is responsible for exercising independent professional judgment and complying with the law. If the CPA does not agree that the client has a valid reason for obtaining an extension, (s)he will not be liable for refusing to sign the client’s request.
(2.4.193)

Question 45

Section 10(b) of the Securities Exchange Act of 1934 provides a safe harbor from liability in connection with releases of information by the corporation through reports, speeches, public announcements, or press releases. Which of the following is(are) protected by this safe harbor?

I Statements that are immaterial
II Statements made without actual knowledge that they are false or misleading
III Statements accompanied by cautionary remarks, even if they are not specific

A. I and II.
B. I, II, and III.
C. II and III.
D. I only.

Answer 45

A. I and II.
Answer (A) is correct.
Claims by buyers or sellers of securities under Section 10(b) often arise in connection with releases of information by corporations through reports, speeches, public announcements, or press releases. Subjects of these releases may include mergers, research developments, rumors, or other matters of material importance. The law provides a safe harbor from liability for companies that make such statements if they are (1) not material, (2) made without actual knowledge that they are false or misleading, or (3) accompanied by meaningful cautionary statements that identify risk factors that could cause actual results to differ from those in the statement.
(2.3.133)

Question 46

Universal Corp. intends to sell its common stock to the public in an interstate offering that will be registered under the Securities Act of 1933. Under the act,

A. A prospectus must be delivered to each purchaser of Universal’s common stock unless the purchaser qualifies as an accredited investor.
B. Universal can make offers to sell its stock before filing a registration statement, provided that it does not actually issue stock certificates until after the registration is effective.
C. Universal’s registration statement becomes effective at the time it is filed, assuming the SEC does not object within 20 days thereafter.
D. Universal’s filing of a registration statement with the SEC does not automatically result in compliance with the “blue-sky” laws of the states in which the offering will be made.

Answer 46

D. Universal’s filing of a registration statement with the SEC does not automatically result in compliance with the “blue-sky” laws of the states in which the offering will be made.
Answer (D) is correct.
Any issuer of a security is required by the Securities Act of 1933 to file a registration statement, unless a specific exemption applies. Each state has adopted its own securities laws, which may require more detailed disclosure than federal securities laws. Both federal and state securities laws must generally be complied with.
(2.1.21)

Question 47

James Fisk recently acquired Valiant Corporation by purchasing all of its outstanding stock pursuant to a tender offer. Fisk demanded and obtained the resignation of the existing board of directors and replaced it with his own slate of nominees. Under these circumstances,

A. Fisk had no right to demand the resignation of the existing board members; their resignations are legally ineffective, and they remain as directors.
B. If Valiant is listed on a national stock exchange, Fisk must file his tender offer with the SEC.
C. If Valiant is engaged in interstate commerce, the acquisition is exempt under the antitrust laws because the SEC has jurisdiction.
D. The former shareholders of Valiant are parties to a tax-free reorganization. Hence, they are not subject to federal income tax on their gain, if any, on transferring their stock to Fisk.

Answer 47

B. If Valiant is listed on a national stock exchange, Fisk must file his tender offer with the SEC.
Answer (B) is correct.
A tender offer is an offer to shareholders to buy their stock to gain control of a corporation. Under the Securities Exchange Act of 1934, anyone who makes a tender offer that would result in the purchase of more than 5% of a class of registered equity securities must file his or her tender offer with the SEC. Because Valiant is listed on a national stock exchange, its shares must be registered, and Fisk’s tender offer must be filed prior to acquisition.
(2.2.79)

Question 48

The Securities and Exchange Commission requires certain information to be included in management’s discussion and analysis (MD&A) in the 10-K annual report. Discussion of all of the following is required except

A. Significant events or uncertainties.
B. The effects of inflation and changing prices.
C. The results of operations.
D. Forward-looking information and forecasts.

Answer 48

D. Forward-looking information and forecasts.
Answer (D) is correct.
Certain information must be disclosed in Form 10-K and the annual report to the shareholders. It includes management’s discussion and analysis (MD&A) of financial condition and results of operations. This discussion must address liquidity, capital resources, results of operations, and the effects of inflation and changing prices. Forward-looking information (a forecast) is encouraged but not required. But MD&A need not include a discussion of forward-looking information and forecasts.
(2.1.54)

Question 49

If a shareholder sues a CPA for nonstatutory fraud based on false statements contained in the financial statements audited by the CPA, which of the following, if present, would be the CPA’s best defense?

A. The false statements were immaterial.
B. The CPA did not financially benefit from the alleged fraud.
C. The shareholder lacks privity to sue.
D. The contributory negligence of the client releases the CPA from liability.

Answer 49

A. The false statements were immaterial.
Answer (A) is correct.
The tort of intentional misrepresentation (fraud, deceit) consists of a material misrepresentation made with scienter and an intent to induce reliance. The misstatement also must have proximately caused damage to a plaintiff who justifiably relied upon it. Scienter exists when the defendant makes a false representation with knowledge of its falsity or with reckless disregard as to its truth. The CPA’s best defense would be that the false statements were immaterial.
(2.4.157)

Question 50

A CPA’s working papers are least likely to be protected from disclosure

A. To a state CPA society peer review team.
B. Pursuant to a state court subpoena.
C. To the trial board of the AICPA.
D. Pursuant to an IRS administrative subpoena seeking information about tax advice rendered by the CPA.

Answer 50

B. Pursuant to a state court subpoena.
Answer (B) is correct.
Most states do not recognize a privilege for accountant-client communications, including those documented in the accountant’s working papers. Thus, a properly issued state court subpoena must be complied with.
(2.5.204)

Question 51

All of the following topics are likely to be addressed in the management discussion and analysis (MD&A) of the 10-K annual report except

A. Favorable trends in liquidity.
B. Significant events affecting capital resources.
C. Uncertainties affecting operations.
D. Management’s responsibility for the financial statements.

Answer 51

D. Management’s responsibility for the financial statements.
Answer (D) is correct.
A statement affirming management’s responsibility for the financial statements is part of the auditor’s report.
(2.1.52)

Question 52

Which of the following is most likely to be effective as a defense in a breach of contract suit brought by a client against a CPA?

A. Alleged obligation within scope of contract.
B. Suspension or termination of performance justified because of the client’s breach.
C. Inadequate consideration.
D. Partial performance.

Answer 52

B. Suspension or termination of performance justified because of the client’s breach.
Answer (B) is correct.
Suspension or termination of the CPA’s performance is justified due to a material breach of contract by the client. The nonbreaching party (the CPA) is discharged from any obligation to perform.
(2.4.188)

Question 53

Fact Pattern: Dart Corp. engaged Jay Associates, CPAs, to assist in a public stock offering. Jay audited Dart’s financial statements and gave an unmodified opinion, despite knowing that the financial statements contained misstatements. Jay’s opinion was included in Dart’s registration statement. Larson purchased shares in the offering and suffered a loss when the stock declined in value after the misstatements became known.
If Larson succeeds in the Section 11 suit against Dart, Larson would be entitled to

A. Rescission of the transaction.
B. Damages, but only if the shares were resold before the suit was started.
C. Damages of three times the original public offering price.
D. Monetary damages only.

Answer 53

D. Monetary damages only.
Answer (D) is correct.
In a civil suit under Section 11 of the 1933 act, a purchaser’s remedy is a suit for monetary damages. The damages are measured as the difference between the price paid for the securities and (1) the sales price, if the security was sold before suit; (2) the market value of the security at the time of the suit, if the security was not sold; or (3) the sales price, if the security was disposed of after suit and the sales price exceeded the market value of the security at the time the suit was brought.
(2.3.88)

Question 54

In a jurisdiction having an accountant-client privilege statute, to whom may a CPA turn over working papers without a client’s permission?

A. State tax authorities.
B. Purchaser of the CPA’s practice.
C. State CPA society peer review panel.
D. State court.

Answer 54

C. State CPA society peer review panel.
Answer (C) is correct.
The AICPA Code of Professional Conduct (Conduct Rule 301) states that a member shall not disclose any confidential client information except with the specific consent of the client. But this rule does not preclude a CPA from responding to an investigative body of a state CPA society, the trial board of the AICPA, or an AICPA or state peer review body, or pursuant to a valid subpoena. In the minority of states that protect confidential accountant-client communications by statute, disclosure to a state CPA peer review panel would not be prohibited.
(2.5.206)

Question 55

A well-known seasoned issuer

A. Does not have to meet capitalization or stock issuance requirements.
B. Has a worldwide market capitalization of at least $1 billion.
C. Has issued for cash at least $700 million of preferred stock in the past 3 years.
D. Has issued for cash at least $1 billion of debt in the past 3 years.

Answer 55

D. Has issued for cash at least $1 billion of debt in the past 3 years.
Answer (D) is correct.
One of the four categories of issuers recognized under the Security and Exchange Commission’s integrated disclosure system is a well-known seasoned issuer. This issuer has filed for at least 1 year and (1) has a worldwide market capitalization of at least $700 million or (2) has issued for cash in a registered offering at least $1 billion of debt or preferred stock in the past 3 years. Such an issuer may use Form S-3.
(2.1.41)

Question 56

Cable Corp. orally engaged Drake & Co., CPAs, to audit its financial statements. Cable’s management informed Drake that it suspected the accounts receivable were materially overstated. Though the financial statements Drake audited included a materially overstated accounts receivable balance, Drake expressed an unmodified opinion. Cable used the financial statements to obtain a loan to expand its operations. Cable defaulted on the loan and incurred a substantial loss. If Cable sues Drake for negligence in failing to discover the overstatement, Drake’s best defense would be that Drake did not

A. Have privity of contract with Cable.
B. Violate generally accepted auditing standards in performing the audit.
C. Perform the audit recklessly or with an intent to deceive.
D. Sign an engagement letter.

Answer 56

B. Violate generally accepted auditing standards in performing the audit.
Answer (B) is correct.
The purpose of an independent external audit of financial statements is the expression of an opinion on whether they are fairly presented in conformity with GAAP. To achieve this objective, the CPA must follow GAAS or, if the client is a public company, PCAOB standards. The auditor provides only reasonable assurance that the statements are free of material misstatements, whether caused by errors or fraud. Thus, their best defense will be to prove that they performed the audit in accordance with GAAS. Although following GAAS or PCAOB standards does not eliminate the possibility of negligence, it is strong evidence of adherence to the due care standard.
(2.4.181)

Question 57

Corcoran, Inc.’s common stock trades on the New York Stock Exchange. The past year was a disappointing one for Corcoran. Cash flow, operating income, and net income were all significantly lower than in previous years. While discussing the financial results, Barbara Freeburg, an outside member of the board of directors, learned that Corcoran’s management has recorded large, one-time expenses in the last quarter of the year that related to warranty, bad-debt, environmental, and other liabilities. Management provided adequate support for the large increase in the liabilities, but Freeburg, believing that liabilities were materially overstated, disagreed and resigned from the board. The large expenses recorded by Corcoran in the last quarter will most likely be reported on

A. The next Form S-1.
B. Form 10-Q for the fourth quarter.
C. Form 10-Q for the first quarter of next year.
D. Form 10-K.

Answer 57

D. Form 10-K.
Answer (D) is correct.
To comply with the registration requirements of the Securities Act of 1933, a nonreporting issuer (one who need not file reports under the Securities Exchange Act of 1934) and an unseasoned issuer (one who has reported under the 1934 act for at least 3 years consecutively) must use detailed Form S-1 (but an unseasoned issuer provides less detail). Form S-1 contains a registration statement and a prospectus. The registration statement includes audited financial statements. Form 10-K is an annual report filed with the SEC, and Form 10-Q is a quarterly report filed with the SEC. Form 10-K contains audited annual financial statements. Accordingly, it will report the large fourth-quarter expenses. However, the entity’s common stock trades publicly. Thus, it may not need to file Form S-1 when it makes another public offering. It may use Form S-3 if it is a seasoned issuer, one that has filed for at least 1 year and has a market capitalization of at least $75 million. Moreover, a reporting entity files Form 10-Q only for the first three quarters of the fiscal year, and Form 10-Q for the first quarter of the next year will report only that quarter’s results.
(2.1.48)

Question 58

Under the Private Securities Litigation Reform Act of 1995, Baker, CPA, reported certain uncorrected illegal acts to Supermart’s board of directors. Baker believed that failure to take remedial action would warrant a qualified audit opinion because the illegal acts had a material effect on Supermart’s financial statements. Supermart failed to take appropriate remedial action, and the board of directors refused to inform the SEC that it had received such notification from Baker. Under these circumstances, Baker is required to

A. Resign from the audit engagement within 10 business days.
B. Notify the shareholders that the financial statements are materially misstated.
C. Deliver a report concerning the illegal acts to the SEC within 1 business day.
D. Withhold an audit opinion until Supermart takes appropriate remedial action.

Answer 58

C. Deliver a report concerning the illegal acts to the SEC within 1 business day.
Answer (C) is correct.
Disclosure of illegal acts to outside parties is not normally the auditor’s responsibility. However, under the Private Securities Litigation Reform Act of 1995, accountants must report illegal acts to the appropriate level of management and the audit committee unless they are clearly inconsequential. If senior management and the board fail to take action on reported material illegal acts and this failure will result in a departure from an unmodified report or resignation from the audit, the accountants should report their conclusions to the board immediately. The board must then, within 1 business day, notify the SEC. If the accountants do not receive a copy of the notice within the 1-day period, they must furnish the SEC with a copy of their report within 1 business day.
(2.3.136)

Question 59

When CPAs fail in their duty to carry out their contracts for services, liability to clients may be based on
Breach of Contract?

Strict Liability?

Answer 59

Breach of Contract Yes

Strict Liability No
Answer (C) is correct.
An accountant’s liability to clients for failure to carry out contracts for services arises from breach of contract. Liability to clients for breach of contract by CPAs is not strict liability.
(2.4.153)

Question 60

The provisions of the Securities Exchange Act of 1934 include all of the following except the

A. Regulation of proxy solicitations for the election of directors or for approval of other corporate actions.
B. Requirement that firms offering securities for public sale to file a registration statement and provide a prospectus to potential investors.
C. Requirement disclosure of all pertinent information in tender offer solicitations.
D. Requirement the registration of national securities exchanges and brokers dealing in over-the-counter markets.

Answer 60

B. Requirement that firms offering securities for public sale to file a registration statement and provide a prospectus to potential investors.
Answer (B) is correct.
The Securities Exchange Act of 1934 applies to the trading of securities subsequent to their initial sale. The filing of a registration statement and the provision of a prospectus to potential investors are requirements of the Securities Act of 1933, which governs initial offerings.
(2.1.44)

Question 61

Which of the following are exempt from the registration requirements of the Securities Act of 1933?

A. Participation interests in a money market fund that consists wholly of short-term negotiable instruments.
B. Stock of a corporation offered and sold only to residents of the state in which the issuer was incorporated and doing all of its business.
C. All industrial development bonds issued by municipalities.
D. Bankers’ acceptances with maturities at the time of issue ranging from 1 to 2 years.

Answer 61

B. Stock of a corporation offered and sold only to residents of the state in which the issuer was incorporated and doing all of its business.
Answer (B) is correct.
One exemption from registration under the Securities Act of 1933 is an intrastate issue of securities. Under SEC Rule 147, an issue qualifies as intrastate if the issuer is incorporated in the state in which the issue is made, 80% of the proceeds are to be used in that state, 80% of its assets are located in the state of incorporation, the issuer does at least 80% of its business (gross revenues) within that state, all the purchasers and offerees are residents of the state, no resales to nonresidents occur for at least 9 months after the last sale, and steps are taken to prevent interstate distribution.
(2.1.23)

Question 62

The Securities and Exchange Commission is not empowered to

A. Sue for treble damages.
B. Suspend a broker-dealer.
C. Recommend criminal proceedings against accountants.
D. Seek an injunction that will suspend trading in a given security.

Answer 62

A. Sue for treble damages.
Answer (A) is correct.
The SEC is not empowered to sue for damages at all. A lawsuit for treble damages is a civil remedy provided for violations of the antitrust laws, and the SEC has no jurisdiction over antitrust violations. However, the SEC can bring an action in a federal district court to impose civil penalties, for example, for insider trading. Moreover, in an action for violation of the securities laws, the SEC may seek any equitable relief that may be appropriate to benefit investors (Sarbanes-Oxley Act of 2002).
(2.1.31)