Module C - Legal Liability

Plaintiff Proof
Economic loss Failure to exercise level of appr professional care
Loss causes by breach contract
Economic loss
Failure to exercise level of appr professional care
Material Misstatement on F/S
Loss cause by reliance on MM F/S
Economic Loss
MM on F/S ** no need to show reliance on f/s
Economic loss
MM on F/S
Loss cause by reliance on MM F/S
Auditor were are MM and acted with intent (scienter)
Ordinary negligence is lack of reasonable care
Gross negligence is lack of minimal care (similar to constructive fraud)
Fraud is a misrepresentation of fact an individual knows to be false Defense * Causation (something else caused client loss) * Contributory negligence (clients were partially responsible for loss)
Client: auditor works for. privity exists.
Primary Beneficiaries: known and named third parties ... privity in contract means a party a contract (client), but the law treats primary beneficiaries as having this privity to contract, so they are generally treated the same as the client
Foreseen Beneficiary: known, but unnamed third parties (banks, for example)
Foreseeable Third Parties: Unknown, unnamed third party (stockholders, etc.) ... class action suits
Sec 1933 * Regulates initial issuance of securities by registrants to investing public * Required to file registration statement with SEC that includes F/S Sec 1934 * Regulates daily trading of securities and requires periodic financial statements and information to be filed with the SEC * Reports filed with SEC * Form 10-K: Annual F/S (audited) * Form 10-Q: Quarterly F/S (reviewed) * Form 8-K: “Current events” report filed as appropriate * Civil Liability (Rule 10b-5 and Section 18) * Plaintiffs have burden of proof * Auditors cannot be held liable for ON Criminal Liability * SEC 1933 Criminal Liability (Section 24) * Auditors must have “willfully” violated provisions of the Securities Act (fraud or GN) * United States vs. Benjamin addressed criminal liability * SEC 1934 Criminal Liability (Section 32) * Did auditors act “willfully and knowingly”? * Fines of up to $5 million and imprisonment for up to 20 years * United States vs. Natelli (“National Student Marketing”) * Cases brought by DOJ or Attorney General SOX * Extends statute of limitations for brining suit under the Securities Exchange Act * Increased penalties for mail fraud and wire fraud * Increased penalties for destruction, alteration, and falsification of records * Increased records retention requirements * Higher potential liability in civil cases Other Development in Aid Liab * Auditors not subject to RICO (and treble damages) * Limitations on aiding and abetting * Organization of firms as limited liability partnerships * Private Securities Litigation Reform Act (1995) * Proportionate liability, instead of joint and several liability * Class Action Fairness Act (2005) * Moves class action cases from state courts to federal courts * Securities Litigation Uniform Standards Act (1998) * Requires class action lawsuits with > 50 parties to be filed in federal courts * Auditor liability caps – capping auditors liab in the engagement letter Reducing Legal Exposure * Carefully plan the audit * Insist on proper accounting treatment of discovered errors * Utilize audit committee * Exercise care in supervision and review * Don't succumb to "time pressures" * Communicate with predecessor auditors *