Kế toán, kiểm toán - Module C: Legal liability

McGraw-Hill/Irwin Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.Module CLegal Liability“When men are pure, laws are useless; when men are corrupt, laws are broken.”Benjamin Disreali, Former British Prime MinisterMod C-2Common LawBreach of contract: Services not performed by auditors in manner described in contractTort liability: Obligation based on failure of auditors to exercise appropriate level of professional careOrdinary 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 falseMod C-3Common Law Liability: ClientsSources of LiabilityBreach of contractTort liability (ON, GN, F)Clients must showEconomic lossAuditors breached contract or failed to exercise appropriate careThe loss was caused by the breach of contract or failure of auditors to exercise the appropriate level of careDefensesAuditors did not breach contract or performed with appropriate level of careCausation (something else caused client loss)Contributory negligence (clients were partially responsible for loss)Mod C-4Common Law Liability: Third PartiesGenerally liable to all third parties for gross negligence and fraudLiability for ordinary negligenceUltramares: No liability for ordinary negligenceCredit Alliance v. Arthur Andersen: Liable to primary beneficiaries for ordinary negligenceFleet National Bank (restatement of torts): Liable to foreseen third parties for ordinary negligenceRosenblum v. Adler: Liable to foreseeable third parties for ordinary negligence Mod C-5Proof and Defenses: Third PartiesThird parties must showEconomic lossAuditors failed to exercise appropriate level of careF/S contained a material misstatementLoss caused by reliance on misstated F/SDefensesLack of appropriate standing (relationship with auditor) to bring suitThird party’s loss caused by factors other than the F/S and auditors examination (causation defense)Audit conducted per GAASMod C-6Summary of Liability for Ordinary NegligenceUltramares: Liable for GN and FCredit Alliance v. Arthur Andersen:ON to primary beneficiariesFleet National Bank v. Gloucester Co:ON to foreseen (restatement of torts)Rosenblum v. Adler:ON to foreseeableLess Exposure More ExposureMod C-7Securities Act of 1933 (Securities Act)Regulates initial issuance of securities by registrants to investing publicRequired to file registration statement with SEC that includes F/STo bring suit, investors must show:LossF/S contained a material misstatementNo need to show reliance on F/S or that loss was caused by misstatementMod C-8Liability Under Securities ActAuditors responsible for ordinary negligence, gross negligence, and fraudDefensesDue diligence (auditors performed a GAAS audit)Causation (loss resulted from other factors)Escott v. BarChris Construction Corp.Auditors held liable for failure to conduct “reasonable investigation” (ordinary negligence)Mod C-9Securities Exchange Act of 1934 (Securities Exchange Act)Regulates daily trading of securities and requires periodic financial statements and information to be filed with the SECReports filed with SECForm 10-K: Annual F/S (audited)Form 10-Q: Quarterly F/S (reviewed)Form 8-K: “Current events” report filed as appropriateMod C-10Liability under the Securities Exchange ActTo bring suit, investors must show:Economic lossF/S contained a material misstatementLoss caused by reliance on F/S (burden of proof shifted to investor)Auditors were aware that the F/S contained a material misstatement (has been interpreted as gross negligence)Mod C-11Liability Under Securities Exchange ActAuditors liable for gross negligence and fraud (“scienter”)DefensesAuditors acted in good faithAuditors were not aware of material misstatementsErnst & Ernst v. HochfelderRelieved auditors from liability for ordinary negligenceDid provide liability for “reckless behavior” in the absence of scienterMod C-12Summary of Auditor LiabilitySourceBurden of ProofOffenseAuditors’ DefensesCommon Law/ClientsClientBreach of contractON, GN, FNo breach or inappropriate performance (GAAS audit)CausationContributory negligenceCommon Law/Third PartiesThird PartiesON depends upon party and jurisdictionGN, FLack of appropriate third party standingCausationNo inappropriate performance (GAAS audit)Securities Act of 1933AuditorsON, GN, FDue diligence (GAAS audit)CausationSecurities Act of 1934InvestorsGN, FGood faithNo knowledge of material misstatements (“scienter”)ON = Ordinary negligenceGN = Gross negligenceF = FraudMod C-13Why Has Auditor Liability Increased?Highly-publicized failures (WorldCom, Enron)Investor awareness of ability to recover monetary losses from auditorsComplex accounting standardsJoint and several liabilityClass action suitsAuditors are an attractive target for plaintiff attorneysMod C-14Sarbanes-OxleyExtends statute of limitations for brining suit under the Securities Exchange ActIncreased penalties for mail fraud and wire fraudIncreased penalties for destruction, alteration, and falsification of recordsIncreased records retention requirementsHigher potential liability in civil casesMod C-15Other Developments in Auditor LiabilityAuditors not subject to RICO (and treble damages)Limitations on aiding and abettingOrganization of firms as limited liability partnershipsPrivate Securities Litigation Reform Act (1995): Proportionate liabilityClass Action Fairness Act (2005): Moves class action cases from state courts to federal courtsSecurities Litigation Uniform Standards Act (1998): Requires class action lawsuits with > 50 parties to be filed in federal courtsAuditor liability capsMod C-16