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 *