CHAPTER 46: LEGAL AND PROFESSIONAL RESPONSIBILITIES OF

AUDITORS, CONSULTANTS, AND SECURITIES PROFESSIONALS

I. General Standard of Performance
A. Skill of the ordinarily prudent person in the profession
1. Focuses on general education or knowledge
2. Accountants must know
a. Generally accepted auditing standards (GAAS! and
". Generally accepted accounting principles (GAAP
#. Act as carefully as the ordinarily prudent person in the profession
II. Professionals$ %ia"ility to &lients
A. &ontractual %ia"ility
1. 'uty to perform as agreed
2. Includes an implied duty to perform the contract as the ordinarily
prudent person would
(. Generally lia"le only for
a. &ompensatory damages
". &onse)uential damages contemplated at time of contract
*. +ot lia"le if client o"structs
,. -ay not delegate duty to perform without client$s consent
#. .ort %ia"ility
1. +egligence
a. #reach of duty to act skillfully and carefully! and
". Pro/imately causes damages to the client
c. Suita"ility and know0your0customer rules1 "roker is
re)uired to know the financial circumstances and
in2estment o"3ecti2es of client "efore recommending
securities or e/ecuting securities transactions
d. Audit 'uties
i. -ust unco2er employee fraud or em"e44lement
if would ha2e "een disco2ered "y the ordinarily
prudent accountant
ii. 'uty to in2estigate suspicious circumstances
that tend to indicate fraud
iii. %ia"le for an amount e)ual to the em"e44lement
that occurred after he or she should ha2e disco2ered
it
e. Some courts allow defenses of
i. &ontri"utory negligence
ii. &omparati2e negligence1 Scioto -emorial
5ospital Ass$n.6 Inc. 2. Price 7aterhouse
2. Fraud
a. 8lements
i. -isstatement or omission of facts in
communications with client! and
ii. 7ith scienter
a 9nowledge of falsity! or
" :eckless disregard of the truth
". Puniti2e damages may "e a2aila"le
&. #reach of .rust
1. Information and assets entrusted to professional may "e used only
to "enefit the client
2. -ust maintain the confidentiality of the client$s information
'. Securities %aw1 generally used "y third parties only
III. Professionals$ %ia"ility to .hird Persons1 &ommon %aw
A. +egligence and +egligent -isrepresentation
1. -any courts ha2e restricted the a"ility of nonclients to sue a
professional for damages
2. Pri2ity of contract1 contracted with the professional
(. .hree tests
a. Primary #enefit .est
i. %ia"le only to foreseen users
ii. Professional knew
a +ame of user! and
" Purpose of use
". :estatement 2d of .orts .est
i. %ia"le to foreseen users and users in a foreseen
class of users
ii. Professional knew at least the purpose of user$s
use
iii. -arcus #rothers .e/tiles6 Inc. 2. Price
7aterhouse6 %%P
c. Foreseea"le ;sers .est
i. %ia"le to all reasona"ly foreseea"le users
ii. &an reasona"ly e/pect or foresee the purpose of
the use
#. Fraud
1. 8/tended to
a. All foreseea"le users of work product
". 7ho suffered damages
c. .hat were pro/imately caused "y the fraud
2. Pri2ity of contract not re)uired
(. Scienter is re)uired
I<. Professional$s %ia"ility to .hird Parties1 Securities %aw
A. Securities Act of 1=((
1. Section 11
a. Applies to underwriters and e/perts
". -isstatement or omission of material fact in registration
statements
c. %ia"le to any purchasers of securities issued under the
defecti2e registration statement
d. +o reliance re)uired
e. +o pri2ity re)uired
f. +egligence standard used6 e/cept for issuers who are lia"le
regardless of fault
g. 'ue diligence defense1 not negligent
2. Section 12(a(2
a. -isstatement or omission of material fact in any
communication in connection with a general distri"ution of
securities "y issuer
". %ia"le to any purchaser of securities offered or sold
c. +o reliance re)uired
d. Pri2ity re)uired
e. +egligence standard
f. 'efense1
i. 'id not know! and
ii. &ould not reasona"ly ha2e known of the untruth
or omission
(. Section 1>(a
a. -isstatement or omission of material fact in any
communication in connection with any offer to sell or sale
of any security
". %ia"le to any purchaser
c. :eliance re)uired
d. +o pri2ity re)uired
e. .wo parts re)uire negligence! on part re)uires scienter
#. Securities 8/change Act of 1=(*
1. Section 1?
a. False or misleading statement of material fact in any
document filed with the S8&
". %ia"le to any purchaser or seller of a security whose price
was affected
c. :eliance re)uired
d. +o pri2ity re)uired
e. Scienter re)uired
f. 'efense1 good faith and no knowledge
2. Section 1@(" and :ule 1@"0,
a. -isstatement or omission of material fact in any
communication in connection with a purchase or sale of a
security
". %ia"le to any purchaser or seller
c. :eliance re)uired
d. +o pri2ity re)uired "ut defendant must
i. &ommunicate with the plaintiff! or
ii. 9now or should know plaintiff will recei2e the
communication with the misstatement or omission
e. Scienter re)uired
(. Aiding and A"etting
a. &entral #ank case
i. +o lia"ility to those in3ured "y fraud
ii. 'istinguishes "etween those primarily
responsi"le (lia"le and those secondarily
responsi"le (no longer lia"le
". -ust act with scienter
c. Ani/ter 2. 5ome0Stake Production &o.
i. :eliance on the statements made "y other
cannot itself form the "asis of lia"ility
ii. +o direct communication re)uirement
iii. :ecklessness will satisfy the scienter
re)uirement
*. 8/tent of %ia"ility
a. Amount of in2estor$s loss for which the defendant is
responsi"le1 proportionate lia"ility
". Aury )uestion
<. %imiting Professionals$ %ia"ility1 Professional &orporations and %imited
%ia"ility Partnerships
A. In a corporation6 professionals are not isolated from lia"ility for
professional misconduct
#. In %%P6
1. A partner$s lia"ility is limited to the partnership$s assets6 unless the
partner super2ised the wrongdoer$s work
2. :etains unlimited lia"ility for own malpractice
(. Preferred form of "usiness for professionals who do not
incorporate
<I. Bualified Cpinions6 'isclaimers of Cpinion6 Ad2erse Cpinions6 and
;naudited Statements
A. Cpinion %etter1 indicates whether the
1. Audit has complied with GAAS
2. Financial statements fairly present client$s financial position
(. :esults of operation in conformity with GAAP
#. ;n)ualified opinion1 compliance with GAAS and GAAP
&. If issues )ualified opinion or disclaimer of opinion
1. :elie2ed of lia"ility only to the e/tent that )ualification or
disclaimer is specifically e/pressed
2. %etters that disclaim lia"ility totally for false and misleading
statements are too general to e/cuse
<II. &riminal6 In3uncti2e6 and Administrati2e Proceedings
A. &riminal %ia"ility ;nder the Securities %aws
1. 1=(( Act
a. 7illful 2iolations of any section or any rule or regulation
". -a/imum penalty is D1@6@@@ fine and , years
imprisonment
2. 1=(* Act
a. 7illful 2iolations of any section or rule or regulation
". ;p to D, million fine and 2@ years imprisonment
c. Prison time does not apply to an indi2idual who shows he
did not know of S8& rule or regulation
d. Professional firm may "e fined up to D2, million
e. ;nited States 2. +atelli
#. Cther &riminal %aw <iolations
1. .a/ %aw
2. -ail Fraud
(. :I&C
a. 8ngaging in a pattern of racketeering acti2ity
". &onduct or participate in the affairs of an enterprise in
almost any pattern of "usiness fraud (pro2ed "y 2 predicate
offenses within a 1@0year period
c. ;p to D2,6@@@ fine and 2@ years imprisonment
d. <ictims may reco2er tre"le damages
*. %aws against destruction of e2idence
a. Generally professionals are not re)uired to retain
documents that pro2e a client$s guilt if they do not destroy
documents with intent to o"struct criminal prosecution
". Arthur Andersen %%P 2. ;nited States
&. In3uctions
'. Administrati2e Proceedings
1. :ule 1@2(e allows S8& to "ar either temporarily or permanently a
professional who has demonstrated a lack of )ualifications
2. -ay discipline accountants who engage in a single instance of
highly unreasona"le conduct leading to a 2iolation of professional
standards or an accountant who in engages in repeated6
unreasona"le conduct
(. Also allows S8& to take action against a professional who has
willfully 2iolated or aided and a"etted another$s 2iolation of the
securities acts
*. -ay suspend an accountant from practicing "efore it
,. -ay impose ci2il penalties up to D,@@6@@@
<III. Securities 8/change Act Audit :e)uirements
A. Auditor must take specific steps if they learn a client may ha2e committed
an illegal act during the course of the audit
1. 'etermine whether an illegal act has6 in fact6 occurred
2. If so6 must calculate prospecti2e impact on client$s financial
statements
(. -ust inform client$s management and audit committee6 unless
inconse)uential
*. -ust make a report to the "oard of directors if management does
not take appropriate remedial action
,. Significant whistle0"lowing duty imposed on independent auditors
#. SCE Section *@*1 re)uires that management maintain ade)uate internal
controls and auditors attest to management$s assessment
IE. Cwnership of 7orking Papers1 records made during an audit
A. #elong to the professional6 not the client
#. &lient has a right of access
&. -ust "e retained for > years
E. Professional0&lient Pri2ilege
A. Generally6 communications "etween clients and nonlawyer professionals
are not protected
#. A large num"er of states ha2e granted an accountant0client pri2ilege "y
statute
1. Pri2ilege "elongs to the client
2. Federal courts do not recogni4e pri2ilege