Exam 15: Legal Liability

Lauren hires Humphrey,a CPA,to audit her financial statements.The engagement letter includes a statement acknowledging that audited financial statements will be provided to Key Largo Bank for a loan.Humphrey completes the audit and issues an unqualified opinion.Based on the audited financial statements,Key Largo Bank approves the loan to Lauren.Four months later,Lauren files for bankruptcy.Key Largo Bank would most likely sue Humphrey claiming

Third-party plaintiffs bringing action under common law need not prove

Lauren hires Humphrey,a CPA,to audit her financial statements.The engagement letter includes a statement acknowledging that audited financial statements are needed for a filing with a regulatory body.Humphrey completes the audit and issues an unqualified opinion.Based on the audited financial statements,Key Largo Bank approves a loan to Lauren.Four months later,Lauren files for bankruptcy.Key Largo Bank would most likely sue Humphrey claiming

Sleek Corporation is a public corporation whose stock is traded on a national securities exchange.Sleek hired Garson Associates,CPAs,to audit Sleek's financial statements.Sleek needed the audit to obtain bank loans and to make a public stock offering so that Sleek could undertake a business expansion program. Before the engagement,Fred Hedge,Sleek's president,told Garson's managing partner that the audited financial statements would be submitted to Sleek's banks to obtain the necessary loans. During the course of the audit,Garson's managing partner found that Hedge and other Sleek officers had embezzled substantial amounts of money from the corporation.These embezzlements threatened Sleek's financial stability.When these findings were brought to Hedge's attention,Hedge promised that the money would be repaid and begged Garson not to disclose the embezzlements. Hedge also told Garson's managing partner that several friends and relatives of Sleek's officers had been advised about the projected business expansion and proposed stock offering,and had purchased significant amounts of Sleek's stock based on this information. Garson submitted an unqualified opinion on Sleek's financial statements,which did not include adjustments for or disclosures of the embezzlements and insider stock transactions.The financial statements and auditors' opinion were submitted to the banks Sleek normally does business with,including Knox Bank.Knox,relying on the financial statements and the auditors' report,loaned Sleek $2,000,000. Sleek's audited financial statements were also included in a registration statement prepared under the provisions of the Securities Act of 1933.The registration statement was filed with the SEC in conjunction with Sleek's public offering of 100,000 shares of its common stock at $100 per share. An SEC investigation of Sleek disclosed the embezzlements and the insider trading.Trading in Sleek's stock was suspended and Sleek defaulted on the Knox loan.As a result,the following legal actions were taken: • Knox Bank sued Garson. • The purchasers of Sleek's stock offering sued Garson. Required: a.Would Knox recover from Garson for fraud? b.Would the purchasers of Sleek's stock offering recover from Garson 1.Under the liability provisions of section 11 of the Securities Act of 1933? 2.Under the antifraud provisions of section 10(b)and Rule 10b-5 of the Securities Exchange Act of 1934?

Mays bought McCovey Corp.common stock in an offering registered under the Securities Act of 1933.Hart & Co.,CPAs,gave an unqualified opinion on McCovey's financial statements that were included in the registration statement filed with the Securities and Exchange Commission.Mays sued Hart under the provisions of the 1933 Act that deal with omission of facts required to be in the registration statement.Mays must prove that

While conducting an audit,Larson Associates,CPAs,failed to detect material misstatements included in its client's financial statements.Larson's unqualified 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.In a suit by a purchaser against Larson,Larson's best defense would be that the

In a common law action against auditors,lack of privity is a viable defense if the plaintiff

Distinguish between the "due diligence" and the "causation" defenses available to auditors under section 11 of the Securities Act of 1933.

Which of the following is not a reason that the Class Action Fairness Act of 2005 will benefit auditors in class action lawsuits?

Beckler & Associates,CPAs,examined and issued an unqualified opinion on the financial statements of Queen Co.The financial statements contained misstatements that resulted in a material overstatement of Queen's net worth.Queen provided the audited financial statements to Mac Bank in connection with a loan made by Mac to Queen.Beckler knew that the financial statements would be provided to Mac.Queen defaulted on the loan.Mac sued Beckler to recover for its losses associated with Queen's default.Which of the following must Mac prove in order to recover? I.Beckler did not conduct the audit with the appropriate level of professional care. II)Mac relied on the financial statements.

Charlie Company is headquartered in Wisconsin.Charlie Company's auditors are headquartered in Minnesota.Bob lives in Bloomington,Indiana but works in Chicago,Illinois.Based on a tip from his boss,Bob calls his stockbroker (Jim,who offices in Chicago)and instructs him to purchase 1,000 shares of Charlie Company despite never having requested or reviewed Charlie Company's financial statements.Charlie Company is traded on the New York Stock Exchange and the transaction takes place 15 minutes later on the floor of the exchange. Charlie Company declared bankruptcy three months later and Bob lost his entire investment.Bob sued Charlie Company's auditors for ordinary negligence. The trial is scheduled for hearing in Madison,Wisconsin.Before the opening of the trial,the attorney for the auditors objects to the trial being held in Wisconsin,since the transaction between Bob and Jim took place in Illinois.The attorney asks that the trial be moved to Illinois. Required: A.Why would the attorney ask for the trial to be moved? B.What defense would you raise if you were the auditors' attorney?

Under the Securities Act of 1933,which of the following defenses is related to auditors performing a reasonable investigation of the financial statements?

Which of the following statements is true concerning auditors' responsibilities during the audit?

The first significant case under section 11 of the Securities Act of 1933 charging auditors with not conducting a reasonable investigation was

The restatement of torts is a general legal doctrine that extends liability for ordinary negligence to