Liability of Accountants and Other Professionals Chapter 11 Liability of Accountants and Other Professionals Chapter 11: Liability of Accountants and Other Professionals McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

Common Law Accountant Liability to Clients: Accountant Liability for Negligence Accountant liable to client for negligence if he/she fails to exercise care of competent, reasonable professional, and that failure causes loss/injury to client Accountant has duty to perform his/her responsibilities according to generally accepted accounting principles (“GAAP”) and generally accepted auditing standards (“GAAS”) An accountant is liable to a client for negligence if the accountant fails to exercise the care of a competent, reasonable professional, and that failure causes loss or injury to the client. Further, an accountant has the duty to perform responsibilities according to generally accepted accounting principles, and generally accepted auditing standards. 11-2

Common Law Accountant Liability to Clients: Accountant Liability for Breach of Contract Whenever accountant hired to perform specific task, he/she enters into contract with client Explicitly, accountant agrees to perform contractual tasks Implicitly, accountant agrees to complete work in a competent and professional manner, according to professional standards (GAAP and GAAS) Accountants may be liable for violating explicit and/or implicit agreements Whenever an accountant is hired to perform a specific task, the accountant enters into contract with the client. Explicitly, the accountant agrees to perform contractual tasks; implicitly, the accountant agrees to complete work in a competent and professional manner, according to professional accounting standards. Accountants may be liable for violating explicit and/or implicit agreements. 11-3

Common Law Accountant Liability to Clients: Accountant Liability for Fraud Accountants who commit fraud liable to those parties accountant reasonably should have foreseen as being injured through justifiable reliance on fraudulent information Accountants may be liable for “actual” or “constructive” fraud Actual fraud—Accountant’s actions meet criteria necessary to prove fraud Constructive fraud—No fraudulent intent, but accountant “grossly negligent” in performing his/her duties An accountant who commits fraud is liable to those parties the accountant reasonably should have foreseen as becoming injured through justifiable reliance on the fraudulent information. The accountant may be liable for “actual” or “constructive” fraud. With actual fraud, the accountant’s actions meet criteria necessary to prove fraud. With constructive fraud, there is no fraudulent intent, but the accountant was “grossly negligent” in performing accounting duties. 11-4

Common Law Accountant Liability to Third Parties Privity or near-privity (the “Ultramares” rule): Requires that third party be in privity of contract with accountant, or be close enough to accountant to constitute near-privity Foreseen users and class of users (the Restatement rule): Requires that third party be known recipient, or be from a class of known recipients, of accountant’s work Reasonably foreseeable users: Allows any third party that should have been reasonably foreseen as using product of accountant’s work to bring suit In terms of accountant liability to third parties, the “Ultramares” rule requires that the third party be in privity of contract with the accountant, or be close enough to the accountant to constitute near-privity. The “Restatement” rule requires that the third party be a known recipient, or be from a class of known recipients, of the accountant’s work. The “reasonably foreseeable users” test allows any third party who should have been reasonably foreseen as using the product of the accountant’s work to bring suit. 11-5

Accountants’ and Clients’ Rights “Working Papers”—Various documents used and developed during audit Accountant is legal owner of working papers, but client may access at any time upon request Accountant-Client Privilege Does not exist under federal law, but some states have granted this right When granted, client has right to privilege, but accountant has fewer protections “Working papers” are various documents used and developed during an audit. The accountant is the legal owner of working papers, but a client may access such papers at any time, upon request. The “accountant-client” privilege does not exist under federal law, but some states have granted this right. When granted, the client has rights with respect to the privilege, but the accountant has fewer protections. 11-6

Federal Securities Law and Accountant Liability: The Securities Act of 1933 Section 11—Accountants civilly liable for misstatements and omissions of material facts made in registration statements filed with the Securities and Exchange Commission (“SEC”) Section 15—Applies liability to controlling persons when Section 11 violation occurs Section 11 of The Securities Act of 1933 holds accountants civilly liable for misstatements and omissions of material facts made in registration statements filed with the Securities and Exchange Commission. Section 15 of the Act applies liability to “controlling persons” when a Section 11 violation occurs. 11-7

Federal Securities Law and Accountant Liability: The Securities Exchange Act of 1934 Section 18—Accountants liable for fraudulent statements made to SEC Section 10(b) and SEC Rule 10b-5—unlawful for accountants to use “any manipulative or deceptive device/contrivance” in contravention of SEC rules and regulations Section 20(a)—When person is “in control” of primary violator of act and person who significantly participated in the illegal activity, he or she may be liable Section 18 of The Securities Exchange Act of 1934 holds accountants liable for fraudulent statements made to the SEC. Section 10(b) and SEC Rule 10b-5 make it unlawful for accountants to use “any manipulative or deceptive device or contrivance” in contravention of SEC rules and regulations. Section 20(a) of the Act states that when a person is “in control” of the primary violator of the Act and significantly participated in the illegal activity, her or she may be liable. 11-8

Federal Securities Law and Accountant Liability: The Private Securities Litigation Reform Act of 1995 Requires that accountants use adequate procedures when performing audit, so they can detect any illegal acts of company being audited Includes specific actions/guidelines accountant must follow after identifying potentially illegal activity when conducting audit The Private Securities Litigation Reform Act of 1995 requires that accountants use adequate procedures when performing an audit, so they can detect any illegal acts of the company being audited. The Act includes specific actions and guidelines the accountant must follow, after identifying potentially illegal activity when conducting an audit. 11-9

Federal Securities Law and Accountant Liability: The Sarbanes-Oxley Act of 2002 Consists of new rules/regulations for public accounting firms, in attempt to reduce fraud in accounting practices Created Public Company Accounting Oversight Board Titles I and II outline duties of board, and establish new requirements for public accounting firms In an attempt to reduce fraud in accounting practices, The Sarbanes-Oxley Act of 2002 consists of new rules and regulations for public accounting firms. The Act created the Public Company Accounting Oversight Board. Titles I and II outline the duties of the board, and establishes new requirements for public accounting firms. 11-10

Liability of Other Professionals Many professionals who provide services (including attorneys, real estate brokers, doctors, and architects) are professionally liable, under theories similar to accountants’ liability Many other service professionals, including attorneys, real estate brokers, doctors, and architects are professionally liable under theories similar to accountants’ liability. 11-11