Chapter 51 Accountants’ Duties and Liability

Learning Objectives Describe an accountant’s liability to his or her client for breach of contract and fraud Describe an accountant’s liability to third parties under the Ultramares doctrine Describe an accountant’s liability to third parties under the Restatement (Second) of Torts and the foreseeability standard

Learning Objectives Describe the accountant’s civil liability and criminal liability under federal securities laws Describe the duties of accountants under the Sarbanes-Oxley Act

Exhibit 51.1 - Accounting Firm LLP

Accounting Standards and Principles Generally accepted accounting principles(GAAPs) Standards for preparation and presentation of financial statements Generally accepted auditing standards(GAASs) Standards for methods and procedures used to conduct audit Audit Verification of company’s books and records

Accountants’ Liability to Their Clients Breach of contract Accountant who fails to perform the terms of engagement may be sued for damages Fraud Actual fraud: intentional misrepresentation that causes damage to client Constructive fraud: accountant acts with “reckless disregard” for consequence of his actions

Accountants’ Liability to Their Clients Accounting malpractice(negligence) Accountant breaches duty of reasonable care, knowledge, skill, and judgment that he owes a client when providing auditing services Accountant may be sued for negligence Accountants liable for negligence in preparing unaudited financial statements

Accountants' Liability to Third Parties Ultramares doctrine Accountant is liable only for negligence to third parties who are in privity of contract or in privity- like relationship with accountant Provides a narrow standard for holding accountants liable to third parties for negligence The majority rule for accountants’ liability for negligence in the country

Case 51.1: Ultramares Doctrine Credit Alliance Corporation v. Arthur Andersen & Company 65 N.Y.2d 536, 493 N.Y.S.2d 435, Web 1985 N.Y. Lexis 15157 Court of Appeals of New York Issue Is Andersen liable under the Ultramares doctrine?

Accountants' Liability to Third Parties Section 552 of the Restatement (Second) of Torts Accountant is liable only for negligence to third parties who are members of a limited class of intended users of the client’s financial statements Provides broader standard than Ultramares doctrine

Accountants' Liability to Third Parties Foreseeability standard Accountant is liable for negligence to third parties who are foreseeable users of client’s financial statements Provides broadest standard for holding accountants liable to third parties for negligence

Case 51.2: Accountants’ Liability to Third Party Johnson Bank v. George Korbakes & Company, LLP 472 F.3d 439, Web 2006 U.S. App. Lexis 31058 (2006) United States Court of Appeals for the Seventh Circuit Issue Is GKCO, the auditor of Brandon, liable to Johnson Bank for negligent misrepresentation?

Accountants' Liability to Third Parties Fraud If an accountant engages in actual or constructive fraud, a third party that relies on the accountant’s fraud and is injured, may bring tort action to recover damages Breach of contract Third parties cannot sue accountants, as they are not in privity of contract with them

Securities Law Violations Section 10A of Securities Act of 1934 Imposes duty on auditors to detect and report illegal acts committed by their clients Section 11(a) of the Securities Act of 1933: imposes civil liability on accountants and others for Making misstatements or omissions in registration statement Failing to find such misstatements or omissions

Securities Law Violations Section 10(b) of the Securities Exchange Act of 1934 Prohibits any manipulative or deceptive practice in connection with purchase or sale of any security Section 18(a) of the Securities Exchange Act of 1934 Imposes civil liability on any person who makes false or misleading statements of material fact in any application filed with the SEC

Securities Law Violations Private Securities Litigation Reform Act of 1995 Imposes pleading and procedural requirements that make it difficult for plaintiffs to bring class action securities lawsuits Replaces joint and several liability of defendants with proportionate liability

Criminal Liability of Accountants Section 24 of Securities Act of 1933 Untrue statements or omissions in registration statements Section 32(a) of Securities Exchange Act of 1934 Criminal offense for person to willfully and knowingly make any false or misleading statement in any application required to be filed with the SEC

Criminal Liability of Accountants Tax Reform Act of 1976 Imposes criminal liability on accountants and others who prepare federal tax returns and commit wrongdoings Racketeer Influenced and Corrupt Organizations Act (RICO) Provides for both criminal and civil penalties for securities fraud State securities laws

Sarbanes-Oxley Act of 2002 Establishment of the Public Company Accounting Oversight Board Public accounting firms must register with the board Separation of audit and nonaudit services Requires audit partner of the accounting firm to supervise and approve an audit Prohibits employment of an accountant by a previous audit client Public corporations must have an audit committee

Accountants’ Privilege and Work Papers Accountant–client privilege Provides that an accountant cannot be called as a witness against a client in a court action Work product immunity Accountant’s work papers cannot be discovered in a court case against the accountant’s client

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