1. Chapter 20 Legal Liability
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2. Historical Perspective
Intro
Historical Perspective
Claims against auditors were relatively uncommon before the 1970’s.
Global credit crisis leads to the Dodd-Frank Act of 2010 and increases scrutiny into auditing profession again.
The recession of led to another upsurge in litigation against auditors.
1970
1980
1990
2002
2010
Due to a slump in the economy in the early 1970’s and the recession of the 1980’s, it became more common for auditors to be sued.
Due to several high-profile frauds, Congress refocused attention on auditors in the Sarbanes-Oxley Act of 2002.
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3. Overview Two Classes of Law Common Law
LO# 2
Two Classes of Law
Common Law
Case law developed over time by judges
Statutory Law
Written law enacted by the legislative branch of government
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4. Common Law—Clients Requires Due Care Types of Liability to the Client
LO# 3
Common Law—Clients
Requires Due Care
Types of Liability to the Client
May be held liable for breach of contract
Negligence
Gross negligence
Fraud (acting with knowledge and intent to deceive)
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5. Common Law—Third Parties
LO# 4
Common Law—Third Parties
Reasonably Foreseeable 3rd Parties 3rd parties whose reliance should be reasonably foreseeable, even if the specific person is unknown to the auditor.
Foreseen 3rd Parties 3rd parties whose reliance should be foreseen, even if the specific person is unknown to the auditor.
Near Privity 3rd parties whose relationship with the CPA approaches privity.
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6. LO# 4
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7. Fraud Third Party Must Prove A false representation by the CPA.
LO# 4
Fraud
Third Party Must Prove
A false representation by the CPA.
Knowledge or belief by the CPA that the representation was false.
The CPA intended to induce the 3rd party to rely on the false representation.
The 3rd party relied on the false representation.
The 3rd party suffered damages.
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8. Securities Exchange Act of 1934
LO# 5
Statutory Liability
Three major statutes provide sources of statutory liability for auditors:
Securities Act of 1933
Securities Exchange Act of 1934
Sarbanes-Oxley Act of 2002
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9. Securities Act of 1933 Third Party Must Prove
LO# 5
Securities Act of 1933
Third Party Must Prove
The 3rd party suffered losses by investing in the registered security.
The audited financial statements contained a material omission or misstatement.
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10. Securities Exchange Act of 1934
LO# 6
Securities Exchange Act of 1934
Third Party Must Prove
A material, factual misrepresentation or omission.
Reliance on the financial statements.
Damages suffered as a result of reliance on the financial statements.
Scienter (gross negligence or recklessness may be enough).
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11. LO# 7
Private Securities Litigation Reform Act of 1995, Securities Litigation Uniform Standards Act of 1998, and the Class Action Fairness Act of 2005
Private Securities Litigation Reform Act of 1995
Securities Litigation Uniform Standards Act of 1998
Class Action Fairness Act of 2005
Provides for proportionate liability where each defendant is liable for the portion of the damages that corresponds to the percentage responsibility of that defendant.
Prevents plaintiffs from seeking to evade the protections that Federal law provides against abusive litigation by filing suit in State, rather than Federal Court
Expands federal jurisdiction to include multistate class actions where there is more than $5 million in dispute. Expected to help in more consistent dismissal of dubious claims.
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12. Sarbanes-Oxley Act of 2002 Most sweeping securities law since 1934
LO# 8
Sarbanes-Oxley Act of 2002
Creation of PCAOB
Most sweeping securities law since 1934
Stricter independence rules
Audits of internal controls
Increased reporting responsibilities
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13. LO# 5-8
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14. SEC and PCAOB Sanctions
LO# 9
SEC and PCAOB Sanctions
Suspend Practicing Privilege
Impose Fines
Remedial Measures
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15. Foreign Corrupt Practices Act (FCPA)
LO# 10
Foreign Corrupt Practices Act (FCPA)
Passed in 1977 in response to the discovery of bribery and other misconduct on the part of more than 300 American companies.
An auditor may be subject to administrative proceedings, civil liability, and civil penalties.
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16. Racketeer Influenced and Corrupt Organizations Act (RICO)
LO# 11
Racketeer Influenced and Corrupt Organizations Act (RICO)
Passed in 1970 to combat the infiltration of legitimate businesses by organized crime.
RICO provides for civil and criminal sanctions for certain illegal acts.
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17. LO#
8 & 12
Criminal Liability
Auditors can be held criminally liable under the laws discussed in the previous section. Criminal prosecutions require that some form of criminal intent be present, such as fraud. However, gross negligence can also be deemed criminal.
Gross Negligence
Fraud
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18. End of Chapter 20
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