Accountants Liability. An accountant may be liable under common law due to negligence or fraud.

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1 Accountants Liability Liability under Common Law An accountant may be liable under common law due to negligence or fraud. Negligence A loss due to negligence occurs when an accountant violates the duty to perform professional services in a competent manner. NEGligence may consist of Nondisclosure of information to a client Errors previously discovered not being corrected GAAP not being followed Best defense to common law negligence is that appropriate professional standards were followed. Professional Responsibilities Module 21 1 COPYRIGHTED MATERIAL

2 Negligence (continued) Simple negligence Careless mistakes Defense of lack of privity may be available But client and intended third beneficiaries have privity Foreseen third parties have privity in majority of states under tort law Foreseen third parties lack privity in states conforming to Ultramares case Gross negligence Reckless disregard for the truth Lack of privity not valid as defense Professional Responsibilities Module 21 2

3 Fraud Fraud refers to conduct that involves all of the following: Material false representation of fact Justifiable reliance on the information Awareness of the false information by the accountant The falsity was made with the ultimate intent to deceive The party must have suffered damages Scienter refers to the accountant s knowledge of a false representation or material omission of fact with the intent to deceive. Potential defenses against fraud include Lack of intent to deceive Immateriality Lack of privity is not a valid defense Professional Responsibilities Module 21 3

4 Liability under Federal Securities Regulations Auditors are liable under both the Securities Act of 1933 (33 Act) and the Securities Exchange Act of 1934 (34 Act). Liability under 33 Act Accountants are liable under Section 11 of the 33 Act Liable if financial statements contain untrue statement or material omission Liable to anyone acquiring security without knowledge of error To be successful, the plaintiff need not prove Privity Scienter Reliance Defenses the accountant may use include Plaintiff s knowledge of the error Due diligence in performance of services Professional Responsibilities Module 21 4

5 Liability under 34 Act Accountants are liable under Rule 10b-5 of the 34 Act Liable for oral or written misrepresentations of fact Liable for wrongful act committed through mail, interstate commerce, or a national securities exchange To be successful, the plaintiff must prove Scienter Reliance Defenses the accountant may use include Plaintiff s knowledge of the error Lack of reliance by plaintiff Professional Responsibilities Module 21 5

6 Summary of Auditor Liability Elements in action taken against an accountant 1) There is a misstatement or omission of a material fact 2) Plaintiff has reasonably relied upon the information 3) Plaintiff suffered a loss 4) Accountant was in error Professional Responsibilities Module 21 6

7 Auditor Common Law Liability Gross Negligence Contracts Negligence or Fraud Who may Client or an Client or (usually) Anyone bring action intended user foreseen user injured Accountant s error Breach of Recklessness or resulting in action contract Carelessness intentional misconduct (scienter) Plaintiff must All 4 All 4 All 4 prove elements elements elements Professional Responsibilities Module 21 7

8 Auditor Liability under Federal Securities Laws 1933 Act 1934 Act Section 11 Rule 10b-5 Who may Any Any bring action purchaser purchaser Accountant s error Lack of Recklessness or resulting in action due diligence intentional misconduct (scienter) Plaintiff must Elements All 4 prove 1 & 3 only Elements Professional Responsibilities Module 21 8

9 Private Securities Litigation Reform Act of 1995 Requires auditor of publicly held company to include specific substantive procedures designed to Identify illegal acts, including management fraud, having a direct and material effect on the financial statements Identify significant related-party transactions Determine if there is substantial doubt related to the entity s ability to continue as a going concern Illegal acts must be reported to management and board of directors must be notified Board of directors must Notify the SEC within 1 business day Provide auditor with copy of report to SEC If auditor not notified Resign from engagement Notify SEC within 1 business day of board s failure to meet deadline Professional Responsibilities Module 21 9

10 Liability as a Tax Preparer Penalties Actions by an accountant preparing a client s tax return can result in penalties Not providing client with copy of return Failing to sign return as a preparer Endorsing & cashing client s refund check Liability to Client Other actions may create a liability to a tax client Failing to file a return timely Not advising client of tax elections Neglecting evaluation of joint versus separate returns Professional Responsibilities Module 21 10

11 AICPA Code of Professional Conduct Independence, Integrity, & Objectivity When performing certain services, CPA must be independent in fact and in appearance. Independence in fact means No direct financial interest in client No material indirect financial interest in client Independence is impaired if a CPA takes on a decision-making role for an audit client. Independence is not impaired if a CPA performs litigation support services for a client. Professional Responsibilities Module 21 11

12 Independence, Integrity, & Objectivity (continued) Independence impaired by Supervising client s personnel Signing client s checks Acting as client s stock transfer agent Entering into lease with client Accepting gifts from client Obtaining material loan from client, even if fully collateralized (except by cash balances) Unpaid audit fees may impair independence. May not extend beyond one year Audit may be performed, but report may not be issued Professional Responsibilities Module 21 12

13 Auditor Takes Employment with Audit Client An auditor who is considering employment with an audit client must follow certain requirements They must inform the audit firm of any conversations with an audit client about possible employment. If they enter into negotiations on possible employment, they must be immediately removed from the engagement and all their work reviewed by the audit firm to ensure proper skepticism was exercised. Once the professional accepts employment with the audit client, the audit firm should consider the need to modify the audit plan or change members of the audit team to deal effectively with the new situation. In any audit performed within a year of the professional joining the client, a member of the audit firm with no connection to the audit must review all work to ensure it takes into account independence difficulties caused by the form firm member s involvement as client. Professional Responsibilities Module 21 13

14 Nonattest Services Members performing attest services for client may perform certain nonattest services without impairing independence. May provide advice, research materials, and recommendations Client must accept responsibility for making all decisions Specific client personnel must be designated to oversee services Client must be responsible for establishing and maintain all internal controls and may not outsource such services to the auditor. An understanding of the objectives of the engagement and client responsibilities must be documented prior to performing the nonattest services for an attest client. Professional Responsibilities Module 21 14

15 General Standards & Accounting Principles A CPA must perform with competence and must exercise due care Competence implies combination of education & experience Due care includes proper supervision & reviewing work of assistants A CPA must comply with standards appropriate for the service being performed Statements on Standards for Consulting Services Standards for Performing & Reporting on Peer Reviews Statements on Responsibilities in Tax Practice Statements on Responsibilities in Personal Financial Planning Practice Statements on Auditing Standards Statements on Standards for Accounting & Review Services Professional Responsibilities Module 21 15

16 General Standards & Accounting Principles (continued) Examples of actions that would violate the standard of due care include Performing professional services without complying with the appropriate standards Expressing an unqualified opinion on financial statements known to be materially misstated Failing to report the discovery of fraud to the client s audit committee When financial statements are materially misstated as a result of fraud 1) Auditor insists on revisions to financial statements 2) If revisions are not made, auditor expresses a modified report or withdraws from the engagement Professional Responsibilities Module 21 16

17 Responsibilities to Clients A CPA must maintain client information as confidential. May disclose client information to Comply with a subpoena Cooperate with a quality control review Other Responsibilities & Practices A CPA should not perform acts discreditable to the profession, such as Retaining client records Understating anticipated fees for services A CPA may not accept a commission in relation to an attest client. A CPA may not practice under a misleading name. Professional Responsibilities Module 21 17

18 Standards for Consulting Services When performing consulting services, a CPA must adhere to certain general standards Professional competence Due professional care Planning & supervision Obtaining sufficient relevant data Specific standards related to consulting services include Serving the client Establishing an understanding with the client as to the nature, scope, & limitation of services Communicate with the client about conflicts of interest, scope of services, or benefits to be derived Professional Responsibilities Module 21 18

19 Standards for Tax Practice A CPA performing tax services May not recommend a tax position that lacks merit Must make a reasonable effort to answer applicable questions on the return May rely on client information when preparing the return Must make reasonable inquiries about questionable or incomplete information May use estimates Professional Responsibilities Module 21 19