Chapter 20 Legal Liability McGraw-Hill/Irwin Copyright 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
Intro Historical Perspective Claims against auditors were relatively uncommon before the 1970 s. The recession of 1990-1992 led to another upsurge in litigation against auditors. Global credit crisis leads to the Dodd-Frank Act of 2010 and increases scrutiny into auditing profession again. 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. 20-2
LO# 2 Overview Two Classes of Law Common Law Statutory Law Case law developed over time by judges Written law enacted by the legislative branch of government 20-3
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) 20-4
LO# 4 Common Law Third Parties Near Privity 3 rd parties whose relationship with the CPA approaches privity. Foreseen 3 rd Parties 3 rd parties whose reliance should be foreseen, even if the specific person is unknown to the auditor. Reasonably Foreseeable 3 rd Parties 3 rd parties whose reliance should be reasonably foreseeable, even if the specific person is unknown to the auditor. 20-5
LO# 4 20-6
LO# 4 Fraud Third Party Must Prove 1. A false representation by the CPA. 2. Knowledge or belief by the CPA that the representation was false. 3. The CPA intended to induce the 3 rd party to rely on the false representation. 4. The 3 rd party relied on the false representation. 5. The 3 rd party suffered damages. 20-7
LO# 5 Statutory Liability Three major statutes provide sources of statutory liability for auditors: The Securities Act of 1933 The Securities Exchange Act of 1934 Sarbanes-Oxley Act of 2002 20-8
LO# 5 Securities Act of 1933 Third Party Must Prove 1. The 3 rd party suffered losses by investing in the registered security. 2. The audited financial statements contained a material omission or misstatement. 20-9
Securities Exchange LO# 6 Act of 1934 Third Party Must Prove 1. A material, factual misrepresentation or omission. 2. Reliance on the financial statements. 3. Damages suffered as a result of reliance on the financial statements. 4. Scienter (gross negligence or recklessness may be enough). 20-10
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 LO# 7 Class Action Fairness Act of 2005 Provides for proportionate liability for defendants based on percentage of responsibility and a specific statement of fraud at the beginning of the case 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. 20-11
LO# 8 Sarbanes-Oxley Act of 2002 Creation of PCAOB Stricter independence rules Audits of internal controls Most sweeping securities law since 1934 Increased reporting responsibilities 20-12
LO# 5-8 20-13
LO# 9 SEC and PCAOB Sanctions Suspend Practicing Privilege Impose Fines Remedial Measures 20-14
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. 20-15
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. 20-16
Criminal Liability LO# 8 & 12 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 20-17
End of Chapter 20 20-18