ModC

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Module C

Legal Liability

True / False Questions

1. Auditors are potentially liable for monetary damages and subject to

criminal penalties for failure to perform professional services properly.

True False

2. Auditors cannot be held liable to their clients for failure to detect

material management fraud.

True False

. !oint and several liability is a doctrine that allo"s a successful plainti#

to recover the full amount of a damage a"ard from any defendant

regardless of the defendant$s level of culpability.

True False

%. &trict privity is the relationship of parties "ho enter into a contract

together.

True False

'. The restatement of torts e(tends liability for ordinary negligence to

)foreseen) third parties "ho may not be e(plicitly *no"n to auditors.

True False

+. The ,rivate &ecurities Litigation -eform Act deals "ith la"suits in both

federal and state courts.

True False

© 2013 by McGraw-Hill Education. This is proprietary material solely or authori!ed instructor use. "ot authori!ed or sale or distribution in

any manner. This document may not be copied# scanned# duplicated# orwarded# distributed# or posted on a website# in whole or part.

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. Legal liabilities of auditors may arise from la"suits brought on the basis

of the la" of contracts or as tort actions.

True False

/. Tort actions cover civil complaints other than breach of contract 0suchas failure to e(ercise the appropriate level of professional care.

True False

. Actions brought under common la" place most of the burden of proof

on the defendant3 usually auditors.

True False

14.

Auditors$ primary defense against a claim for ordinary negligence is too#er evidence that the audit had been conducted in accordance "ith

generally accepted auditing standards.

True False

11

.

The Ultramares case holds auditors to a higher level of responsibility

than the Rosenblum v. Adler case in terms of common la" liability to

third parties.

True False

12

.

5ross negligence represents a more signi6cant departure from

appropriate professional care than ordinary negligence.

True False

1

.

The &ecurities Act of 1 regulates subse7uent trading of securities3

and the &ecurities 8(change Act of 1% regulates the initial issuance

of securities.

True False

1%

.

The general registration form for ne" issues of securities is Form 149:.

True False



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1'

.

&ection 11 of the &ecurities Act of 1 contains the principal criteria

de6ning civil liabilities under the statute.

True False

1+.

The e#ect of section 11 of the &ecurities Act of 1 is to shift themajor burden of proof from auditors to the plainti#.

True False

1

.

;f auditors can prove that a reasonable e(amination "as performed3

then auditors are not liable for damages under section 11 of the

&ecurities Act of 1.

True False

1/

.

-ule 14b9' re7uires that the plainti# must prove that auditors acted

"ith intent to deceive in order to impose liability.

True False

1

.

As a defense under -ule 14b9'3 auditors must prove that they acted in

good faith and had no *no"ledge of the material misstatements in the

6nancial statements.

True False

24

.

Liability to foreseen third parties "ould e(pose auditors to a greater

potential obligation than liability to foreseeable third parties.

True False

Multiple Choice Questions



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21

.

Auditors should not be liable to any party if they perform services that

meet the standards of

A. <rdinary negligence.

=. -egulatory providence.C. >ue care.

>. 5ood faith.

22

.

A principle that may reduce or eliminates auditors$ liability to clients is

A. Client$s constructive negligence.

=. Client$s contributory negligence.

C. Auditors$ ordinary negligence.

>. Auditors$ gross negligence.

2

.

8lliot Corp. is interested in purchasing -oger Corp. ,rior to the

purchase3 8lliot hired Adam ? Co. to audit -oger$s 6nancial statements.

>uring the audit3 Adam failed to discover a fraud that resulted in

material misstatements in -oger$s 6nancial statements. After the

ac7uisition3 the fraud "as discovered3 and 8lliot Corp. su#ered

substantial losses. To sue Adam ? Co.3 8lliot must prove that Adam

A. Acted rec*lessly or "ith lac* of reasonable grounds for belief.=. :ne" of the instances of fraud.

C. Failed to e(ercise the appropriate level of professional care.

>. >emonstrated gross negligence.

2%

.

@hich of the follo"ing statements is true concerning auditors$

responsibilities during the audit

A. Auditors must e(ercise the level of care3 s*ill3 and judgment e(pected

of a reasonably prudent auditor under the circumstances.=. Auditors must plan the audit to gather suBcient competent evidence

to guarantee the accuracy of the 6nancial statements.

C. Auditors are strictly liable for failures to discover client fraud.

>. Auditors are not liable unless they commit gross negligence or

intentionally disregard generally accepted auditing standards.



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.

:erry C,A is the auditor for &ammy Corp. >uring the audit3 :erry

discovers a material misstatement in &ammy$s 6nancial statements.

&ammy$s management tells :erry that if the misstatement is corrected

or if :erry issues an opinion that indicates there is a material

misstatement3 &ammy Corp. "ill li*ely have to declare ban*ruptcy and

thousands of employees "ill lose their jobs. @hich of the follo"ing

statements is true if &ammy does not correct the misstatement and

:erry issues an un7uali6ed opinion on &ammy$s 6nancial statements

A. :erry is liable only to third parties in privity of contract.

=. :erry is liable only to *no"n users of the 6nancial statements.

C. :erry is li*ely liable to any person "ho su#ered a loss as a result of

the material misstatement.

>. :erry is li*ely liable to third parties only if the third parties "erea"are of the material misstatements and relied on the 6nancial

statements.

2+

.

Mays bought McCovey Corp. common stoc* in an o#ering registered

under the &ecurities Act of 1. art ? Co.3 C,As3 gave an un7uali6ed

opinion on McCovey$s 6nancial statements that "ere included in the

registration statement 6led "ith the &ecurities and 8(change

Commission. Mays sued art under the provisions of the 1 Act that

deal "ith omission of facts re7uired to be in the registration statement.

Mays must prove that

A. There "as fraudulent activity by art.

=. The 6nancial statements contained a material misstatement.

C. Mays relied on art$s opinion.

>. Mays "as in privity "ith art.

2

.

To prevail in an action brought under common la"3 the plainti# must

sho" all of the follo"ing except

A. e or she "as damaged or su#ered a loss.


C. Auditors *ne" the 6nancial statements contained a material

misstatement.

>. e or she relied on the 6nancial statements.



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2/

.

Failure to provide any level care in ful6lling a duty o"ed to another

party3 including rec*less disregard for the truth3 is called

A. =reach of contract.

=. <rdinary negligence.C. ,rivity.

>. Constructive fraud.

2

.

D. Lauren hires >. umphrey3 C,A3 to audit her 6nancial statements.

The engagement letter includes a statement ac*no"ledging that

audited 6nancial statements are re7uired to be 6led "ith a regulatory

body by <ctober 1. umphrey does not complete the audit until

<ctober '. Lauren is late 6ling the 6nancial statements and is 6ned

E1443444 by the regulatory body. Lauren "ould most li*ely sue

umphrey claiming


=. <rdinary negligence.

C. 5ross negligence.


4

.



audited 6nancial statements "ill be provided to :ey Largo =an* for aloan. umphrey completes the audit and issues an un7uali6ed opinion.

=ased on the audited 6nancial statements3 :ey Largo =an* approves

the loan to Lauren. Four months later3 Lauren 6les for ban*ruptcy. :ey

Largo =an* "ould most li*ely sue umphrey claiming that

A. ;t "as in privity of the contract.

=. ;t "as a primary bene6ciary.

C. ;t "as a foreseen party.

>. ;t "as a foreseeable party.



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1

.

D. Lauren hires >. umphrey3 C,A3 to provide an audit of her 6nancial

statements. The engagement letter includes a statement

ac*no"ledging that audited 6nancial statements "ill be provided to

6nancial institutions for a loan but does not name any 6nancial

institution. umphrey completes the audit and issues an un7uali6ed

opinion. =ased on the audited 6nancial statements3 :ey Largo =an*

approves the loan to Lauren. Four months later3 Lauren 6les for

ban*ruptcy. :ey Largo =an* "ould most li*ely sue umphrey claiming

that





2

.



audited 6nancial statements are needed for a 6ling "ith a regulatory

body. umphrey completes the audit and issues an un7uali6ed opinion.

=ased on the audited 6nancial statements3 :ey Largo =an* approves a

loan to Lauren. Four months later3 Lauren 6les for ban*ruptcy. :ey

Largo =an* "ould most li*ely sue umphrey claiming that





.

;f an audit is performed for the bene6t of a speci6c person or

organiation3 that person or organiation is *no"n as a0n

A. ,arty to the contract.=. ,rimary bene6ciary.

C. Foreseeable third party.

>. ,rime benefactor.



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%

.

At the re7uest of !ames Company$s management3 8.5. Company

audited !ames$s 6nancial statements and "as a"are that !ames$s

management intended to deliver the 6nancial statements to its 2'

shareholders for the purpose of repurchasing their shares for E'4 per

share 0the investors had originally purchased the shares for E' per

share. The audit "as conducted in accordance "ith generally accepted

auditing standards and the 6nancial statements "ere prepared in

accordance "ith generally accepted accounting principles. Later3 the

shareholders sued the auditors3 claiming that if they had fully realied

the signi6cance of disclosures about the mar*et value of the assets3

they could have received E' per share from !ames Company. The

shareholders$ la"suit "ill probably fail because

A. The shareholders did not su#er a loss.=. The shareholders "ere not primary bene6ciaries of the audit

engagement and they have no standing to sue.

C. The shareholders failed to prove lac* of appropriate professional care

on the part of auditors.

>. The shareholders did not rely properly on the 6nancial statements.

'

.

@hich of the follo"ing claims concerning the 7uality of auditors$ "or*

"ould least li*ely result in civil liability for damages

A. 5ross negligence amounting to constructive fraud.

=. Failure to investigate possible fraud "hen other entities in the

industry have e(perienced frauds.

C. -ec*less disregard of evidence that the 6nancial statements do not

conform to generally accepted accounting principles.

>. ;ssuing an un7uali6ed auditors$ opinion "hen evidence suggests that

the 6nancial statements "ere not prepared according to generally

accepted accounting principles.



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+

.

Lancaster ? Company3 C,As3 is auditing the 6nancial statements of

Cooper Corporation. >uring the course of the audit3 Cooper sent the

follo"ing memo to the engagement partnerG

)@e have re7uested E1 million "orth of products from Ladd Corporation

"ith credit terms of net 4 days. Ladd has re7uested audited 6nancial

statements for its credit decision. @e noti6ed Ladd that our annual

audit "as in process and "e "ould provide the audited 6nancial

statements to them as soon as they "ere completed.)

@hich of the follo"ing statements is true "ith regard to this memo

A. ;t is an amendment to the engagement letter and ma*es Ladd a

primary bene6ciary of the audited 6nancial statements.=. ;t may move Ladd closer to a primary bene6ciary and reposition it as

a third party "ith a standing to sue3 depending on the jurisdiction of

any future la"suits.

C. ;t is only a courtesy and does not alter the terms of the engagement

letter or change the nature of Ladd$s standing to sue.

>. ;t is an additional contract placing Ladd in privity of contract.

.

@hen bringing suit against auditors under section 140b of the

&ecurities 8(change Act of 1%3 plainti#s must allege and prove that

A. The 6nancial statements in the o#ering registration 6ling contained a

material misstatement.

=. The auditors "ere a"are of material misstatements in the 6nancial

statements.

C. The auditors "ere guilty of ordinary negligence and failed to discover

material misstatements in the 6nancial statements.

>. The plainti#s purchased the speci6c securities through a public

o#ering and thus have a right to sue.



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/

.

@hich of the follo"ing parties is most li*ely to recover losses resulting

from acts of ordinary negligence from auditors

A. Third parties that auditors should have foreseen could rely on the

client$s 6nancial statements.

=. The auditors$ client.

C. ,urchasers and sellers of securities under the &ecurities 8(change

Act of 1%.

>. Third parties "hose reliance on the client$s 6nancial statements "as

reasonably foreseeable.

.

An audit failure occurs "hen

A. A client goes ban*rupt or has serious 6nancial diBculty.=. Auditors fail to conduct the e(amination in accordance "ith generally

accepted auditing standards3 "hich results in the failure to identify

material misstatements in the 6nancial statements.

C. Auditors cannot collect audit fees o"ed to them by the client.

>. Auditors are sued by a third party.

%4

.

Third9party plainti#s bringing action under common la" need not prove

that

A. They "ere damaged or su#ered an economic loss.

=. They relied on the 6nancial statements.

C. The 6nancial statements "ere the direct cause of loss.

>. =reach of contract occurred.

%1

.

Typical defenses for auditors in common la" actions include all of the

follo"ing except

A. The plainti# "as foreseen.=. The plainti# contributed to the failure to detect material

misstatements.

C. The 6nancial statements "ere not materially misstated.

>. The audit "as conducted in accordance "ith generally accepted

auditing standards.



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%2

.

The &ecurities Act of 1

A. -egulates trading in securities.

=. Approves and guarantees investments.

C. -egulates the initial issuance of securities.>. -egulates the accounting profession.

%

.

@hich of the follo"ing "ould third parties not need to demonstrate

"hen bringing suit against auditors for losses sustained under the

&ecurities Act of 1

A. Auditors "ere a"are of the materially misstated 6nancial

statements.

=. Third9party purchasers su#ered a loss.C. The client$s 6nancial statements contained a material misstatement.

>. ,urchasers "ould need to demonstrate all of the above.

%%

.

The &8C -ule 14b9' deals "ith

A. Fraud in the purchase or sale of securities.

=. ,enalties for "illfully and *no"ingly violating the &ecurities 8(change

Act of 1%.

C. The use of the )due diligence) defense to avoid liability.>. ;ntegrated disclosure system for annual reports.

%'

.

The 6rst signi6cant case under section 11 of the &ecurities Act of 1

charging auditors "ith not conducting a reasonable investigation "as

A. Rusch Factors v. Levin.

=. United States v. Benjamin.

C. Escott v. BarChris Construction Corp.

>. Ernst Ernst v. !ochfelder.



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%+

.

Foreseeable third parties are best described as

A. Management of the entity.

=. Those third parties that have a direct relationship "ith auditors

through previous contract related to the audit engagement.C. Those third parties "ho "ill rely on the audit and are speci6cally

*no"n by auditors.

>. Those third parties "hose decisions normally rely on audited 6nancial

statements and opinions on those 6nancial statements.

%

.

@hich of the follo"ing statements about the &ecurities Act of 1 is

not true

A. The plainti# must prove damages or an economic loss.=. The plainti#s must prove they read and relied upon the 6nancial

statements.

C. Any purchaser of securities may sue auditors.

>. The plainti#s need not prove that the materially misstated 6nancial

statements are the direct cause of the loss.

%/

.

The restatement of torts is a general legal doctrine that e(tends liability

for ordinary negligence to

A. Foreseeable third parties.

=. Foreseen third parties.

C. ,rimary bene6ciaries.

>. All users of 6nancial statements.



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%

.

@hich of the follo"ing is not part of the de6nition of proportionate

liability adopted by the ,rivate &ecurities Litigation -eform Act

A. The total responsibility for loss is divided among all parties

responsible for the loss.

=. >efendants "ho *no"ingly committed a violation of securities la"s

remain jointly and severally liable.

C. The full amount of damages may be recovered from any defendants

involved in the action.

>. A solvent defendant$s liability may be increased by '4 percent if

other defendants are insolvent.

'4

.

A. ,aula performed the audit of the 6nancial statements of Abdul

Company 0a nonpublic entity currently not subject to 6ling

re7uirements under the &ecurities Act of 1 or &ecurities 8(change

Act of 1%. Abdul is currently considering several alternatives for

raising capital3 including see*ing 6nancing from area ban*s or an initial

public o#ering of its securities. @hich of the follo"ing parties "ould

have the lo"est li*elihood of successfully bringing suit for ordinary

negligence against ,aula

A. Abdul Company.

=. ,urchasers of Abdul$s securities in an initial public o#ering.C. First &tate =an*3 a ban* "ith "hich Abdul has not previously done

business.

>. &imon @hita*er3 a private investor "ho is considering ac7uiring

Abdul.

'1

.

@hich of the follo"ing factors"ould not inHuence third parties$ abilities

to bring suit against auditors for ordinary negligence under common

la"

A. The e(tent to "hich the third party relied upon the misstated

6nancial statements and this reliance resulted in their loss.

=. The nature of the activity by the auditors that resulted in their failure

to e(ercise appropriate levels of professional care.

C. The relationship bet"een the auditors and a third party.

>. The jurisdiction in "hich the action occurred.



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'2

.

According to &arbanes9<(ley3 accountants performing an audit or

revie" must maintain all engagement documentation for a period of

A. 2 years.

=. years.C. ' years.

>. years.

'

.

@hich of the follo"ing statements concerning the Ultramares Corp. v.

#ouche case is not true

A. This case "as brought under common la" liability.

=. This case provided a test to determine "hether a third party 7uali6ed

as a primary bene6ciary and could bring suit for ordinary negligence.C. This case established the rights of third parties to bring suits against

auditors under common la" liability.

>. This case concluded that auditors$ liability to third parties "ould be

generally limited to gross negligence or fraud.

'%

.

;n a common la" action against auditors3 lac* of privity is a viable

defense if the plainti#

A. ;s the client$s creditor "ho sues auditors for ordinary negligence.=. Can prove auditors$ gross negligence that amounts to a rec*less

disregard for the truth.

C. ;s the auditors$ client.

>. =ases the action upon fraud.



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''

.

Inder the liability provisions of section 11 of the &ecurities Act of 13

auditors may be liable to any purchaser of a security for certifying

materially misstated 6nancial statements that are included in the

registration statement. Inder section 113 auditors usually are not liable

to the purchaser

A. ;f they can sho" contributory negligence on the part of the

purchaser.

=. ;f they can demonstrate due diligence.

C. Inless the purchaser can prove privity "ith the auditors.

>. Inless the purchaser can prove scienter on the part of the auditors.

'+

.

Inder the liability provisions of section 11 of the &ecurities Act of 13

auditors may be liable to any purchaser of securities for certifying

materially misstated 6nancial statements that are included in the

registration statement. Inder section 113 "hich of the follo"ing must a

purchaser of the security prove

A. -eliance on 6nancial statements3 yesJ fraud by auditors3 yes.

=. -eliance on 6nancial statements3 yesJ fraud by auditors3 no.

C. -eliance on 6nancial statements3 noJ fraud by auditors3 yes.

>. -eliance on 6nancial statements3 noJ fraud by auditors3 no.



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'

.

=ec*ler ? Associates3 C,As3 e(amined and issued an un7uali6ed opinion

on the 6nancial statements of Kueen Co. The 6nancial statements

contained misstatements that resulted in a material overstatement of

Kueen$s net "orth. Kueen provided the audited 6nancial statements to

Mac =an* in connection "ith a loan made by Mac to Kueen. =ec*ler

*ne" that the 6nancial statements "ould be provided to Mac. Kueen

defaulted on the loan. Mac sued =ec*ler to recover for its losses

associated "ith Kueen$s default. @hich of the follo"ing must Mac prove

in order to recover

;. =ec*ler did not conduct the audit "ith the appropriate level of

professional care.

;;. Mac relied on the 6nancial statements.

A. ; only.

=. ;; only.

C. =oth ; and ;;.

>. Deither ; nor ;;.

'/

.

@hile conducting an audit3 Larson Associates3 C,As3 failed to detect

material misstatements included in its client$s 6nancial statements.

Larson$s un7uali6ed opinion "as included "ith the 6nancial statements

in a registration statement and prospectus for a public o#ering of

securities made by the client. Larson *ne" that its opinion and the6nancial statements "ould be used for this purpose. @hich of the

follo"ing statements is correct "ith regard to a suit against Larson and

the client by a purchaser of the securities under section 11 of the

&ecurities Act of 1

A. The purchaser must prove that Larson failed to conduct the audit in

accordance "ith generally accepted auditing standards.

=. The purchaser must prove that Larson *ne" of the material

misstatements.C. Larson "ill not be liable if it had reasonable grounds to believe the

6nancial statements "ere accurate.

>. Larson "ill not be liable if the purchaser did not rely on the 6nancial

statements.



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'

.

@hile conducting an audit3 Larson Associates3 C,As3 failed to detect


Larson$s un7uali6ed opinion "as included "ith the 6nancial statements

in a registration statement and prospectus for a public o#ering of

securities made by the client. Larson *ne" that its opinion and the

6nancial statements "ould be used for this purpose. ;n a suit by a

purchaser against Larson3 its best defense "ould be that the

A. Audit "as conducted in accordance "ith generally accepted auditing

standards.

=. Client "as a"are of the misstatements.

C. ,urchaser "as not in privity of contract "ith Larson.

>. Larson did not *no" the identity of the purchaser at the time of the

audit.

+4

.

@hile conducting an audit of a public entity3 @allace failed to identify

material misstatements in its client$s 6nancial statements. ;nvestors

then sued @allace in connection "ith this audit. @hich of the follo"ing

"ould not need to be demonstrated in order for the shareholders to

successfully bring suit against @allace

A. @allace "as in privity "ith the shareholders.

=. The shareholders relied upon the materially misstated 6nancialstatements.

C. @allace acted "ith gross negligence in the audit.

>. The reliance on the materially misstated 6nancial statements caused

the shareholders$ losses.



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+1

.

&un Corp. approved a merger plan "ith Cord Corp. Among the

determining factors in approving the merger "as Cord$s 6nancial

statements audited by Fran* ? Co.3 C,As. &un had engaged Fran* to

audit Cord$s 6nancial statements. @hile performing the audit3 Fran*

failed to discover certain irregularities that later caused &un to su#er

substantial losses. For Fran* to be liable under common la" liability3

&un at a minimum must prove that Fran*

A. :ne" of the irregularities.

=. Failed to e(ercise the appropriate level of professional care.

C. >emonstrated gross negligence.

>. Acted "ith scienter.

+2

.

@hich of the follo"ing elements3 if present3 "ould support a 6nding of

constructive fraud on the part of auditors

A. 5ross negligence in conducting the engagement.

=. <rdinary negligence in conducting the engagement.

C. Failure to perform the engagement in accordance "ith the terms in

the engagement letter.

>. Actions that demonstrated scienter.

+

.

To be successful in a civil action under section 11 of the &ecurities Act

of 1 against auditors for liability for a materially misstatedregistration statement3 the plainti# must prove the

A. Auditors$ intent to deceive3 yesJ plainti#$s reliance on the registration

statement3 yes.

=. Auditors$ intent to deceive3 yesJ plainti#$s reliance on the registration

statement3 no.

C. Auditors$ intent to deceive3 noJ plainti#$s reliance on the registration

statement3 yes.

>. Auditors$ intent to deceive3 noJ plainti#$s reliance on the registration

statement3 no.



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+%

.

@hich of the follo"ing is the best defense that auditors can assert in a

suit for common la" fraud based on their un7uali6ed opinion on

materially misstated 6nancial statements

A. Contributory negligence on the part of the client.

=. A disclaimer contained in the engagement letter.

C. Lac* of privity.

>. Lac* of scienter.

+'

.

Inder the antifraud provisions of section 140b of the &ecurities

8(change Act of 1%3 auditors may be liable if they acted

A. @ith ordinary negligence.

=. @ith independence.C. @ithout due diligence.

>. @ithout good faith.

++

.

o" does the &ecurities Act of 13 "hich imposes civil liability on

auditors for misrepresentations or omissions of material facts in a

registration statement3 e(pand auditors$ liability to purchasers of

securities beyond that of common la"

A. ,urchasers have to prove only loss caused by reliance on audited6nancial statements.

=. ,rivity "ith purchasers is not a necessary element of proof.

C. ,urchasers have to prove either fraud or gross negligence as a basis

for recovery.

>. Auditors are held to a standard of care described as professional

s*epticism.



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+

.

@hich of the follo"ing is not a reason that the Class Action Fairness Act

of 244' "ill bene6t auditors in class action la"suits

A. Federal courts provide a higher level of scrutiny for class action

la"suits than state courts.

=. Federal courts have more resources at their disposal for managing

class action la"suits.

C. &tate courts may discriminate against defendants from other

jurisdictions.

>. erdicts in state courts are normally more appropriate to apply to

multiple jurisdictions than verdicts in federal courts.

+/

.

Inder the &ecurities Act of 13 "hich of the follo"ing defenses is

related to auditors$ performing a reasonable investigation of the

6nancial statements

A. Causation.

=. Contributory negligence.

C. >ue diligence.

>. ,rudent auditor.

+

.

@hich of the follo"ing is not a valid defense for auditors$ liability to

third parties for ordinary negligence under common la"

A. The loss "as caused by factors other than the materially misstated


=. The third parties lac* the proper standing 0relationship to bring suit

in that jurisdiction.

C. The third parties lac* a privity relationship "ith auditors.

>. The third parties did not rely upon the 6nancial statements.



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4

.

A lac* of reasonable care that may be characteried by the failure of

auditors to follo" 5AA& in the conduct of the audit is *no"n as

A. Constructive fraud.

=. Fraud.C. 5ross negligence.

>. <rdinary negligence.

1

.

From the auditors$ point of vie"3 "hich of the follo"ing is a preferable

provision for imposition of civil liability in a la"suit for 6nancial

damages

A. !oint and several liability.

=. -easonably foreseeable users$ approach to privity.C. Foreseen third parties$ approach to privity.

>. ,roportionate liability.

2

.

Isers of 6nancial statements have a di#erent perception concerning

the nature of auditors$ services than the actual objectives of an audit.

This di#erence is *no"n as

A. >iverse liability perception.

=. -easonable foreseeable third parties.C. ;nsurance hypothesis.

>. 8(pectations gap.

.

;ndividuals "ho believe they relied on misstated 6nancial statements to

ma*e a decision and have su#ered losses as a result "ill issue an action

*no"n as a


=. Tort.C. &ecurities litigation.




7/18/2019 ModC


%

.

Assume that auditors lost a civil la"suit for damages and the court

found total losses of E' million. ;f the auditors "ere determined to be

4 percent at fault and "ere the only solvent defendant3 "hat is the

auditors$ li*ely obligation under proportionate liability

A. E '34443444.

=. ero.

C. E232'43444.

>. E13'443444.

'

.

&uppose that the auditors in the preceding 7uestion participated

*no"ingly in commission of violations of securities la"s 0"ith managers

and directors of the audit client. @hat is the auditors$ li*ely obligation

A. E'34443444.

=. ero.

C. E232'43444.

>. E13'443444.

+

.

@hen a client sues an accountant for failure to perform consulting "or*

properly3 the accountants$ best defense is probably based on the

doctrine of

A. Lac* of privity of contract.

=. Contributory negligence on the part of the client.

C. Lac* of any measurable dollar amount of damages.

>. Do negligence on the part of the consultant.



7/18/2019 ModC


.

@hen creditors "ho relied on an entity$s audited 6nancial statements

su#er monetary losses after a customer 0the auditors$ client goes

ban*rupt3 "hat must the plainti# creditors in a la"suit for damages

sho" in a court that follo"s the doctrine in Credit Alliance

A. The auditors *ne" and speci6cally ac*no"ledged identi6cation of the

creditors.

=. The auditors could reasonably foresee them as bene6ciaries of the

audit because entities such as this client use 6nancial statements to

obtain credit from vendors.

C. The plainti#s "ere foreseen users of the audited 6nancial statements

because they "ere vendors of long standing.

>. All of the above.

/

.

@hen accountants agree to perform a compilation or revie" of

unaudited 6nancial statements3 the best "ay to avoid clients

misunderstanding the nature of the "or* is to describe it completely in

A. An engagement letter.

=. The auditors$ opinion.

C. A report to the clients$ board of directors at the close of the

engagement.

>. A management letter to the board of directors$ audit committee.

.

8ntities desiring to issue e7uity or debt must provide a set of 6nancial

statements to any prospective purchaser. This set of 6nancial

statements and other information for prospective purchasers is *no"n

as a

A. ,rospectus.

=. -evie".

C. ,atron$s ac7uisition statement.

>. ,rojected audited 6nancial information.



7/18/2019 ModC


/4

.

The &ecurities Act of 1 and &ecurities 8(change Act of 1% contain

A. Civil liability provisions applicable to auditors.

=. Criminal liability provisions applicable to auditors.

C. Deither a nor b.>. =oth a and b.

/1

.

@hich of the follo"ing third parties is *no"n by name to auditors as the

audit is conducted

A. Foreseeable third party.

=. Foreseen third party.

C. 5eneral third party.

>. ,rimary bene6ciary.

/2

.

@hich of the follo"ing "ould be auditors$ most li*ely defense in an

action brought under the &ecurities 8(change Act of 1%

A. The investor did not have privity "ith auditors.

=. The investor did not su#er a loss based on the materially misstated


C. The auditors acted in good faith and "ere not a"are of the materially

misstated 6nancial statements.>. The 6nancial statements "ere not 6led "ith the &ecurities and

8(change Commission.

/

.

@hich of the follo"ing statements regarding auditors$ liability under the

&ecurities Act of 1 is not true

A. The act relates to the initial issuance of securities to the public3

normally through an initial public o#ering.

=. Auditors$ liability arises because of audited 6nancial information 6led"ith the &8C.

C. Third parties must demonstrate that they relied on misstated

6nancial statements that "ere e(amined by auditors.

>. Auditors may be liable if they are found to have engaged in ordinary

negligence.



7/18/2019 ModC


/%

.

Inder the &ecurities 8(change Act of 1%3 entities are re7uired to

report to the public about changing auditors on

A. Form 149:.

=. Form &91.C. Form 149K.

>. Form /9:.

/'

.

&ection 110b of the &ecurities Act of 1 provides that individuals can

be sued and may be liable for investors$ losses in connection "ith a

public securities o#ering under "hich of these circumstances

A. The chairman of the board of directors performed a reasonable

investigation of facts in connection "ith preparing the section in theregistration statement concerning the speci6cation of the use of the

proceeds of the o#ering.

=. A consulting engineer performed a reasonable investigation and

reported in the registration statement on the feasibility of

construction of a road"ay to be 6nanced "ith the o#ering proceeds.

C. The president of the issuing entity had no reason to doubt the report

of the consulting engineer3 although the president did not perform a

separate reasonable investigation of her o"n.

>. The oBcers of the issuing entity "ere relieved that the independentauditors did not ma*e an issue about the e(cessive valuation of

inventory held to support construction in progress.

/+

.

;n comparison to the burden of proof re7uired of plainti#s in civil

la"suits against independent auditors under common la"3 section

140b of the &ecurities 8(change Act of 1%

A. ;s the same regarding plainti#s$ need to prove damages or losses.

=. ;s the same regarding plainti#s$ need to establish privity or a

bene6ciary relationship "ith auditors.

C. >oes not re7uire that plainti#s prove their reliance on materially

misstated 6nancial statements.

>. >oes not re7uire that plainti#s prove that relying on the materially

misstated 6nancial statements caused their losses.



7/18/2019 ModC


/

.

@hich of the follo"ing cases provides auditors the broadest e(posure

for liability to third parties for ordinary negligence under common la"

A. Credit Alliance v. Arthur Andersen.

=. Fleet $ational Ban% v. &loucester Co.C. Rosenblum' (nc. v. Adler .

>. Ultramares.

//

.

@hich of the follo"ing is a major di#erence in auditors$ liability under

the &ecurities Act of 1 and the &ecurities 8(change Act of 1%

A. The burden of proving reliance on misstated 6nancial statements and

the relationship bet"een these 6nancial statements and the

economic loss.=. The auditors$ re7uired degree of professional care 0level of

substandard performance.

C. =oth of the above.

>. Done of the above.

/

.

@hen an entity registers a security o#ering under the &ecurities Act of

13 the la" provides an investor

A. An &8C guarantee that the information in the registration statementis true.

=. ;nsurance against loss from the investment.

C. Financial information e(amined by independent auditors.

>. ;nside information about the entity$s trade secrets.



7/18/2019 ModC


4

.

A group of investors sued Anderson3 <lds3 and @atershed3 C,As 0A<@

for alleged damages su#ered "hen the entity in "hich they held

common stoc* "ent ban*rupt. To avoid liability under the common la"3

A<@ must prove "hich of the follo"ing

A. The investors actually su#ered a loss.

=. The investors relied on the 6nancial statements audited by A<@.

C. The investors$ loss "as a direct result of their reliance on the audited



auditing standards and "ith due care.

1

.

The &ecurities and 8(change Commission document that governs

accounting in 6nancial statements 6led "ith the &8C is

A. -egulation >.

=. Form /9:.

C. Form &=9l.

>. -egulation &9N.

2

.

@hich of the follo"ing cases upheld the re7uirement that plainti#s

demonstrate scienter "hen bringing action under the &ecurities

8(change Act of 1%

A. Ernst Ernst v. !ochfelder .

=. Escott v. BarChris Construction Corp.

C. Smith v. London Assurance Corp.

>. Ultramares.

.

A public entity subject to the periodic reporting re7uirements of the

&ecurities 8(change Act of 1% must 6le an annual report "ith the &8C

*no"n as the

A. Form 149:.

=. Form 149K.

C. Form /9:.

>. -egulation &9N.



7/18/2019 ModC


%

.

@hen investors sue for damages under section 11 of the &ecurities Act

of 13 they must allege and prove

A. &cienter on the part of auditors.

=. The audited 6nancial statements contained a material misstatement.C. They relied on the materially misstated 6nancial statements.

>. Their reliance on the materially misstated 6nancial statements "as

the direct cause of their loss.

'

.

@hich of the follo"ing is not part of &arbanes9<(ley

A. An increased duty on the part of auditors to identify 6nancial

statement fraud.

=. A re7uirement that the C8< and CF< certify the 6nancial statements.C. ;ncreased penalties for destruction of records in federal

investigations.

>. ;ncreased penalties for mail fraud and criminal violations of the

&ecurities 8(change Act of 1%.

+

.

;f a C,A 6rm is being sued for common la" fraud by a third party based

upon materially false 6nancial statements3 "hich of the follo"ing is the

best defense the auditors could assert

A. Lac* of privity.

=. Lac* of reliance.

C. A disclaimer contained in the engagement letter.

>. Contributory negligence on the part of the client.



7/18/2019 ModC


.

Loc*e3 C,A "as engaged by all3 ;nc. to audit @illo" Company. all

purchased @illo" after receiving @illo"$s audited 6nancial statements3

"hich included Loc*e$s un7uali6ed auditors$ opinion. Loc*e "as

negligent in the performance of the @illo" audit engagementJ this

negligence "as caused by failure to perform the engagement in

accordance "ith the terms of the engagement letter. As a result of

Loc*e$s negligence3 all su#ered damages of E'3444. all appears to

have grounds to sue Loc*e for

A. <ption A

=. <ption =

C. <ption C

>. <ption >

/

.

An investor see*ing to recover stoc* mar*et losses from a C,A 6rm

associated "ith an initial o#ering of securities based on an un7uali6edopinion on 6nancial statements that accompanied a registration

statement3 must establish that

A. The audited 6nancial statements contain a false statement or

omission of material fact.

=. The investor relied on the 6nancial statements.

C. The C,A 6rm did not act in good faith.

>. The C,A 6rm "ould have discovered the false statement or omission

if it had e(ercised due care in its e(amination.



7/18/2019 ModC


.

>onalds ? Company3 C,As3 audited the 6nancial statements included in

the annual report submitted by Mar*um &ecurities3 ;nc.3 to the

&ecurities and 8(change Commission. The audit "as improper in

several respects. Mar*um is no" insolvent and unable to satisfy the

claims of its customers. Customers have instituted legal action against

>onalds based on &ection 140b and -ule 140b9' of the &ecurities

8(change Act of 1%. @hich of the follo"ing is li*ely to be >onalds$

best defense

A. The 6rm did not intentionally certify the false 6nancial statements.

=. &ection 140b does not apply to the case.

C. The 6rm "as not in privity of contract "ith the creditors.

>. The engagement letter speci6cally disclaimed any liability to any

party that resulted from Mar*um$s fraudulent conduct.

144

.

@est ? Co.3 C,As3 rendered an un7uali6ed opinion on the 6nancial

statements of ,ride Corp.3 "hich "ere included in ,ride$s registration

statement 6led "ith the &8C. &ubse7uently3 e( purchased '44 shares

of ,ride$s preferred stoc* as part of a public o#ering subject to the

&ecurities Act of 1. e( has commenced an action against @est

based on the &ecurities Act of 1 for losses resulting from

misstatements of facts in the 6nancial statements included in the

registration statement.

@hich of the follo"ing elements must e( prove to hold @est liable

A. @est rendered its opinion "ith *no"ledge of material

misstatements.

=. @est performed the audit negligently.

C. e( relied on the 6nancial statements included in the registration

statement.

>. The misstatements "ere material.



7/18/2019 ModC


141

.

@est ? Co.3 C,As3 rendered an un7uali6ed opinion on the 6nancial


statement 6led "ith the &8C. &ubse7uently3 e( purchased '44 shares

of ,ride$s preferred stoc* as part of a public o#ering subject to the

&ecurities Act of 1. e( has commenced an action against @est

based on the &ecurities Act of 1 for losses resulting from



@hich of the follo"ing defenses "ould be least helpful to @est in

avoiding liability to e(

A. @est "as not in privity of contract "ith e(.

=. @est conducted the audit in accordance "ith 5AA&.C. e($s losses "ere caused by factors other than the misstatements.

>. e( *ne" of the misstatements "hen e( ac7uired the preferred

stoc*.

142

.

;n general3 "hich of the follo"ing parties "ould have the lo"est

burden of proof in bringing suit against an auditor

A. Clients.

=. A lender "ho meets the de6nition of a primary bene6ciary.C. A third9party investor under the &ecurities Act.

>. A lender "ho meets the de6nition of a foreseen third party.

14

.

Inder generally accepted auditing standards3 auditors are responsible

for detecting

A. All manners of fraud.

=. Theft and illegal acts.

C. iolations of auditing standards.

>. Material misstatements of 6nancial statements.



7/18/2019 ModC


14%

.

The ,rivate &ecurities Litigation -eform Act adopted the doctrine of


=. !oint and several liability.

C. ,roportionate liability.>. Foreseen third parties.

14'

.

The primary defense for auditors against a claim of ordinary

negligence is to o#er evidence that the

A. Audit "as conducted in accordance "ith 5AA&.

=. ,lainti# "as not in privity or not foreseen.

C. Financial statements did not contain a material misstatement.

>. ,lainti# contributed to the negligence.

14+

.

,lainti#s bringing action under common la" need not prove

A. They have a )reliance letter) from auditors.

=. They "ere damaged or su#ered a loss.

C. The 6nancial statements contained a material misstatement.

>. Auditors failed to e(ercise the appropriate level of professional care

and "ere responsible for the damages.

14

.

The landmar* case that stated criteria for auditors$ liability to third

parties for gross negligence or fraud3 but not ordinary negligence3 "as

A. Smith v. London Assurance Corp.

=. Ultramares Corp. v. #ouche.

C. ))*+ #enants, Corp. v. -ax Rothenber Co.

>. -c/esson Robbins (nc.



7/18/2019 ModC


14/

.

The &ecurities and 8(change Commission document that governs the

reporting of all business3 analytical3 and supplementary disclosures in

reports re7uired to be 6led "ith the &8C is

A. Form 149:.

=. Financial -eporting -eleases.

C. -egulation &9:.

>. -egulation &9N.

14

.

Inder section 11 of the &ecurities Act of 13 a plainti# suing for

damages must prove

A. A privity relationship "ith auditors.

=. -eliance on the 6nancial statements in registration statement.C. Materially misstated 6nancial statements caused the damages or

loss.

>. >amages or loss from the purchase of securities.

114

.

&ince the Ernst Ernst v. !ochfelder court decision3 plainti#s suing for

damages under -ule 14b9' must prove

A. The 6nancial statements contained a material misstatement.

=. The reliance on the materially misstated 6nancial statementscaused the damages and loss.

C. <rdinary negligence on the part of auditors.

>. &cienter on the part of auditors.

111

.

@hich of the follo"ing is a third party "hose name the auditor *no"s

and for "hose purpose the audit is conducted

A. Foreseen third party.

=. Foreseeable third party.C. ,rimary bene6ciary.

>. &ubrogee.



7/18/2019 ModC


Fill in the Blank Questions

112

.

;n a0n OOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOO3 a small number of

plainti#s "ith small individual claims can bring suit for large damagesin the name of an e(tended class.

OOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOO

11

.

The Rosenblum' (nc. v. Adler decision allo"s potential auditor liability

for ordinary negligence to third parties "ho are reasonably

OOOOOOOOOOOOOOOOOOOOOOOOOOOOO users of auditors$ opinions and 6nancial

statements.


11%

.

A third party "ho is *no"n by name to auditors is referred to as a0n

OOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOO.


11'

.

The ,rivate Litigation &ecurities -eform Act adopted the doctrine of

OOOOOOOOOOOOOOOOOOOOOOOOOOOOO liability3 "hich bases damages on the

e(tent of fault e(hibited by a convicted defendant.


11+

.

The I.&. &upreme Court ruled that auditors are not subject to civil

OOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOO complaints unless

they actually participated in the management or operation of a corrupt

business.


11.

OOOOOOOOOOOOOOOOOOOOOOOOOOOOOO liability refers to auditors$ liability basedon prior legal judgments and precedents.




7/18/2019 ModC


11/

.

OOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOO is a claim by plainti#s that

auditors did not perform services in the manner stated in the

engagement letter.


11

.

The contractual relationship bet"een parties is *no"n as

OOOOOOOOOOOOOOOOOOOOOOOO.


124

.

OOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOO is the lac* of reasonable care in the

performance of professional services.


121

.

The OOOOOOOOOOOOOOOOOOOOOOOOOOOOO v. #ouche case provided the

precedent to allo" third parties not in privity "ith auditors to bring suit

for failure to e(ercise the appropriate level of professional care.


122

.

Auditors have high e(posure to liability under the &ecurities Act of

13 section 113 primarily because the

OOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOO has been placed on auditors.


12

.

-egulation OOOOOOOOOOOOOOOOOOOOOOOOOOOOO contains accounting

re7uirements for annual and interim 6nancial statements 6led under

the &ecurities Act of 1 and &ecurities 8(change Act of 1%.


12%

.

The &8C$s OOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOO e(press ne" rules

and policies about accounting and disclosures.




7/18/2019 ModC


12'

.

A0n OOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOO must be 6led and must be

e#ective before a sale of securities to the public is la"ful.


12+.

The OOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOO doctrine holds that auditorsmay be liable for ordinary negligence to foreseen third parties.


12

.

OOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOO involves cases in "hich

auditors are sued for violating a "ritten la" or statute.


12/.

Inder section 110b of the &ecurities Act of 13 if auditors can provethat a reasonable investigation "as performed 0e.g.3 an audit

conducted in accordance "ith

OOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOO3 they are not liable for

damages.


12

.

Inder &8C -ule 14b9'3 the plainti# must prove

OOOOOOOOOOOOOOOOOOOOOOOOOOOOO 0or mental state embracing the intent to

deceive in order to impose liability on auditors.


14

.

The defense for auditors under the &ecurities 8(change Act of 1% is

to prove they acted in OOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOO and had

no *no"ledge of the material misstatements.


11. The Ernst Ernst v. OOOOOOOOOOOOOOOOO 00 case concluded that auditorsmight be liable for gross negligence under the &ecurities 8(change Act

of 1% even in the absence of scienter.




7/18/2019 ModC


Short Answer Questions



7/18/2019 ModC


12

.

;n each of the individual cases3 indicate the potential liability and

identify the appropriate basis under common or statutory la".



7/18/2019 ModC


Essay Questions

1

.

>istinguish bet"een the )due diligence) and the )causation) defenses

available to auditors under section 11 of the &ecurities Act of 1.

1%

.

@hat are the legal liabilities of auditors under common la"



7/18/2019 ModC


1'

.

&lee* Corporation is a public corporation "hose stoc* is traded on a

national securities e(change. &lee* hired 5arson Associates3 C,As3 to

audit &lee*$s 6nancial statements. &lee* needed the audit to obtain

ban* loans and to ma*e a public stoc* o#ering so that it could

underta*e a business e(pansion program.

=efore the engagement3 F. edge3 &lee*$s president3 told 5arson$s

managing partner that the audited 6nancial statements "ould be

submitted to &lee*$s ban*s to obtain the necessary loans.

>uring the course of the audit3 5arson$s managing partner found that

edge and other &lee* oBcers had embeled substantial amounts of

money from the corporation. These embelements threatened &lee*$s

6nancial stability. @hen these 6ndings "ere brought to edge$s

attention3 edge promised that the money "ould be repaid andbegged 5arson not to disclose the embelements.

edge also told 5arson$s managing partner that several friends and

relatives of &lee*$s oBcers had been advised about the projected

business e(pansion and proposed stoc* o#ering and had purchased

signi6cant amounts of &lee*$s stoc* based on this information.

5arson submitted an un7uali6ed opinion on &lee*$s 6nancial

statements3 "hich did not include adjustments for or disclosures of the

embelements and insider stoc* transactions. The 6nancial

statements and auditors$ opinion "ere submitted to the ban*s &lee*

normally does business "ith3 including :no( =an*. -elying on the

6nancial statements and the auditors$ report3 :no( loaned &lee*

E234443444.

&lee*$s audited 6nancial statements "ere also included in a

registration statement prepared under the provisions of the &ecurities

Act of 1. The registration statement "as 6led "ith the &8C in

conjunction "ith &lee*$s public o#ering of 1443444 shares of itscommon stoc* at E144 per share.

An &8C investigation of &lee* disclosed the embelements and the

insider trading. Trading in &lee*$s stoc* "as suspended3 and &lee*

defaulted on the :no( loan. As a result3 the follo"ing legal actions

"ere ta*enG



7/18/2019 ModC


P :no( =an* sued 5arson.

P The purchasers of &lee*$s stoc* o#ering sued 5arson.

Required:

a. @ould :no( be able to recover from 5arson for fraud

b. @ould the purchasers of &lee*$s stoc* o#ering recover from 5arson

1. Inder the liability provisions of section 11 of the &ecurities Act of

1

2. Inder the antifraud provisions of section 140b and -ule 14b9' of

the &ecurities 8(change Act of 1%

1+

.

=rieHy e(plain the concept of proportionate liability. @hy is the

adoption of proportionate liability important to the accountingprofession



7/18/2019 ModC


1

.

Charlie Company is head7uartered in @isconsin. ;ts auditors are

head7uartered in Minnesota. :. =ob lives in =loomington3 ;ndiana3 but

"or*s in Chicago3 ;llinois. =ased on a tip from his boss3 =ob called his

stoc*bro*er 0=. !im "hose oBce is in Chicago and instructs him to

purchase 13444 shares of Charlie Company despite never having

re7uested or revie"ed Charlie Company$s 6nancial statements. Charlie

is traded on the De" Qor* &toc* 8(change3 and the transaction too*

place 1' minutes later on the Hoor of the e(change.

Charlie Company declared ban*ruptcy three months later3 and =ob lost

the entire investment. =ob sued Charlie Company$s auditors for

ordinary negligence.

The trial is scheduled for hearing in Madison3 @isconsin. =efore the

opening of the trial3 the attorney for the auditors objects to the trialbeing held in @isconsin because the transaction bet"een =ob and !im

too* place in ;llinois. The attorney as*s that the trial be moved to

;llinois.

Required:

A. @hy "ould the attorney as* for the trial to be moved

=. @hat defense "ould you raise if you "ere the auditors$ attorney

Matchin Questions



7/18/2019 ModC


1/

.

Ising the follo"ing letters3 identify the case to "hich each statement

is most closely relatedG

1. 8stablished a three9point

test for auditor liability3

including that auditors

demonstrate some action to

ac*no"ledge the e(istence of

the third party and the third

party$s intent to rely on the

opinion and 6nancial

statements

Credit

Alliance v.

Arthur

Andersen OOOO

2. @as the 6rst I.&. caseinvolving a suit against

auditors

Smith v.

London Assurance

Corp. OOOO. Concluded that rec*less

misstatements even if not

deliberate are the basis for

liability to third parties

Ultramares

Corp. v.

#ouche OOOO%. Found auditors liable for

ordinary negligence under the

&ecurities Act of 1

Ernst

Ernst v.

!ochfelder OOOO

'. Concluded that auditors had

a duty to inform clients of

instances of fraud even if hired

for "rite9up "or*

))*+#enants, Corp.

v. -ax

Rothenber

Co. OOOO+. Concluded that auditors

could be liable to third parties

"ho "ere not in privity "ith

them

State Street

#rust v. Ernst OOOO. 8stablished precedent for

the plainti# to prove scienterto recover damages under

section 140b of the &ecurities

8(change Act of 1%

Escott v.BarChris

Construction

Corp. OOOO



7/18/2019 ModC


1

.

Ising the follo"ing letters3 identify the case to "hich each statement

is most closely related.

1. Third parties cannot rely

on revie"ed 6nancial

statements to the same

e(tent as they can on

audited 6nancial

statements

Rosenblum'

(nc. v. Adler OOOO2. Auditors may be liable to

third parties for ordinary

negligence if the auditors

should foresee these parties

as relying on the 6nancialstatements

United Statesv. Benjamin OOOO

. ;t established precedent

for plainti#$s need to allege

and prove scienter to

impose section 140b

liability

Ernst Ernst

v. !ochfelder OOOO%. Auditors are liable to

reasonably foreseeable

third9party users for

ordinary negligence

(selin v.

Landau OOOO'. The court applied the

restatement of torts

doctrine to identify the

plainti# as a primary

bene6ciary

Fleet $ational

Ban% v.

&loucester Co. OOOO+. Auditors "illfully violated

&ecurities 8(change Act of

1% by ma*ing false and

misleading statements in a

pro(y statement

Credit Alliance

v. Arthur

Andersen OOOO. Conviction of auditors for

"illingly conspiring to

defraud in an engagement

related to a pro forma

6nancial statement

United States

v. $atelli 0Dational

&tudent

Mar*eting OOOO



7/18/2019 ModC




7/18/2019 ModC


Module C Legal Liability Ans"er :ey

True / False Questions

1. Auditors are potentially liable for monetary damages and subject to

criminal penalties for failure to perform professional services

properly.

TR!E

-eferenceG Kuestion also found in study guide

AACSB1 Anal2tic

A(C3A BB1 (ndustr2

A(C3A BB1 Leal

A(C3A F$1 4ecision -a%in

Blooms1 Understand

4i5cult21 6 -edium

Learnin 7bjective1 C89) (dentif2 and describe auditors, exposure to la"suits and loss judments.

#opic1 #he Leal Environment

2. Auditors cannot be held liable to their clients for failure to detectmaterial management fraud.

FA"SE


AACSB1 Anal2tic

A(C3A BB1 (ndustr2

A(C3A BB1 Leal


Blooms1 Understand

4i5cult21 6 -edium


#opic1 #he Leal Environment



7/18/2019 ModC


. !oint and several liability is a doctrine that allo"s a successful plainti#

to recover the full amount of a damage a"ard from any defendant

regardless of the defendant$s level of culpability.

TR!E


AACSB1 Anal2tic

A(C3A BB1 (ndustr2

A(C3A BB1 Leal


Blooms1 Understand

4i5cult21 6 -edium

Learnin 7bjective1 C89+ Understand recent developments that a:ect auditors, liabilit2 to clients and third

parties.

#opic1 #he Chanin Landscape of Auditors, Liabilit2

%. &trict privity is the relationship of parties "ho enter into a contract

together.

TR!E


AACSB1 Anal2tic

A(C3A BB1 (ndustr2 A(C3A BB1 Leal


Blooms1 Understand

4i5cult21 6 -edium

Learnin 7bjective1 C896 Specif2 the characteristics of auditors, liabilit2 under common la" and cite speci;c

case precedents.

#opic1 Liabilit2 Under Common La"

'. The restatement of torts e(tends liability for ordinary negligence to

)foreseen) third parties "ho may not be e(plicitly *no"n to auditors.

TR!E


AACSB1 Anal2tic

A(C3A BB1 (ndustr2

A(C3A BB1 Leal




7/18/2019 ModC


Blooms1 Understand

4i5cult21 6 -edium


case precedents.


+. The ,rivate &ecurities Litigation -eform Act deals "ith la"suits in

both federal and state courts.

FA"SE


AACSB1 Anal2tic

A(C3A BB1 (ndustr2

A(C3A BB1 Leal


Blooms1 Understand4i5cult21 6 -edium


parties.

#opic1 #he Chanin Landscape of Auditors, Liabilit2

. Legal liabilities of auditors may arise from la"suits brought on the

basis of the la" of contracts or as tort actions.

TR!E


AACSB1 Anal2tic

A(C3A BB1 (ndustr2

A(C3A BB1 Leal


Blooms1 Understand

4i5cult21 6 -edium


case precedents.




7/18/2019 ModC


/. Tort actions cover civil complaints other than breach of contract 0such

as failure to e(ercise the appropriate level of professional care.

TR!E


AACSB1 Anal2tic

A(C3A BB1 (ndustr2

A(C3A BB1 Leal


Blooms1 Understand

4i5cult21 6 -edium


case precedents.


. Actions brought under common la" place most of the burden of proof

on the defendant3 usually auditors.

FA"SE


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A(C3A BB1 Leal


Blooms1 Understand

4i5cult21 6 -edium


case precedents.


14. Auditors$ primary defense against a claim for ordinary negligence is

to o#er evidence that the audit had been conducted in accordance

"ith generally accepted auditing standards.

TR!E


AACSB1 Anal2tic

A(C3A BB1 (ndustr2

A(C3A BB1 Leal




7/18/2019 ModC


Blooms1 Understand

4i5cult21 6 -edium


case precedents.


11. The Ultramares case holds auditors to a higher level of responsibility

than the Rosenblum v. Adler case in terms of common la" liability to

third parties.

FA"SE


AACSB1 Anal2tic

A(C3A BB1 (ndustr2

A(C3A BB1 Leal A(C3A F$1 4ecision -a%in

Blooms1 Understand

4i5cult21 6 -edium


case precedents.


12. 5ross negligence represents a more signi6cant departure from

appropriate professional care than ordinary negligence.

TR!E


AACSB1 Anal2tic

A(C3A BB1 (ndustr2

A(C3A BB1 Leal


Blooms1 Understand

4i5cult21 6 -edium


case precedents.




7/18/2019 ModC


1. The &ecurities Act of 1 regulates subse7uent trading of securities3

and the &ecurities 8(change Act of 1% regulates the initial issuance

of securities.

FA"SE


AACSB1 Anal2tic

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A(C3A BB1 Leal


Blooms1 Understand

4i5cult21 6 -edium

Learnin 7bjective1 C89< Specif2 the civil and criminal liabilit2 provisions of the Securities Act of )=**.

#opic1 #he Securities Act of )=** >Securities Act?

1%. The general registration form for ne" issues of securities is Form 149

:.

FA"SE


AACSB1 Anal2tic

A(C3A BB1 (ndustr2

A(C3A BB1 Leal A(C3A F$1 4ecision -a%in

Blooms1 Understand

4i5cult21 6 -edium



1'. &ection 11 of the &ecurities Act of 1 contains the principal criteria

de6ning civil liabilities under the statute.

TR!E


AACSB1 Anal2tic

A(C3A BB1 (ndustr2

A(C3A BB1 Leal


Blooms1 Understand

4i5cult21 6 -edium



7/18/2019 ModC




1+. The e#ect of section 11 of the &ecurities Act of 1 is to shift the

major burden of proof from auditors to the plainti#.

FA"SE


AACSB1 Anal2tic

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A(C3A BB1 Leal


Blooms1 Understand

4i5cult21 6 -edium



1. ;f auditors can prove that a reasonable e(amination "as performed3

then auditors are not liable for damages under section 11 of the

&ecurities Act of 1.

TR!E


AACSB1 Anal2tic

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Blooms1 Understand

4i5cult21 6 -edium



1/. -ule 14b9' re7uires that the plainti# must prove that auditors acted

"ith intent to deceive in order to impose liability.

TR!E


AACSB1 Anal2tic

A(C3A BB1 (ndustr2

A(C3A BB1 Leal



7/18/2019 ModC



Blooms1 Understand

4i5cult21 6 -edium

Learnin 7bjective1 C89@ Specif2 the civil and criminal liabilit2 provisions of the Securities Exchane Act of

)=*<.

#opic1 #he Securities Exchane Act of )=*< >Securities Exchane Act?

1. As a defense under -ule 14b9'3 auditors must prove that they actedin good faith and had no *no"ledge of the material misstatements in

the 6nancial statements.

TR!E


AACSB1 Anal2tic

A(C3A BB1 (ndustr2 A(C3A BB1 Leal


Blooms1 Understand

4i5cult21 6 -edium


)=*<.

#opic1 #he Securities Exchane Act of )=*< >Securities Exchane Act?

24. Liability to foreseen third parties "ould e(pose auditors to a greater

potential obligation than liability to foreseeable third parties.

FA"SE


AACSB1 Anal2tic

A(C3A BB1 (ndustr2

A(C3A BB1 Leal


Blooms1 Understand

4i5cult21 6 -edium


case precedents.


Multiple Choice Questions



7/18/2019 ModC


21. Auditors should not be liable to any party if they perform services

that meet the standards of

A. <rdinary negligence.

=. -egulatory providence.C# >ue care.

>. 5ood faith.

AACSB1 Ethics

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Blooms1 Understand

4i5cult21 6 -edium


case precedents.

Source1 7riinal

#opic1 Auditor 4efenses under Common La"

22. A principle that may reduce or eliminates auditors$ liability to clients

is

A. Client$s constructive negligence.

B# Client$s contributory negligence.

C. Auditors$ ordinary negligence.

>. Auditors$ gross negligence.

AACSB1 Ethics A(C3A BB1 Leal

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Blooms1 Remember

4i5cult21 ) Eas2


case precedents.

Source1 7riinal

#opic1 Liabilit2 to Clients



7/18/2019 ModC


2. 8lliot Corp. is interested in purchasing -oger Corp. ,rior to the

purchase3 8lliot hired Adam ? Co. to audit -oger$s 6nancial

statements. >uring the audit3 Adam failed to discover a fraud that

resulted in material misstatements in -oger$s 6nancial statements.

After the ac7uisition3 the fraud "as discovered3 and 8lliot Corp.

su#ered substantial losses. To sue Adam ? Co.3 8lliot must prove that

Adam

A. Acted rec*lessly or "ith lac* of reasonable grounds for belief.

=. :ne" of the instances of fraud.

C# Failed to e(ercise the appropriate level of professional care.

>. >emonstrated gross negligence.

AACSB1 Ethics

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case precedents.

Source1 7riinal

#opic1 Liabilit2 to #hird 3arties

2%. @hich of the follo"ing statements is true concerning auditors$

responsibilities during the audit

A# Auditors must e(ercise the level of care3 s*ill3 and judgment

e(pected of a reasonably prudent auditor under the

circumstances.

=. Auditors must plan the audit to gather suBcient competent

evidence to guarantee the accuracy of the 6nancial statements.

C. Auditors are strictly liable for failures to discover client fraud.

>. Auditors are not liable unless they commit gross negligence or

intentionally disregard generally accepted auditing standards.

AACSB1 Ethics


Blooms1 Understand

4i5cult21 6 -edium


case precedents.

Source1 7riinal

#opic1 Common La" Liabilit2



7/18/2019 ModC


2'. :erry C,A is the auditor for &ammy Corp. >uring the audit3 :erry

discovers a material misstatement in &ammy$s 6nancial statements.

&ammy$s management tells :erry that if the misstatement is

corrected or if :erry issues an opinion that indicates there is a

material misstatement3 &ammy Corp. "ill li*ely have to declare

ban*ruptcy and thousands of employees "ill lose their jobs. @hich of

the follo"ing statements is true if &ammy does not correct the

misstatement and :erry issues an un7uali6ed opinion on &ammy$s

6nancial statements

A. :erry is liable only to third parties in privity of contract.

=. :erry is liable only to *no"n users of the 6nancial statements.

C# :erry is li*ely liable to any person "ho su#ered a loss as a result of

the material misstatement.>. :erry is li*ely liable to third parties only if the third parties "ere

a"are of the material misstatements and relied on the 6nancial

statements.

AACSB1 Ethics

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Blooms1 Appl2

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case precedents.

Source1 7riinal


2+. Mays bought McCovey Corp. common stoc* in an o#ering registered

under the &ecurities Act of 1. art ? Co.3 C,As3 gave an

un7uali6ed opinion on McCovey$s 6nancial statements that "ere

included in the registration statement 6led "ith the &ecurities and

8(change Commission. Mays sued art under the provisions of the

1 Act that deal "ith omission of facts re7uired to be in the

registration statement. Mays must prove that

A. There "as fraudulent activity by art.

B# The 6nancial statements contained a material misstatement.

C. Mays relied on art$s opinion.

>. Mays "as in privity "ith art.

AACSB1 Ethics

A(C3A BB1 Leal



7/18/2019 ModC


A(C3A F$1 Research

Blooms1 Remember

4i5cult21 ) Eas2


Source1 7riinal

#opic1 Burden of 3roof

2. To prevail in an action brought under common la"3 the plainti# mustsho" all of the follo"ing except

A. e or she "as damaged or su#ered a loss.


C# Auditors *ne" the 6nancial statements contained a material

misstatement.

>. e or she relied on the 6nancial statements.


A(C3A F$1 Research

Blooms1 Remember

4i5cult21 ) Eas2


case precedents.

Source1 7riinal


2/. Failure to provide any level care in ful6lling a duty o"ed to another

party3 including rec*less disregard for the truth3 is called



C. ,rivity.

$# Constructive fraud.

AACSB1 Ethics

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Blooms1 Remember

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case precedents.Source1 7riinal

#opic1 #ort Liabilit2



7/18/2019 ModC


2. D. Lauren hires >. umphrey3 C,A3 to audit her 6nancial statements.


audited 6nancial statements are re7uired to be 6led "ith a regulatory

body by <ctober 1. umphrey does not complete the audit until

<ctober '. Lauren is late 6ling the 6nancial statements and is 6ned

E1443444 by the regulatory body. Lauren "ould most li*ely sue

umphrey claiming

A# =reach of contract.




AACSB1 Ethics


Blooms1 Understand

4i5cult21 6 -edium


case precedents.

Source1 7riinal


4. D. Lauren hires >. umphrey3 C,A3 to audit her 6nancial statements.


audited 6nancial statements "ill be provided to :ey Largo =an* for a

loan. umphrey completes the audit and issues an un7uali6edopinion. =ased on the audited 6nancial statements3 :ey Largo =an*



that


B# ;t "as a primary bene6ciary.


>. ;t "as a foreseeable party. AACSB1 Ethics

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A(C3A F$1 Research

Blooms1 Understand

4i5cult21 6 -edium


case precedents.

Source1 7riinal



7/18/2019 ModC



1. D. Lauren hires >. umphrey3 C,A3 to provide an audit of her 6nancial

statements. The engagement letter includes a statement

ac*no"ledging that audited 6nancial statements "ill be provided to

6nancial institutions for a loan but does not name any 6nancialinstitution. umphrey completes the audit and issues an un7uali6ed




that



C# ;t "as a foreseen party.>. ;t "as a foreseeable party.

AACSB1 Ethics

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Blooms1 Understand

4i5cult21 6 -edium


case precedents.

Source1 7riinal


2. D. Lauren hires >. umphrey3 C,A3 to audit her 6nancial statements. The engagement letter includes a statement ac*no"ledging that

audited 6nancial statements are needed for a 6ling "ith a regulatory

body. umphrey completes the audit and issues an un7uali6ed


approves a loan to Lauren. Four months later3 Lauren 6les for


that

A. ;t "as in privity of the contract.=. ;t "as a primary bene6ciary.


$# ;t "as a foreseeable party.

AACSB1 Ethics

A(C3A BB1 Leal

A(C3A F$1 Research



7/18/2019 ModC


Blooms1 Understand

4i5cult21 6 -edium


case precedents.

Source1 7riinal


. ;f an audit is performed for the bene6t of a speci6c person ororganiation3 that person or organiation is *no"n as a0n

A. ,arty to the contract.

B# ,rimary bene6ciary.

C. Foreseeable third party.

>. ,rime benefactor.

AACSB1 Ethics

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Blooms1 Remember

4i5cult21 ) Eas2


case precedents.

Source1 7riinal




7/18/2019 ModC


%. At the re7uest of !ames Company$s management3 8.5. Company

audited !ames$s 6nancial statements and "as a"are that !ames$s

management intended to deliver the 6nancial statements to its 2'

shareholders for the purpose of repurchasing their shares for E'4 per

share 0the investors had originally purchased the shares for E' per

share. The audit "as conducted in accordance "ith generally

accepted auditing standards and the 6nancial statements "ere

prepared in accordance "ith generally accepted accounting

principles. Later3 the shareholders sued the auditors3 claiming that if

they had fully realied the signi6cance of disclosures about the

mar*et value of the assets3 they could have received E' per share

from !ames Company. The shareholders$ la"suit "ill probably fail

because

A. The shareholders did not su#er a loss.

=. The shareholders "ere not primary bene6ciaries of the audit

engagement and they have no standing to sue.

C# The shareholders failed to prove lac* of appropriate professional

care on the part of auditors.

>. The shareholders did not rely properly on the 6nancial statements.

AACSB1 Ethics

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A(C3A F$1 Research

Blooms1 Evaluate4i5cult21 * !ard


case precedents.

Source1 7riinal




7/18/2019 ModC


'. @hich of the follo"ing claims concerning the 7uality of auditors$ "or*

"ould least li*ely result in civil liability for damages

A. 5ross negligence amounting to constructive fraud.

B# Failure to investigate possible fraud "hen other entities in the

industry have e(perienced frauds.

C. -ec*less disregard of evidence that the 6nancial statements do not

conform to generally accepted accounting principles.

>. ;ssuing an un7uali6ed auditors$ opinion "hen evidence suggests

that the 6nancial statements "ere not prepared according to

generally accepted accounting principles.

AACSB1 Ethics

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A(C3A F$1 Research

Blooms1 Understand

4i5cult21 6 -edium


case precedents.

Source1 7riinal




7/18/2019 ModC


+. Lancaster ? Company3 C,As3 is auditing the 6nancial statements of

Cooper Corporation. >uring the course of the audit3 Cooper sent the

follo"ing memo to the engagement partnerG

)@e have re7uested E1 million "orth of products from Ladd

Corporation "ith credit terms of net 4 days. Ladd has re7uested

audited 6nancial statements for its credit decision. @e noti6ed Ladd

that our annual audit "as in process and "e "ould provide the

audited 6nancial statements to them as soon as they "ere

completed.)

@hich of the follo"ing statements is true "ith regard to this memo

A. ;t is an amendment to the engagement letter and ma*es Ladd aprimary bene6ciary of the audited 6nancial statements.

B# ;t may move Ladd closer to a primary bene6ciary and reposition it

as a third party "ith a standing to sue3 depending on the

jurisdiction of any future la"suits.

C. ;t is only a courtesy and does not alter the terms of the

engagement letter or change the nature of Ladd$s standing to sue.

>. ;t is an additional contract placing Ladd in privity of contract.

AACSB1 Ethics

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A(C3A F$1 ResearchBlooms1 Appl2

4i5cult21 * !ard


case precedents.

Source1 7riinal




7/18/2019 ModC


. @hen bringing suit against auditors under section 140b of the

&ecurities 8(change Act of 1%3 plainti#s must allege and prove

that

A. The 6nancial statements in the o#ering registration 6ling

contained a material misstatement.

B# The auditors "ere a"are of material misstatements in the 6nancial

statements.

C. The auditors "ere guilty of ordinary negligence and failed to

discover material misstatements in the 6nancial statements.

>. The plainti#s purchased the speci6c securities through a public

o#ering and thus have a right to sue.

AACSB1 Ethics


Blooms1 Remember

4i5cult21 ) Eas2


)=*<.

Source1 7riinal


/. @hich of the follo"ing parties is most li*ely to recover losses

resulting from acts of ordinary negligence from auditors

A. Third parties that auditors should have foreseen could rely on the

client$s 6nancial statements.

B# The auditors$ client.

C. ,urchasers and sellers of securities under the &ecurities 8(change

Act of 1%.

>. Third parties "hose reliance on the client$s 6nancial statements

"as reasonably foreseeable.

AACSB1 Ethics

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4i5cult21 6 -edium


case precedents.

Source1 7riinal




7/18/2019 ModC


. An audit failure occurs "hen

A. A client goes ban*rupt or has serious 6nancial diBculty.

B# Auditors fail to conduct the e(amination in accordance "ith

generally accepted auditing standards3 "hich results in the failure

to identify material misstatements in the 6nancial statements.

C. Auditors cannot collect audit fees o"ed to them by the client.

>. Auditors are sued by a third party.

AACSB1 Ethics

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case precedents.

Source1 7riinal#opic1 Common La" Liabilit2

%4. Third9party plainti#s bringing action under common la" need not

prove that

A. They "ere damaged or su#ered an economic loss.

=. They relied on the 6nancial statements.

C. The 6nancial statements "ere the direct cause of loss.

$# =reach of contract occurred.

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case precedents.

Source1 7riinal




7/18/2019 ModC


%1. Typical defenses for auditors in common la" actions include all of the

follo"ing except

A# The plainti# "as foreseen.

=. The plainti# contributed to the failure to detect material

misstatements.

C. The 6nancial statements "ere not materially misstated.


auditing standards.

AACSB1 Ethics

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Blooms1 Remember

4i5cult21 ) Eas2


case precedents.

Source1 7riinal


%2. The &ecurities Act of 1

A. -egulates trading in securities.

=. Approves and guarantees investments.

C# -egulates the initial issuance of securities.

>. -egulates the accounting profession.

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Source1 7riinal

#opic1 Auditor Liabilit2



7/18/2019 ModC


%. @hich of the follo"ing "ould third parties not need to demonstrate

"hen bringing suit against auditors for losses sustained under the

&ecurities Act of 1

A# Auditors "ere a"are of the materially misstated 6nancial

statements.

=. Third9party purchasers su#ered a loss.

C. The client$s 6nancial statements contained a material

misstatement.

>. ,urchasers "ould need to demonstrate all of the above.

AACSB1 Ethics

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Blooms1 Remember

4i5cult21 ) Eas2 Learnin 7bjective1 C89< Specif2 the civil and criminal liabilit2 provisions of the Securities Act of )=**.

Source1 7riinal


%%. The &8C -ule 14b9' deals "ith

A# Fraud in the purchase or sale of securities.

=. ,enalties for "illfully and *no"ingly violating the &ecurities

8(change Act of 1%.

C. The use of the )due diligence) defense to avoid liability.>. ;ntegrated disclosure system for annual reports.

AACSB1 Ethics

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Blooms1 Remember

4i5cult21 ) Eas2


)=*<.

Source1 7riinal




7/18/2019 ModC


%'. The 6rst signi6cant case under section 11 of the &ecurities Act of

1 charging auditors "ith not conducting a reasonable

investigation "as

A. Rusch Factors v. Levin.

=. United States v. Benjamin.

C# Escott v. BarChris Construction Corp.

>. Ernst Ernst v. !ochfelder.

AACSB1 Ethics

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Source1 7riinal

#opic1 Leal Cases

%+. Foreseeable third parties are best described as

A. Management of the entity.

=. Those third parties that have a direct relationship "ith auditors

through previous contract related to the audit engagement.

C. Those third parties "ho "ill rely on the audit and are speci6cally

*no"n by auditors.

$# Those third parties "hose decisions normally rely on audited6nancial statements and opinions on those 6nancial statements.

AACSB1 Ethics

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Blooms1 Remember

4i5cult21 ) Eas2


case precedents.

Source1 7riinal




7/18/2019 ModC


%. @hich of the follo"ing statements about the &ecurities Act of 1 is

not true

A. The plainti# must prove damages or an economic loss.

B# The plainti#s must prove they read and relied upon the 6nancial

statements.

C. Any purchaser of securities may sue auditors.

>. The plainti#s need not prove that the materially misstated

6nancial statements are the direct cause of the loss.

AACSB1 Ethics

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A(C3A F$1 Research

Blooms1 Understand

4i5cult21 6 -edium


Source1 7riinal


%/. The restatement of torts is a general legal doctrine that e(tends

liability for ordinary negligence to


B# Foreseen third parties.

C. ,rimary bene6ciaries.

>. All users of 6nancial statements. AACSB1 Ethics

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Blooms1 Remember

4i5cult21 ) Eas2


case precedents.

Source1 7riinal




7/18/2019 ModC


%. @hich of the follo"ing is not part of the de6nition of proportionate

liability adopted by the ,rivate &ecurities Litigation -eform Act

A. The total responsibility for loss is divided among all parties

responsible for the loss.

=. >efendants "ho *no"ingly committed a violation of securities la"s

remain jointly and severally liable.

C# The full amount of damages may be recovered from any

defendants involved in the action.

>. A solvent defendant$s liability may be increased by '4 percent if

other defendants are insolvent.

AACSB1 Ethics

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Blooms1 Understand

4i5cult21 6 -edium


parties.

Source1 7riinal

#opic1 3rivate Securities Litiation Reform Act

'4. A. ,aula performed the audit of the 6nancial statements of Abdul

Company 0a nonpublic entity currently not subject to 6ling

re7uirements under the &ecurities Act of 1 or &ecurities 8(change

Act of 1%. Abdul is currently considering several alternatives for

raising capital3 including see*ing 6nancing from area ban*s or aninitial public o#ering of its securities. @hich of the follo"ing parties

"ould have the lo"est li*elihood of successfully bringing suit for

ordinary negligence against ,aula

A. Abdul Company.

=. ,urchasers of Abdul$s securities in an initial public o#ering.

C. First &tate =an*3 a ban* "ith "hich Abdul has not previously done

business.

$# &imon @hita*er3 a private investor "ho is considering ac7uiringAbdul.

AACSB1 Ethics

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Blooms1 Appl2

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case precedents.



7/18/2019 ModC


Source1 7riinal


'1. @hich of the follo"ing factors"ould not inHuence third parties$

abilities to bring suit against auditors for ordinary negligence under

common la"

A. The e(tent to "hich the third party relied upon the misstated

6nancial statements and this reliance resulted in their loss.

B# The nature of the activity by the auditors that resulted in their

failure to e(ercise appropriate levels of professional care.

C. The relationship bet"een the auditors and a third party.

>. The jurisdiction in "hich the action occurred.

AACSB1 Ethics


Blooms1 Understand

4i5cult21 6 -edium


case precedents.

Source1 7riinal


'2. According to &arbanes9<(ley3 accountants performing an audit or

revie" must maintain all engagement documentation for a period of

A. 2 years.

=. years.

C. ' years.

$# years.

AACSB1 Ethics

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parties.

Source1 7riinal#opic1 Sarbanes87xle2



7/18/2019 ModC


'. @hich of the follo"ing statements concerning the Ultramares Corp. v.

#ouche case is not true

A. This case "as brought under common la" liability.

B# This case provided a test to determine "hether a third party

7uali6ed as a primary bene6ciary and could bring suit for ordinary

negligence.

C. This case established the rights of third parties to bring suits

against auditors under common la" liability.

>. This case concluded that auditors$ liability to third parties "ould be

generally limited to gross negligence or fraud.

AACSB1 Ethics

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case precedents.

Source1 7riinal


'%. ;n a common la" action against auditors3 lac* of privity is a viable

defense if the plainti#

A# ;s the client$s creditor "ho sues auditors for ordinary negligence.

=. Can prove auditors$ gross negligence that amounts to a rec*less

disregard for the truth.

C. ;s the auditors$ client.

>. =ases the action upon fraud.

AACSB1 Ethics

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Blooms1 Understand

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case precedents.

Source1 A(C3A#opic1 Liabilit2 to #hird 3arties



7/18/2019 ModC


''. Inder the liability provisions of section 11 of the &ecurities Act of

13 auditors may be liable to any purchaser of a security for

certifying materially misstated 6nancial statements that are included

in the registration statement. Inder section 113 auditors usually are

not liable to the purchaser

A. ;f they can sho" contributory negligence on the part of the

purchaser.

B# ;f they can demonstrate due diligence.

C. Inless the purchaser can prove privity "ith the auditors.

>. Inless the purchaser can prove scienter on the part of the

auditors.

AACSB1 Ethics


Blooms1 Understand

4i5cult21 6 -edium


Source1 A(C3A

#opic1 Auditor 4efenses under )=** Act

'+. Inder the liability provisions of section 11 of the &ecurities Act of

13 auditors may be liable to any purchaser of securities for

certifying materially misstated 6nancial statements that are included

in the registration statement. Inder section 113 "hich of the

follo"ing must a purchaser of the security prove

A. -eliance on 6nancial statements3 yesJ fraud by auditors3 yes.

=. -eliance on 6nancial statements3 yesJ fraud by auditors3 no.

C. -eliance on 6nancial statements3 noJ fraud by auditors3 yes.

$# -eliance on 6nancial statements3 noJ fraud by auditors3 no.

AACSB1 Ethics

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Blooms1 Remember

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Source1 A(C3A




7/18/2019 ModC


'. =ec*ler ? Associates3 C,As3 e(amined and issued an un7uali6ed

opinion on the 6nancial statements of Kueen Co. The 6nancial

statements contained misstatements that resulted in a material

overstatement of Kueen$s net "orth. Kueen provided the audited

6nancial statements to Mac =an* in connection "ith a loan made by

Mac to Kueen. =ec*ler *ne" that the 6nancial statements "ould be

provided to Mac. Kueen defaulted on the loan. Mac sued =ec*ler to

recover for its losses associated "ith Kueen$s default. @hich of the

follo"ing must Mac prove in order to recover

;. =ec*ler did not conduct the audit "ith the appropriate level of

professional care.

;;. Mac relied on the 6nancial statements.

A. ; only.

=. ;; only.

C# =oth ; and ;;.

>. Deither ; nor ;;.

AACSB1 Ethics

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Blooms1 Understand

4i5cult21 6 -edium


case precedents.Source1 A(C3A




7/18/2019 ModC


'/. @hile conducting an audit3 Larson Associates3 C,As3 failed to detect


Larson$s un7uali6ed opinion "as included "ith the 6nancial

statements in a registration statement and prospectus for a public

o#ering of securities made by the client. Larson *ne" that its opinion

and the 6nancial statements "ould be used for this purpose. @hich

of the follo"ing statements is correct "ith regard to a suit against

Larson and the client by a purchaser of the securities under section

11 of the &ecurities Act of 1

A. The purchaser must prove that Larson failed to conduct the audit

in accordance "ith generally accepted auditing standards.

=. The purchaser must prove that Larson *ne" of the material

misstatements.C# Larson "ill not be liable if it had reasonable grounds to believe the

6nancial statements "ere accurate.

>. Larson "ill not be liable if the purchaser did not rely on the


AACSB1 Ethics

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Blooms1 Evaluate

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Source1 A(C3A#opic1 Burden of 3roof



7/18/2019 ModC


'. @hile conducting an audit3 Larson Associates3 C,As3 failed to detect


Larson$s un7uali6ed opinion "as included "ith the 6nancial

statements in a registration statement and prospectus for a public

o#ering of securities made by the client. Larson *ne" that its opinion

and the 6nancial statements "ould be used for this purpose. ;n a suit

by a purchaser against Larson3 its best defense "ould be that the

A# Audit "as conducted in accordance "ith generally accepted

auditing standards.

=. Client "as a"are of the misstatements.

C. ,urchaser "as not in privity of contract "ith Larson.

>. Larson did not *no" the identity of the purchaser at the time of

the audit. AACSB1 Ethics

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Source1 A(C3A


+4. @hile conducting an audit of a public entity3 @allace failed to identify

material misstatements in its client$s 6nancial statements. ;nvestors

then sued @allace in connection "ith this audit. @hich of thefollo"ing "ould not need to be demonstrated in order for the

shareholders to successfully bring suit against @allace

A# @allace "as in privity "ith the shareholders.

=. The shareholders relied upon the materially misstated 6nancial

statements.

C. @allace acted "ith gross negligence in the audit.

>. The reliance on the materially misstated 6nancial statements

caused the shareholders$ losses.

AACSB1 Ethics

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A(C3A F$1 Research

Blooms1 Understand

4i5cult21 6 -edium


)=*<.

Source1 7riinal



7/18/2019 ModC



+1. &un Corp. approved a merger plan "ith Cord Corp. Among the

determining factors in approving the merger "as Cord$s 6nancial

statements audited by Fran* ? Co.3 C,As. &un had engaged Fran* to

audit Cord$s 6nancial statements. @hile performing the audit3 Fran*failed to discover certain irregularities that later caused &un to su#er

substantial losses. For Fran* to be liable under common la" liability3

&un at a minimum must prove that Fran*

A. :ne" of the irregularities.

B# Failed to e(ercise the appropriate level of professional care.

C. >emonstrated gross negligence.

>. Acted "ith scienter.

AACSB1 Ethics

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case precedents.

Source1 A(C3A


+2. @hich of the follo"ing elements3 if present3 "ould support a 6nding

of constructive fraud on the part of auditors

A# 5ross negligence in conducting the engagement.

=. <rdinary negligence in conducting the engagement.

C. Failure to perform the engagement in accordance "ith the terms in

the engagement letter.

>. Actions that demonstrated scienter.

AACSB1 Ethics

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Blooms1 Remember

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case precedents.

Source1 A(C3A




7/18/2019 ModC


+. To be successful in a civil action under section 11 of the &ecurities Act

of 1 against auditors for liability for a materially misstated

registration statement3 the plainti# must prove the

A. Auditors$ intent to deceive3 yesJ plainti#$s reliance on the

registration statement3 yes.

=. Auditors$ intent to deceive3 yesJ plainti#$s reliance on the

registration statement3 no.

C. Auditors$ intent to deceive3 noJ plainti#$s reliance on the

registration statement3 yes.

$# Auditors$ intent to deceive3 noJ plainti#$s reliance on the

registration statement3 no.

AACSB1 Ethics


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Source1 A(C3A


+%. @hich of the follo"ing is the best defense that auditors can assert in

a suit for common la" fraud based on their un7uali6ed opinion on

materially misstated 6nancial statements

A. Contributory negligence on the part of the client.

=. A disclaimer contained in the engagement letter.

C. Lac* of privity.

$# Lac* of scienter.

AACSB1 Ethics

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Blooms1 Understand

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case precedents.

Source1 A(C3A




7/18/2019 ModC


+'. Inder the antifraud provisions of section 140b of the &ecurities

8(change Act of 1%3 auditors may be liable if they acted

A. @ith ordinary negligence.

=. @ith independence.

C. @ithout due diligence.

$# @ithout good faith.

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)=*<.

Source1 A(C3A


++. o" does the &ecurities Act of 13 "hich imposes civil liability on

auditors for misrepresentations or omissions of material facts in a

registration statement3 e(pand auditors$ liability to purchasers of

securities beyond that of common la"

A. ,urchasers have to prove only loss caused by reliance on audited


B# ,rivity "ith purchasers is not a necessary element of proof.

C. ,urchasers have to prove either fraud or gross negligence as a

basis for recovery.

>. Auditors are held to a standard of care described as professional

s*epticism.

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Source1 A(C3A




7/18/2019 ModC


+. @hich of the follo"ing is not a reason that the Class Action Fairness

Act of 244' "ill bene6t auditors in class action la"suits

A. Federal courts provide a higher level of scrutiny for class action

la"suits than state courts.

=. Federal courts have more resources at their disposal for managing

class action la"suits.

C. &tate courts may discriminate against defendants from other

jurisdictions.

$# erdicts in state courts are normally more appropriate to apply to

multiple jurisdictions than verdicts in federal courts.

AACSB1 Ethics

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Blooms1 Understand

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parties.

Source1 7riinal

#opic1 Class Action Fairness Act

+/. Inder the &ecurities Act of 13 "hich of the follo"ing defenses is

related to auditors$ performing a reasonable investigation of the

6nancial statements

A. Causation.

=. Contributory negligence.

C# >ue diligence.

>. ,rudent auditor.

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Source1 7riinal




7/18/2019 ModC


+. @hich of the follo"ing is not a valid defense for auditors$ liability to

third parties for ordinary negligence under common la"

A. The loss "as caused by factors other than the materially misstated


=. The third parties lac* the proper standing 0relationship to bring

suit in that jurisdiction.

C# The third parties lac* a privity relationship "ith auditors.

>. The third parties did not rely upon the 6nancial statements.

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case precedents.

Source1 7riinal


4. A lac* of reasonable care that may be characteried by the failure of

auditors to follo" 5AA& in the conduct of the audit is *no"n as

A. Constructive fraud.

=. Fraud.


$# <rdinary negligence.

-eferenceG Kuestion also found in te(tboo*

AACSB1 Ethics

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Blooms1 Remember

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case precedents.

Source1 7riinal#opic1 #ort Liabilit2



7/18/2019 ModC


1. From the auditors$ point of vie"3 "hich of the follo"ing is a preferable

provision for imposition of civil liability in a la"suit for 6nancial

damages

A. !oint and several liability.

=. -easonably foreseeable users$ approach to privity.

C. Foreseen third parties$ approach to privity.

$# ,roportionate liability.


AACSB1 Ethics

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parties.

Source1 7riinal

#opic1 3roportionate Liabilit2

2. Isers of 6nancial statements have a di#erent perception concerning

the nature of auditors$ services than the actual objectives of an audit.

This di#erence is *no"n as

A. >iverse liability perception.

=. -easonable foreseeable third parties.

C. ;nsurance hypothesis.

$# 8(pectations gap.


AACSB1 Anal2tic

A(C3A BB1 Critical #hin%in

A(C3A F$1 Ris% Anal2sis

Blooms1 Remember 4i5cult21 ) Eas2


Source1 7riinal

#opic1 Expectations &ap



7/18/2019 ModC


. ;ndividuals "ho believe they relied on misstated 6nancial statements

to ma*e a decision and have su#ered losses as a result "ill issue an

action *no"n as a


B# Tort.

C. &ecurities litigation.



AACSB1 Ethics

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case precedents.

Source1 7riinal


%. Assume that auditors lost a civil la"suit for damages and the court

found total losses of E' million. ;f the auditors "ere determined to be

4 percent at fault and "ere the only solvent defendant3 "hat is the

auditors$ li*ely obligation under proportionate liability

A. E '34443444.

=. ero.

C# E232'43444.

>. E13'443444.


AACSB1 Ethics

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Blooms1 Appl2

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parties.

Source1 7riinal




7/18/2019 ModC


'. &uppose that the auditors in the preceding 7uestion participated

*no"ingly in commission of violations of securities la"s 0"ith

managers and directors of the audit client. @hat is the auditors$

li*ely obligation

A# E'34443444.

=. ero.

C. E232'43444.

>. E13'443444.


AACSB1 Ethics


Blooms1 Appl2

4i5cult21 * !ard


parties.

Source1 7riinal


+. @hen a client sues an accountant for failure to perform consulting

"or* properly3 the accountants$ best defense is probably based on

the doctrine of

A. Lac* of privity of contract.

B# Contributory negligence on the part of the client.

C. Lac* of any measurable dollar amount of damages.

>. Do negligence on the part of the consultant.


AACSB1 Ethics

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case precedents.

Source1 7riinal




7/18/2019 ModC


. @hen creditors "ho relied on an entity$s audited 6nancial statements

su#er monetary losses after a customer 0the auditors$ client goes

ban*rupt3 "hat must the plainti# creditors in a la"suit for damages

sho" in a court that follo"s the doctrine in Credit Alliance

A# The auditors *ne" and speci6cally ac*no"ledged identi6cation of

the creditors.

=. The auditors could reasonably foresee them as bene6ciaries of the

audit because entities such as this client use 6nancial statements

to obtain credit from vendors.

C. The plainti#s "ere foreseen users of the audited 6nancial

statements because they "ere vendors of long standing.

>. All of the above.


AACSB1 Ethics

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Blooms1 Understand

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case precedents.

Source1 7riinal


/. @hen accountants agree to perform a compilation or revie" of

unaudited 6nancial statements3 the best "ay to avoid clients

misunderstanding the nature of the "or* is to describe it completely

in

A# An engagement letter.

=. The auditors$ opinion.

C. A report to the clients$ board of directors at the close of the

engagement.>. A management letter to the board of directors$ audit committee.


AACSB1 Communication

A(C3A BB1 -ar%etin

A(C3A F$1 Reportin



7/18/2019 ModC


Blooms1 Remember

4i5cult21 ) Eas2


case precedents.

Source1 7riinal

#opic1 Compilation Enaement

. 8ntities desiring to issue e7uity or debt must provide a set of6nancial statements to any prospective purchaser. This set of

6nancial statements and other information for prospective

purchasers is *no"n as a

A# ,rospectus.

=. -evie".

C. ,atron$s ac7uisition statement.

>. ,rojected audited 6nancial information.


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Blooms1 Remember

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Source1 7riinal


/4. The &ecurities Act of 1 and &ecurities 8(change Act of 1%

contain

A. Civil liability provisions applicable to auditors.

=. Criminal liability provisions applicable to auditors.

C. Deither a nor b.

$# =oth a and b.


AACSB1 Ethics

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Learnin 7bjective1 C89* 4escribe auditors, liabilit2 to third parties under statutor2 la".

Source1 7riinal



7/18/2019 ModC


#opic1 Statutor2 Liabilit2

/1. @hich of the follo"ing third parties is *no"n by name to auditors as

the audit is conducted

A. Foreseeable third party.

=. Foreseen third party.

C. 5eneral third party.

$# ,rimary bene6ciary.


AACSB1 Ethics

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Blooms1 Remember

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case precedents.

Source1 7riinal


/2. @hich of the follo"ing "ould be auditors$ most li*ely defense in an

action brought under the &ecurities 8(change Act of 1%

A. The investor did not have privity "ith auditors.=. The investor did not su#er a loss based on the materially


C# The auditors acted in good faith and "ere not a"are of the

materially misstated 6nancial statements.

>. The 6nancial statements "ere not 6led "ith the &ecurities and

8(change Commission.


AACSB1 Ethics

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A(C3A F$1 Research

Blooms1 Understand

4i5cult21 6 -edium


)=*<.

Source1 7riinal

#opic1 Auditor 4efenses under )=*< Act



7/18/2019 ModC


/. @hich of the follo"ing statements regarding auditors$ liability under

the &ecurities Act of 1 is not true

A. The act relates to the initial issuance of securities to the public3

normally through an initial public o#ering.

=. Auditors$ liability arises because of audited 6nancial information

6led "ith the &8C.

C# Third parties must demonstrate that they relied on misstated

6nancial statements that "ere e(amined by auditors.

>. Auditors may be liable if they are found to have engaged in



AACSB1 Ethics

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Source1 7riinal


/%. Inder the &ecurities 8(change Act of 1%3 entities are re7uired to

report to the public about changing auditors on

A. Form 149:.

=. Form &91.

C. Form 149K.

$# Form /9:.


AACSB1 Ethics


Blooms1 Remember

4i5cult21 ) Eas2


)=*<.

Source1 7riinal




7/18/2019 ModC


/'. &ection 110b of the &ecurities Act of 1 provides that individuals

can be sued and may be liable for investors$ losses in connection "ith

a public securities o#ering under "hich of these circumstances

A. The chairman of the board of directors performed a reasonable

investigation of facts in connection "ith preparing the section in

the registration statement concerning the speci6cation of the use

of the proceeds of the o#ering.

=. A consulting engineer performed a reasonable investigation and

reported in the registration statement on the feasibility of

construction of a road"ay to be 6nanced "ith the o#ering

proceeds.

C. The president of the issuing entity had no reason to doubt the

report of the consulting engineer3 although the president did notperform a separate reasonable investigation of her o"n.

$# The oBcers of the issuing entity "ere relieved that the

independent auditors did not ma*e an issue about the e(cessive

valuation of inventory held to support construction in progress.


AACSB1 Ethics

A(C3A BB1 Leal

A(C3A F$1 ResearchBlooms1 Appl2

4i5cult21 * !ard


Source1 7riinal




7/18/2019 ModC


/+. ;n comparison to the burden of proof re7uired of plainti#s in civil

la"suits against independent auditors under common la"3 section

140b of the &ecurities 8(change Act of 1%

A# ;s the same regarding plainti#s$ need to prove damages or losses.

=. ;s the same regarding plainti#s$ need to establish privity or a

bene6ciary relationship "ith auditors.

C. >oes not re7uire that plainti#s prove their reliance on materially


>. >oes not re7uire that plainti#s prove that relying on the materially

misstated 6nancial statements caused their losses.


AACSB1 Ethics

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Blooms1 Understand

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)=*<.

Source1 7riinal


/. @hich of the follo"ing cases provides auditors the broadest e(posure

for liability to third parties for ordinary negligence under common

la"

A. Credit Alliance v. Arthur Andersen.

=. Fleet $ational Ban% v. &loucester Co.

C# Rosenblum' (nc. v. Adler .

>. Ultramares.


AACSB1 Ethics

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Blooms1 Appl2

4i5cult21 * !ard


case precedents.

Source1 7riinal




7/18/2019 ModC


//. @hich of the follo"ing is a major di#erence in auditors$ liability under

the &ecurities Act of 1 and the &ecurities 8(change Act of 1%

A. The burden of proving reliance on misstated 6nancial statementsand the relationship bet"een these 6nancial statements and the

economic loss.

=. The auditors$ re7uired degree of professional care 0level of

substandard performance.

C# =oth of the above.

>. Done of the above.


AACSB1 Ethics

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Blooms1 Understand

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)=*<.

Source1 7riinal


/. @hen an entity registers a security o#ering under the &ecurities Act

of 13 the la" provides an investor

A. An &8C guarantee that the information in the registration

statement is true.

=. ;nsurance against loss from the investment.

C# Financial information e(amined by independent auditors.

>. ;nside information about the entity$s trade secrets.


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Source1 7riinal




7/18/2019 ModC


4. A group of investors sued Anderson3 <lds3 and @atershed3 C,As

0A<@ for alleged damages su#ered "hen the entity in "hich they

held common stoc* "ent ban*rupt. To avoid liability under the

common la"3 A<@ must prove "hich of the follo"ing

A. The investors actually su#ered a loss.

=. The investors relied on the 6nancial statements audited by A<@.

C. The investors$ loss "as a direct result of their reliance on the

audited 6nancial statements.

$# The audit "as conducted in accordance "ith generally accepted

auditing standards and "ith due care.


AACSB1 Ethics

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case precedents.

Source1 7riinal


1. The &ecurities and 8(change Commission document that governs

accounting in 6nancial statements 6led "ith the &8C is

A. -egulation >.

=. Form /9:.

C. Form &=9l.

$# -egulation &9N.


AACSB1 Ethics

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Blooms1 Remember

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)=*<.

Source1 7riinal




7/18/2019 ModC


2. @hich of the follo"ing cases upheld the re7uirement that plainti#s

demonstrate scienter "hen bringing action under the &ecurities

8(change Act of 1%

A# Ernst Ernst v. !ochfelder .

=. Escott v. BarChris Construction Corp.

C. Smith v. London Assurance Corp.

>. Ultramares.


AACSB1 Ethics

A(C3A BB1 Leal

A(C3A F$1 ResearchBlooms1 Remember

4i5cult21 ) Eas2


)=*<.

Source1 7riinal

#opic1 Leal Cases

. A public entity subject to the periodic reporting re7uirements of the

&ecurities 8(change Act of 1% must 6le an annual report "ith the

&8C *no"n as the

A# Form 149:.

=. Form 149K.

C. Form /9:.

>. -egulation &9N.


AACSB1 Ethics

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4i5cult21 ) Eas2


)=*<.

Source1 7riinal




7/18/2019 ModC


%. @hen investors sue for damages under section 11 of the &ecurities

Act of 13 they must allege and prove

A. &cienter on the part of auditors.

B# The audited 6nancial statements contained a material

misstatement.

C. They relied on the materially misstated 6nancial statements.

>. Their reliance on the materially misstated 6nancial statements "as

the direct cause of their loss.


AACSB1 Ethics


Blooms1 Remember

4i5cult21 ) Eas2


Source1 7riinal


'. @hich of the follo"ing is not part of &arbanes9<(ley

A# An increased duty on the part of auditors to identify 6nancial

statement fraud.=. A re7uirement that the C8< and CF< certify the 6nancial

statements.

C. ;ncreased penalties for destruction of records in federal

investigations.

>. ;ncreased penalties for mail fraud and criminal violations of the

&ecurities 8(change Act of 1%.


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parties.

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#opic1 Sarbanes87xle2



7/18/2019 ModC


+. ;f a C,A 6rm is being sued for common la" fraud by a third party

based upon materially false 6nancial statements3 "hich of the

follo"ing is the best defense the auditors could assert

A. Lac* of privity.

B# Lac* of reliance.

C. A disclaimer contained in the engagement letter.

>. Contributory negligence on the part of the client.


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case precedents.

Source1 A(C3A




7/18/2019 ModC


. Loc*e3 C,A "as engaged by all3 ;nc. to audit @illo" Company. all

purchased @illo" after receiving @illo"$s audited 6nancial

statements3 "hich included Loc*e$s un7uali6ed auditors$ opinion.

Loc*e "as negligent in the performance of the @illo" audit

engagementJ this negligence "as caused by failure to perform the

engagement in accordance "ith the terms of the engagement letter.

As a result of Loc*e$s negligence3 all su#ered damages of E'3444.

all appears to have grounds to sue Loc*e for

A# <ption A

=. <ption =

C. <ption C

>. <ption >


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7/18/2019 ModC


/. An investor see*ing to recover stoc* mar*et losses from a C,A 6rm

associated "ith an initial o#ering of securities based on an

un7uali6ed opinion on 6nancial statements that accompanied a

registration statement3 must establish that

A# The audited 6nancial statements contain a false statement or

omission of material fact.

=. The investor relied on the 6nancial statements.

C. The C,A 6rm did not act in good faith.

>. The C,A 6rm "ould have discovered the false statement or

omission if it had e(ercised due care in its e(amination.


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. >onalds ? Company3 C,As3 audited the 6nancial statements included

in the annual report submitted by Mar*um &ecurities3 ;nc.3 to the

&ecurities and 8(change Commission. The audit "as improper inseveral respects. Mar*um is no" insolvent and unable to satisfy the

claims of its customers. Customers have instituted legal action

against >onalds based on &ection 140b and -ule 140b9' of the

&ecurities 8(change Act of 1%. @hich of the follo"ing is li*ely to be

>onalds$ best defense

A# The 6rm did not intentionally certify the false 6nancial statements.

=. &ection 140b does not apply to the case.

C. The 6rm "as not in privity of contract "ith the creditors.>. The engagement letter speci6cally disclaimed any liability to any

party that resulted from Mar*um$s fraudulent conduct.


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#opic1 Auditor 4efenses under )=*< Act

144. @est ? Co.3 C,As3 rendered an un7uali6ed opinion on the 6nancial


statement 6led "ith the &8C. &ubse7uently3 e( purchased '44

shares of ,ride$s preferred stoc* as part of a public o#ering subject to

the &ecurities Act of 1. e( has commenced an action against

@est based on the &ecurities Act of 1 for losses resulting from



@hich of the follo"ing elements must e( prove to hold @est liable

A. @est rendered its opinion "ith *no"ledge of material

misstatements.

=. @est performed the audit negligently.

C. e( relied on the 6nancial statements included in the registration

statement.

$# The misstatements "ere material.


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141. @est ? Co.3 C,As3 rendered an un7uali6ed opinion on the 6nancial


statement 6led "ith the &8C. &ubse7uently3 e( purchased '44

shares of ,ride$s preferred stoc* as part of a public o#ering subject to

the &ecurities Act of 1. e( has commenced an action against

@est based on the &ecurities Act of 1 for losses resulting from



@hich of the follo"ing defenses "ould be least helpful to @est in

avoiding liability to e(

A# @est "as not in privity of contract "ith e(.

=. @est conducted the audit in accordance "ith 5AA&.C. e($s losses "ere caused by factors other than the misstatements.

>. e( *ne" of the misstatements "hen e( ac7uired the preferred

stoc*.


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142. ;n general3 "hich of the follo"ing parties "ould have the lo"est

burden of proof in bringing suit against an auditor

A. Clients.

=. A lender "ho meets the de6nition of a primary bene6ciary.

C# A third9party investor under the &ecurities Act.>. A lender "ho meets the de6nition of a foreseen third party.


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7/18/2019 ModC


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Source1 7riinal


14. Inder generally accepted auditing standards3 auditors areresponsible for detecting

A. All manners of fraud.

=. Theft and illegal acts.

C. iolations of auditing standards.

$# Material misstatements of 6nancial statements.


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#opic1 Auditors, Responsibilities

14%. The ,rivate &ecurities Litigation -eform Act adopted the doctrine of


=. !oint and several liability.

C# ,roportionate liability.

>. Foreseen third parties.


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parties.

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#opic1 3rivate Securities Litiation Reform Act



7/18/2019 ModC


14'. The primary defense for auditors against a claim of ordinary

negligence is to o#er evidence that the

A# Audit "as conducted in accordance "ith 5AA&.

=. ,lainti# "as not in privity or not foreseen.

C. Financial statements did not contain a material misstatement.

>. ,lainti# contributed to the negligence.


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14+. ,lainti#s bringing action under common la" need not prove

A# They have a )reliance letter) from auditors.

=. They "ere damaged or su#ered a loss.

C. The 6nancial statements contained a material misstatement.

>. Auditors failed to e(ercise the appropriate level of professionalcare and "ere responsible for the damages.


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7/18/2019 ModC


14. The landmar* case that stated criteria for auditors$ liability to third

parties for gross negligence or fraud3 but not ordinary negligence3

"as

A. Smith v. London Assurance Corp.

B# Ultramares Corp. v. #ouche.

C. ))*+ #enants, Corp. v. -ax Rothenber Co.

>. -c/esson Robbins (nc.


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14/. The &ecurities and 8(change Commission document that governs the

reporting of all business3 analytical3 and supplementary disclosures in

reports re7uired to be 6led "ith the &8C is

A. Form 149:.

=. Financial -eporting -eleases.

C# -egulation &9:.

>. -egulation &9N.


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7/18/2019 ModC


14. Inder section 11 of the &ecurities Act of 13 a plainti# suing for

damages must prove

A. A privity relationship "ith auditors.

=. -eliance on the 6nancial statements in registration statement.

C. Materially misstated 6nancial statements caused the damages or

loss.

$# >amages or loss from the purchase of securities.


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114. &ince the Ernst Ernst v. !ochfelder court decision3 plainti#s suing

for damages under -ule 14b9' must prove

A. The 6nancial statements contained a material misstatement.

=. The reliance on the materially misstated 6nancial statementscaused the damages and loss.

C. <rdinary negligence on the part of auditors.

$# &cienter on the part of auditors.


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7/18/2019 ModC


111. @hich of the follo"ing is a third party "hose name the auditor *no"s

and for "hose purpose the audit is conducted

A. Foreseen third party.

=. Foreseeable third party.

C# ,rimary bene6ciary.

>. &ubrogee.


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case precedents.

Source1 7riinal


Fill in the Blank Questions

112. ;n a0n OOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOO3 a small number of

plainti#s "ith small individual claims can bring suit for large damages

in the name of an e(tended class.

class action suit




7/18/2019 ModC


11. The Rosenblum' (nc. v. Adler decision allo"s potential auditor liability

for ordinary negligence to third parties "ho are reasonably

OOOOOOOOOOOOOOOOOOOOOOOOOOOOO users of auditors$ opinions and 6nancial

statements.

%oreseea&le


11%. A third party "ho is *no"n by name to auditors is referred to as a0n

OOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOO.

pri'ary &ene(ciary


11'. The ,rivate Litigation &ecurities -eform Act adopted the doctrine of

OOOOOOOOOOOOOOOOOOOOOOOOOOOOO liability3 "hich bases damages on the

e(tent of fault e(hibited by a convicted defendant.

proportionate


11+. The I.&. &upreme Court ruled that auditors are not subject to civil

OOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOO complaints unless

they actually participated in the management or operation of a

corrupt business.

R)C* +Racketeer )n,uenced and Corrupt *rani-ation Act.




7/18/2019 ModC


11. OOOOOOOOOOOOOOOOOOOOOOOOOOOOOO liability refers to auditors$ liability

based on prior legal judgments and precedents.

Co''on law


11/. OOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOO is a claim by plainti#s that

auditors did not perform services in the manner stated in the

engagement letter.

Breach o% contract


11. The contractual relationship bet"een parties is *no"n as

OOOOOOOOOOOOOOOOOOOOOOOO.

priity


124. OOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOO is the lac* of reasonable care in theperformance of professional services.

*rdinary nelience


121. The OOOOOOOOOOOOOOOOOOOOOOOOOOOOO v. #ouche case provided the

precedent to allo" third parties not in privity "ith auditors to bring

suit for failure to e(ercise the appropriate level of professional care.

!ltra'ares Corp




7/18/2019 ModC


122. Auditors have high e(posure to liability under the &ecurities Act of

13 section 113 primarily because the

OOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOO has been placed on auditors.

&urden o% proo%


12. -egulation OOOOOOOOOOOOOOOOOOOOOOOOOOOOO contains accounting

re7uirements for annual and interim 6nancial statements 6led under

the &ecurities Act of 1 and &ecurities 8(change Act of 1%.

S01


12%. The &8C$s OOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOO e(press ne"

rules and policies about accounting and disclosures.

Financial Reportin Releases


12'. A0n OOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOO must be 6led and must be

e#ective before a sale of securities to the public is la"ful.

reistration state'ent


12+. The OOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOO doctrine holds that auditors

may be liable for ordinary negligence to foreseen third parties.

restate'ent o% torts




7/18/2019 ModC


12. OOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOO involves cases in "hich

auditors are sued for violating a "ritten la" or statute.

Statutory lia&ility


12/. Inder section 110b of the &ecurities Act of 13 if auditors can

prove that a reasonable investigation "as performed 0e.g.3 an audit

conducted in accordance "ith

OOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOO3 they are not liable for

damages.

enerally accepted auditin standards


12. Inder &8C -ule 14b9'3 the plainti# must prove

OOOOOOOOOOOOOOOOOOOOOOOOOOOOO 0or mental state embracing the intent to

deceive in order to impose liability on auditors.

scienter


14. The defense for auditors under the &ecurities 8(change Act of 1% is

to prove they acted in OOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOO and

had no *no"ledge of the material misstatements.

ood %aith




7/18/2019 ModC


11. The Ernst Ernst v. OOOOOOOOOOOOOOOOO 00 case concluded that auditors

might be liable for gross negligence under the &ecurities 8(change

Act of 1% even in the absence of scienter.

2och%elder


Short Answer Questions



7/18/2019 ModC


12. ;n each of the individual cases3 indicate the potential liability and

identify the appropriate basis under common or statutory la".



7/18/2019 ModC


1. !ones may be liable to ;ceberg3 depending on the common la"

doctrine applied. For e(ample3 under Rosenblum' (nc. v. Adler 3

;ceberg might be considered a reasonably foreseeable third party

"ho could bring suit for ordinary negligence. Inder more strict

guidelines3 it "ould be unli*ely that ;ceberg could recover from !ones

for ordinary negligence.

2. &mith may be liable to City Dational =an* for ordinary negligence if

it can be proved that the reports "ere for the primary bene6t of the

third party3 ma*ing City Dational =an* a primary bene6ciary. The fact

that &mith "as apparently a"are that City Dational =an* "ould rely

on these 6nancial statements suggests this possibility. The privity

criterion may not serve as a defense. &ee Fleet $ational Ban% v.&louster Co. ;t "ould also depend upon the precedent follo"ed in the

jurisdiction in "hich the case "as tried.

. ;f the terms of the engagement "ere *no"n to both Amaon and

&mall Co. through the use of an engagement letter3 Amaon "ould

probably not be liable. This response assumes that Amaon

performed the compilation engagement in accordance "ith A;C,A

standards3 "hich do not typically involve the performance of auditing

procedures that are speci6cally designed to detect fraud. ;n addition3

the engagement letter "ould be e(pected to provide a disclaimer

"ith respect to Amaon$s responsibility for detecting fraud.

%. Alister$s liability "ill depend upon =eo$s ability to demonstrate

that the 6nancial statements contained a material misstatement. ;f

=eos does so3 Alister can defend against =eos by using the )due

diligence) defense and demonstrating that Alister conducted a

)reasonable e(amination.) Alister can also use the )causation

defense) that the loss by =eos "as caused by some other reason

than the material misstatements included in the registrationstatement. &ee the Escott v. Bar Chris Construction Corp. case.

'. Assuming that they have already demonstrated an economic loss

0decline in the price of the stoc* and that the 6nancial statements

contained a material misstatement3 investors "ould also need to

demonstrate that 01 the loss "as caused by reliance on the



7/18/2019 ModC


materially misstated 6nancial statements and 02 Andre" acted "ith

scienter 0a mental state embracing the intent to deceive. &ee the

Ernst Ernst v. !ochfelder case.

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Essay Questions

1. >istinguish bet"een the )due diligence) and the )causation)

defenses available to auditors under section 11 of the &ecurities Act

of 1.

&ection 110b describes the due diligence defense. ;f auditors can

prove that a reasonable e(amination "as performed3 they are not

liable for damages.

&ection 110e de6nes the causation defense. ;f auditors can prove

that the plainti#$s damages "ere caused by something other than the

materially misstated 6nancial statements3 then auditors are not

liable.


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#opic1 Auditor 4efenses



7/18/2019 ModC


1%. @hat are the legal liabilities of auditors under common la"

Legal liabilities of auditors may arise from la"suits brought on the

basis of the la" of contracts or as tort actions for failure to e(ercise

the appropriate level of professional care. =reach of contract is a

claim that accounting or auditing services "ere not performed in the

manner agreed. Tort actions cover complaints other than breach of

contract and normally involve accusations that auditors failed to

detect material misstatements. Isers of 6nancial statements

normally initiate such actions.

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7/18/2019 ModC




7/18/2019 ModC


1'. &lee* Corporation is a public corporation "hose stoc* is traded on a

national securities e(change. &lee* hired 5arson Associates3 C,As3 to

audit &lee*$s 6nancial statements. &lee* needed the audit to obtain

ban* loans and to ma*e a public stoc* o#ering so that it could

underta*e a business e(pansion program.

=efore the engagement3 F. edge3 &lee*$s president3 told 5arson$s

managing partner that the audited 6nancial statements "ould be

submitted to &lee*$s ban*s to obtain the necessary loans.

>uring the course of the audit3 5arson$s managing partner found that

edge and other &lee* oBcers had embeled substantial amounts

of money from the corporation. These embelements threatened

&lee*$s 6nancial stability. @hen these 6ndings "ere brought to

edge$s attention3 edge promised that the money "ould be repaidand begged 5arson not to disclose the embelements.

edge also told 5arson$s managing partner that several friends and

relatives of &lee*$s oBcers had been advised about the projected

business e(pansion and proposed stoc* o#ering and had purchased

signi6cant amounts of &lee*$s stoc* based on this information.

5arson submitted an un7uali6ed opinion on &lee*$s 6nancial

statements3 "hich did not include adjustments for or disclosures of

the embelements and insider stoc* transactions. The 6nancial

statements and auditors$ opinion "ere submitted to the ban*s &lee*

normally does business "ith3 including :no( =an*. -elying on the

6nancial statements and the auditors$ report3 :no( loaned &lee*

E234443444.

&lee*$s audited 6nancial statements "ere also included in a

registration statement prepared under the provisions of the

&ecurities Act of 1. The registration statement "as 6led "ith the

&8C in conjunction "ith &lee*$s public o#ering of 1443444 shares ofits common stoc* at E144 per share.

An &8C investigation of &lee* disclosed the embelements and the

insider trading. Trading in &lee*$s stoc* "as suspended3 and &lee*

defaulted on the :no( loan. As a result3 the follo"ing legal actions

"ere ta*enG



7/18/2019 ModC


P :no( =an* sued 5arson.

P The purchasers of &lee*$s stoc* o#ering sued 5arson.

Required:

a. @ould :no( be able to recover from 5arson for fraud

b. @ould the purchasers of &lee*$s stoc* o#ering recover from 5arson

1. Inder the liability provisions of section 11 of the &ecurities Act of

1

2. Inder the antifraud provisions of section 140b and -ule 14b9' of

the &ecurities 8(change Act of 1%

a. :no( "ould recover from 5arson for fraud. =ecause :no( su#ered

a loss because of reliance on materially misstated 6nancial

statements3 it "ould need to demonstrate that 5arson "as a"are of

the embelement and insider transactions. 5arson "as a"are of the

embelement and insider transactions and3 as such3 committed

fraud. ;t is important to note that auditors o"e all parties

responsibility for fraud.

b.

1. The purchasers of &lee*$s stoc* o#ering "ould recover from

5arson under the liability provisions of section 11 of the &ecurities

Act of 1. &ection 11 provides that anyone3 such as auditors3 "ho

submit or contribute to a registration statement or allo"s material

misrepresentations or omissions to appear in a registration

statement3 is liable to anyone purchasing the security "ho sustains a

loss. Inder the facts presented3 5arson "ould not be able to

establish a )due diligence) defense for a section 11 action because it*ne" that the registration statement contained materially misstated


2. The purchasers of &lee*$s stoc* o#ering "ould also recover from

5arson under the antifraud provisions of section 140b and -ule 14b9

' of the &ecurities 8(change Act of 1%. Inder -ule 14b9'3 5arson$s



7/18/2019 ModC


*no"ledge that the registration statement included materially

misstated 6nancial statements is considered a fraudulent action.

5arson$s action "as intentional or3 at a minimum3 a result of gross

negligence or rec*lessness. These purchasers relied on 5arson$s

opinion on the 6nancial statements and incurred a loss.

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1+. =rieHy e(plain the concept of proportionate liability. @hy is the

adoption of proportionate liability important to the accounting

profession

Inder proportionate liability3 a defendant is re7uired to pay a

proportionate share of the court$s damage a"ard3 depending upon

the degree of fault determined by a judge or jury. For e(ample3 a

defendant determined to be %4 percent at fault "ill be re7uired to

pay %4 percent of the damages a"arded. This is important to the

audit profession because under alternative legal concept of )joint and

several liability3) auditors could be held liable for all of losses incurred

by third parties. This is especially true "hen the client had declared

ban*ruptcy and "as not able to provide any compensation to

plainti#s for damages.

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7/18/2019 ModC


1. Charlie Company is head7uartered in @isconsin. ;ts auditors are

head7uartered in Minnesota. :. =ob lives in =loomington3 ;ndiana3 but

"or*s in Chicago3 ;llinois. =ased on a tip from his boss3 =ob called his

stoc*bro*er 0=. !im "hose oBce is in Chicago and instructs him to

purchase 13444 shares of Charlie Company despite never having

re7uested or revie"ed Charlie Company$s 6nancial statements.

Charlie is traded on the De" Qor* &toc* 8(change3 and the

transaction too* place 1' minutes later on the Hoor of the e(change.

Charlie Company declared ban*ruptcy three months later3 and =ob

lost the entire investment. =ob sued Charlie Company$s auditors for


The trial is scheduled for hearing in Madison3 @isconsin. =efore the

opening of the trial3 the attorney for the auditors objects to the trialbeing held in @isconsin because the transaction bet"een =ob and

!im too* place in ;llinois. The attorney as*s that the trial be moved to

;llinois.

Required:

A. @hy "ould the attorney as* for the trial to be moved

=. @hat defense "ould you raise if you "ere the auditors$ attorney

A. Third parties have di#erent standing to sue in di#erent

jurisdictions. ;n @isconsin3 =ob may be able to bring suit against

auditors for ordinary negligence as a foreseeable party3 but in ;llinois3

=ob may have to prove he is a foreseen party or allege gross

negligence or fraud on the part of auditors in order to have a right to

bring suit.

=. The best defense is a lac* of causation bet"een the materiallymisstated 6nancial statements and =ob$s loss. =ob never evaluated

the 6nancial statements but purchased the stoc* through a tip from

his boss. Auditors may also claim that they performed the audit "ith

due care and according to generally accepted auditing standards.



7/18/2019 ModC


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Source1 7riinal#opic1 Auditor Liabilit2 to #hird 3arties

Matchin Questions



7/18/2019 ModC


1/. Ising the follo"ing letters3 identify the case to "hich each statement

is most closely relatedG

1. 8stablished a three9point test

for auditor liability3 including

that auditors demonstrate some

action to ac*no"ledge the

e(istence of the third party and

the third party$s intent to rely on

the opinion and 6nancial

statements

Credit

Alliance v.

Arthur

Andersen 3

2. @as the 6rst I.&. caseinvolving a suit against auditors

Smith v.

London

AssuranceCorp. 4

. Concluded that rec*less

misstatements even if not

deliberate are the basis for

liability to third parties

Ultramares

Corp. v. #ouche 5 %. Found auditors liable for

ordinary negligence under the

&ecurities Act of 1

Ernst

Ernst v.

!ochfelder 6

'. Concluded that auditors had aduty to inform clients of

instances of fraud even if hired

for "rite9up "or*

))*+

#enants, Corp.v. -ax

Rothenber

Co. 7 +. Concluded that auditors could

be liable to third parties "ho

"ere not in privity "ith them

State Street

#rust v. Ernst 8 . 8stablished precedent for the

plainti# to prove scienter to

recover damages under section

140b of the &ecurities 8(changeAct of 1%

Escott v.

BarChris

ConstructionCorp. 9

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#opic1 Leal Cases



7/18/2019 ModC


1. Ising the follo"ing letters3 identify the case to "hich each statement

is most closely related.

1. Third parties cannot rely

on revie"ed 6nancial

statements to the same

e(tent as they can on audited

6nancial statements

Rosenblum'

(nc. v. Adler 9 2. Auditors may be liable to

third parties for ordinary

negligence if the auditors

should foresee these parties

as relying on the 6nancial

statements

United States v.

Benjamin 6 . ;t established precedent for

plainti#$s need to allege and

prove scienter to impose

section 140b liability

Ernst Ernst v.

!ochfelder 8 %. Auditors are liable to

reasonably foreseeable third9

party users for ordinary

negligence

(selin v.

Landau 3 '. The court applied the

restatement of torts doctrineto identify the plainti# as a

primary bene6ciary

Fleet $ationalBan% v. &loucester

Co. 4 +. Auditors "illfully violated

&ecurities 8(change Act of

1% by ma*ing false and

misleading statements in a

pro(y statement

Credit Alliance

v. Arthur

Andersen 7 . Conviction of auditors for

"illingly conspiring to defraud

in an engagement related toa pro forma 6nancial

statement

United States v.

$atelli 0Dational&tudent

Mar*eting 5

AACSB1 Ethics

A(C3A BB1 Leal

A(C3A F$1 Research

Blooms1 Understand

4i5cult21 6 -edium



7/18/2019 ModC





)=*<.

Source1 7riinal

#opic1 Leal Cases

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