Learning Objectives

Learning Objectives LO1 List some examples of potential civil and criminal litigation facing PAs. LO2 Apply and integrate the chapter topics to analyze a practical auditing situation/case/scenario. LO3 Recognize U.S. SEC, SOX, and other (statutory) law liability issues. (Appendix 20A)

Characteristics of Common Law Actions Burden of proof on the plaintiff: • Plaintiff must prove the following: • That there was damage or loss. • That there was a privity or beneficiary relationship. • That financial statements were materially misleading. • That the statements were relied on. • That the statements were the direct cause of the loss. • That the accountant was negligent in performance of duties. LO1

Characteristics of Common Law Actions Clients may bring a lawsuit for breach of contract. • The relationship of direct involvement between parties to a contract is known as privity. • When privity exists, the plaintiff usually need only show that the defendant was negligent. • See Smith v. London Assurance Corp. LO1

Characteristics of Common Law Actions Third parties may file a lawsuit under the tort law of negligence. • Negligence is failure to perform a duty with requisite standard care. • Plaintiff must demonstrate: • There is a duty of care owed the plaintiff. • There must be a breach in that duty. • There must be proof that damage resulted. • There must be a reasonably proximate connection between the breach of duty and the resulting damages. LO1

Due Care to Whom? To whom do auditors owe a duty of care? • To the contractual party (client). • To the financial stakeholders (owners). • Owners cannot sue on behalf of the corporation. • Stakeholders can only take action as third parties. • Need to establish damages separate from the corporation. • Foss V. Harbottle (1842). LO1

Due Care to Whom? Third Parties: • In the case of fraud or constructive fraud, the auditor is held liable to third parties. • Ultramares Corporation v. Touche (1931). • Reasonably foreseeable third parties can sue in the case of negligence. • Hedley Byrne v. Heller and Partners (1964). • Includes shareholders, lenders, some prospective shareholders and lenders. • This decision has been upheld in a number of subsequent cases. LO1

Due Care: Its Meaning Due care implies the careful application of all the standards of the profession. • Due care is that of a reasonably prudent practitioner. Neither the highest nor minimum standards would be considered due care. LO1

Misleading Financial Information If the courts find the auditor is associated with misleading statements they may conclude the auditor is fraudulently negligent. • No limit to third party liability. LO1

Liability in Compilation and Review Services Approximately 11% of losses involve compilation and review engagements. • Accountants are still expected to perform these services in accordance with professional standards. LO1

Other Elements of Negligence In Canada and the United States there is joint and several liability. • Any of several defendants are liable to plaintiffs for the entire amount of damages. Limited Liability Partnerships (LLPs) • Negligent partner is liable to the extent of personal assets; other partners are liable only to the extent of the assets of the partnership. LO1

Characteristics of Common Law Actions The auditor’s best defense is to demonstrate that at least one of the four elements is missing. • Demonstrate that there was no breach of duty, the audit was conducted in accordance with GAAS. • In some cases, a defense of contributory negligence may be used. LO1

Learning Objectives