The legal environment in business law part 1

www.downloadslide.net Copyright 2019 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part WCN 02-200-203 Tai Lieu Chat Luong www.downloadslide.net CengageBrain.com is the smart move when it comes to getting the right stuff on time, every time Whether you rent or buy, we’ll save you time, money, and frustration • You’ve Got Options: Convenient digital solutions and textbooks the way you want them — to buy or rent • You Get Access: Anytime, anywhere access of digital products, eBooks, and eChapters, on your desktop, laptop, or phone • You Get Free Stuff: Free 14-day eBook access, free shipping on orders of $25 or more, free study tools like flashcards and quizzes, and a free trial period for most digital products Look, we get it You’ve got a full schedule — we’ve got your back(pack) Get what you need to get the grades at CengageBrain.com Copyright 2019 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole 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Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part WCN 02-200-203 Copyright 2019 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it www.downloadslide.net Standard Edition t h E DITION Business Law And The Legal Environment Jeffrey F Beatty Boston University Susan S Samuelson Boston University Patricia Sánchez Abril University of Miami Australia • Brazil • Mexico • Singapore • United Kingdom • United States Copyright 2019 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part WCN 02-200-203 Copyright 2019 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it www.downloadslide.net This is an electronic version of the print textbook Due to electronic rights restrictions, some third party content may be suppressed Editorial review has deemed that any suppressed content does not materially affect the overall learning experience The publisher reserves the right to remove content from this title at any time if subsequent rights restrictions require it For valuable information on pricing, previous editions, changes to current editions, and alternate formats, please visit www.cengage.com/highered to search by ISBN#, author, title, or keyword for materials in your areas of interest Important Notice: Media content referenced within the product description or the product text may not be available in the eBook version Copyright 2019 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part WCN 02-200-203 Copyright 2019 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it www.downloadslide.net Business Law and the Legal Environment— Standard Edition, 8th Edition Jeffrey F Beatty, Susan S Samuelson, and Patricia Sánchez Abril © 2019, 2016 Cengage Learning, Inc Senior Vice President/General Manager Social permitted by U.S copyright law, without the prior written permission of the Sciences, Business, & Humanities: Erin Joyner Unless otherwise noted, all content is © Cengage ALL RIGHTS RESERVED No part of this work covered by the copyright herein may be reproduced or distributed in any form or by any means, except as copyright owner Executive Product Director Business & Economics: Mike Schenk For product information and technology assistance, contact us at Product Director: Bryan Gambrel Cengage Customer & Sales Support, 1-800-354-9706 Senior Product Manager: Vicky True-Baker For permission to use material from this text or product, submit all Senior Content Developer: Kristen Meere requests online at www.cengage.com/permissions Further permissions questions can be emailed to Product Assistant: Christian Wood permissionrequest@cengage.com Marketing Manager: Katie Jergens Senior Content Project Manager: Kim Kusnerak Production Service/Composition: SPi Global Senior Art Director: Bethany Bourgeois Cover/Internal Design: Mike Stratton/Stratton Design Intellectual Property Analyst: Jennifer Bowes Project Manager: Reba Frederics Library of Congress Control Number: 2017948377 Student Edition: ISBN: 978-1-337-40453-2 Loose-leaf Edition: ISBN: 978-1-337-40466-2 Cengage 20 Channel Center Street Boston, MA 02210 USA Cengage is a leading provider of customized learning solutions with employees residing in nearly 40 different countries and sales in more than 125 countries around the world Find your local representative at www.cengage.com Cengage products are represented in Canada by Nelson Education, Ltd To learn more about Cengage platforms and services, visit www.cengage.com To register or access your online learning solution or purchase materials for your course, visit www.cengagebrain.com Printed in the United States of America Print Number: 01 Year: 2017 Copyright 2019Print Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part WCN 02-200-203 Copyright 2019 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it www.downloadslide.net C o n t e n t s : O v e rv i e w Preface xix Unit  Unit  Sales499 The Legal Environment 21 Introduction to Sales 22 Ownership, Risk, and Warranties 23 Performance and Remedies 24 59 Unit  Introduction to Law Ethics and Corporate Social Responsibility International Law Common Law, Statutory Law, and Administrative Law Constitutional Law Dispute Resolution 7 Crime 86 112 139 173 Additional CPA Topics 24 25 26 27 Secured Transactions Creating a Negotiable Instrument Liability for Negotiable Instruments Accountants’ Liability 500 527 556 581 582 617 642 667 Unit  Torts205 Intentional Torts and Business Torts Negligence, Strict Liability, and Product Liability 10 Privacy and Internet Law 206 228 252 Unit  Contracts279 11 Introduction to Contracts 12 The Agreement: Offers and Acceptances 13 Consideration 14 Legality 15 Voidable Contracts: Capacity and Consent  16 Written Contracts 17 Third Parties 18 Contract Termination 19 Remedies 20 Practical Contracts 280 300 323 344 366 388 409 429 451 474 Unit  Agency and Employment Law 693 28 Agency Law 29 Employment and Labor Law 30 Employment Discrimination 694 723 753 Unit  Business Organizations 31 Starting a Business: LLCs and Other Options 32 Partnerships 33 Life and Death of a Corporation 34 Management Duties 35 Shareholder Rights 36 Bankruptcy 789 790 814 841 866 889 917 iii Copyright 2019 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part WCN 02-200-203 Copyright 2019 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it www.downloadslide.net iv C ONT E NT S : OV E RVI E W Unit Government Regulation 945 37 Securities Regulation 38 Antitrust 39 Consumer Protection 40 Environmental Law 946 975 1000 1029 Appendix A The Constitution of the United States Appendix B Uniform Commercial Code (Selected Provisions) Appendix C Answers to Selected End-of-Chapter Questions A1 B1 C1 Glossary G1 Unit Property1057 41 42 43 44 Intellectual Property Real Property and Landlord–Tenant Law Personal Property and Bailment Planning for the Future: Wills, Trusts, and Insurance Table of Cases T1 Index I1 1058 1084 1112 1133 Copyright 2019 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part WCN 02-200-203 Copyright 2019 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it www.downloadslide.net Contents Preface xix Unit The Legal Environment Chapter 1  Introduction to Law 1-1 Exploring the Law 1-1a The Role of Law in Society 1-1b Origins of Our Law 1-2 Sources of Contemporary Law 1-2a The United States Constitution 1-2b Statutes 1-2c Common Law 1-2d Court Orders 1-2e Administrative Law 1-2f Treaties 1-3 Classifications 1-3a Criminal and Civil Law 1-3b Law and Morality 1-4 Jurisprudence 1-4a Legal Positivism 1-4b Natural Law 1-4c Legal Realism 1-5 Working with the Book’s Features 1-5a Analyzing a Case 1-5b  Exam Strategy 1-5c You Be the Judge 3 6 9 10 10 10 10 11 12 12 13 13 14 14 16 17 Chapter Conclusion Exam Review Multiple-Choice Questions Case Questions Discussion Questions 18 18 20 21 22 Chapter 2  Ethics and Corporate Social Responsibility 24 2-1 Why Study Ethics? 2-1a Ethics in Business 2-1b Why Be Ethical? 2-2 Theories of Ethics 2-2a Utilitarian Ethics 2-2b Deontological Ethics 26 27 28 30 30 31 2-2c Rawlsian Justice 2-2d Front Page Test 2-2e Moral Universalism and Relativism 2-2f Ethics Case: Up in Smoke 2-3 Ethics Traps 2-3a Money 2-3b Competition 2-3c Rationalization 2-3d We Cannot Be Objective about Ourselves 2-3e Moral Licensing 2-3f Conflicts of Interest 2-3g Conformity 2-3h Ethics Case: Diamonds in the Rough 2-3i Following Orders 2-3j Euphemisms and Reframing 2-3k Lost in a Crowd 2-3l Ethics Case: Man Down 2-3m Short-Term Perspective 2-3n Ethics Case: Wobbly Platform 2-3o Blind Spots 2-3p Avoiding Ethics Traps 2-3q Lying: A Special Case 2-3r Ethics Case: Truth (?) in Borrowing 2-4 Reacting to Unethical Behavior 2-4a Loyalty 2-4b Exit 2-4c Voice 2-4d Ethics Case: Truth or Consequences 2-5 Applying the Principles 2-5a Personal Ethics in the Workplace 2-5b Ethics Case: Weird Wierdsma 2-5c The Organization’s Responsibility to Society 2-5d Ethics Case: Breathing the Fumes 2-5e The Organization’s Responsibility to Its Employees 2-5f Ethics Case: The Storm after the Storm 2-5g The Organization’s Responsibility to Its Customers 2-5h Ethics Case: Mickey Weighs In 2-5i The Organization’s Responsibility to Overseas Workers 2-5j Ethics Case: A Worm in the Apple 2-5k Corporate Social Responsibility (CSR) 2-5l Ethics Case: The Beauty of a Well-Fed Child 31 32 32 33 34 34 34 35 36 37 37 37 37 38 38 39 39 40 40 41 41 42 43 43 43 44 44 44 46 46 46 47 47 48 48 49 49 50 50 51 51 v Copyright 2019 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part WCN 02-200-203 Copyright 2019 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it www.downloadslide.net vi Contents Chapter Conclusion Exam Review Multiple-Choice Questions Case Questions Discussion Questions 52 52 54 55 56 Chapter Conclusion Exam Review Multiple-Choice Questions Case Questions Discussion Questions Chapter 3  International Law 59 Chapter 5  Constitutional Law 3-1 International Law: Public and Private 60 3-2 Actors in International Law 60 3-2a The United Nations 60 3-2b The International Court of Justice 61 3-2c International Chamber of Commerce 63 3-2d Sovereign Nations 63 3-3 The World’s Legal Systems 64 3-3a Common Law 64 3-3b Civil Law 65 3-3c Islamic Law 66 3-4 Sources and Applicability of International Law 68 3-4a Sources of International Law 68 3-4b Interaction of Foreign and Domestic Laws 75 3-4c Choosing the Applicable Law and Jurisdiction 80 Chapter Conclusion Exam Review Multiple-Choice Questions Case Questions Discussion Questions 80 80 83 84 85 Chapter 4  Common Law, Statutory Law, and Administrative Law 86 4-1 Common Law 4-1a Stare Decisis 4-1b Bystander Cases 4-2 Statutory Law 4-2a Bills 4-2b Discrimination: Congress and the Courts 4-2c Debate 4-2d Conference Committee 4-2e Statutory Interpretation 4-2f Changing Times 4-2g Voters’ Role 4-2h Congressional Override 4-3 Administrative Law 4-3a Creation of Agencies 4-3b Power of Agencies 4-3c Limits on Agency Power 87 87 87 89 90 91 92 93 94 96 96 96 97 98 99 102 5-1 Who Will Have Power? 5-1a Overview 5-1b Creating the Constitution: Important Principles 5-1c Powers Granted 5-2 Protected Rights 5-2a Incorporation 5-2b First Amendment: Free Speech 5-2c Fifth Amendment: Due Process and the Takings Clause 5-2d Fourteenth Amendment: Equal Protection Clause Chapter Conclusion Exam Review Multiple-Choice Questions Case Questions Discussion Questions Chapter 6  Dispute Resolution 6-1 Court Systems 6-1a State Courts 6-1b Federal Courts 6-2 Before Trial 6-2a Pleadings 6-2b Discovery 6-2c Summary Judgment 6-2d Final Preparation 6-3 The Anatomy of a Trial and Appeal 6-3a The Trail 6-3b Appeals 6-4 Alternative Dispute Resolution 6-4a Negotiation 6-4b Mediation 6-4c Arbitration Chapter Conclusion Exam Review Multiple-Choice Questions Case Questions Discussion Questions 107 107 109 110 110 112 113 113 113 114 120 121 122 125 130 133 133 136 137 137 139 140 140 144 148 148 153 157 159 160 160 164 165 166 166 166 167 167 169 170 171 Copyright 2019 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part WCN 02-200-203 Copyright 2019 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it www.downloadslide.net 678 Unit Additional CPA Topics Suppose, however, that the company takes its financial statements to the Last National Bank of Tucson instead Under the Ultramares doctrine, Adrienne would not be liable because she did not prepare the documents for the Last Bank She would be liable under the foreseeable doctrine because it was foreseeable that the Last Bank would receive the financial statements from the client and rely on them She would also be liable under the Restatement doctrine because the Last Bank is in the same class as the First Bank Once Adrienne knows that a bank will rely on the statements she has prepared, the identity of the particular bank should not make any difference to her when doing her work Suppose that BeachBall uses the financial statements to persuade a landlord to rent it a manufacturing facility In this case, Adrienne would be liable under the foreseeable doctrine because this was a foreseeable use of the financial statements She would not be liable under the Restatement doctrine, however, because the landlord is not in the same class as the First Bank, for whom Adrienne knew she was preparing the documents Finally, if a major shareholder of BeachBall uses the financial statements to convince her boyfriend to marry her, Adrienne is not liable under any doctrine The following table summarizes the three doctrines: Under this doctrine: Ultramares Doctrine Accountants who fail to exercise due care are liable to a third party if: They know the identity of the third party who: • Will see their work product and Foreseeable Doctrine Restatement Doctrine • Will rely on the work product for a particular, known purpose • It is foreseeable that the third party will receive financial statements from the accountant’s client and • The third party relies on these statements • The accountants knew the third party would rely on the information or • The third party was in the same class as someone who the accountant knew would rely on the information In the following case, a potential employee relied on audited financial statements that proved to be faulty Was the accounting firm liable under the Restatement doctrine? You be the judge You Be the Judge Ellis v Grant Thornton 530 F.3d 280 United States Court of Appeals for the Fourth Circuit, 2008 Facts:  The First National Bank of Keystone could nothing right For five years, it issued many risky mortgage loans on which the borrowers defaulted Then Keystone management turned bad into worse by lying about the value of the loans When the Office of the Comptroller of the Currency (OCC) first began to smell trouble, it required Keystone to hire a nationally recognized independent accounting firm to audit its books The bank hired Grant Thornton (GT), who assigned Stan Quay as the lead partner on the account As Quay was finishing his audit, the board began talking with Gary Ellis about becoming president of the bank Ellis Copyright 2019 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part WCN 02-200-203 Copyright 2019 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it www.downloadslide.net Chapter 27 already had a perfectly good job, so he was understandably reluctant to move to a bank that the OCC was investigating To reassure him, the Keystone board suggested he talk with Quay and look at the bank’s financials Quay told Ellis that Keystone would receive a clean, unqualified opinion Ellis then attended a shareholders’ meeting at which Quay announced that his opinion would be unqualified Quay did ultimately issue a clean opinion reporting shareholders’ equity of $184 million when, in fact, the bank was insolvent to the tune of hundreds of millions of dollars The first page of the report stated: “This report is intended for the information and use of the Board of Directors and Management of The First National Bank of Keystone and its regulatory agencies and should not be used by third parties for any other purpose.” A week later, the Board voted to hire Ellis, who then quit his job elsewhere to join Keystone Five months later, the OCC declared Keystone insolvent and shut it down Ellis was out of work He filed suit against GT, seeking compensation for his lost wages The district court ruled in favor of Ellis and granted him $2.5 million in damages GT appealed You Be the Judge:  Was GT liable to Ellis for its negligence in preparing Keystone’s financial statements? Accountants’ Liability 679 Arguments for Ellis:  Stan Quay was negligent in preparing Keystone’s financial statements He reassured Ellis that the statements were accurate Ellis reasonably relied on both Quay’s written financial statements and oral assurances As a result, Ellis suffered grave harm It is only reasonable to hold GT liable to Ellis for a harm that was completely foreseeable Arguments for Grant Thornton:  Under the Restate- ment doctrine, accountants who fail to exercise due care are liable to (1) anyone they knew would rely on the information and (2) anyone else in the same class Keystone’s financial statements very clearly stated that they were designed for the benefit of Keystone’s board of directors, management and regulatory agencies Ellis was not in any of these classes when he got the audit report Therefore, he cannot recover from GT for any harm he may have suffered Moreover, Keystone did not pay GT to discuss the financial statements with existing or potential employees Indeed, GT was unaware that Ellis might be hired until after it had reached a decision to give a clean opinion It is unreasonable to hold GT liable for a risk of which it was unaware EXAMStrategy Question:  Tara bought stock in Flying Feet In doing so, she relied on financial state- ments prepared for the company by YoungPrice The accounting firm was negligent and Flying Feet crashed into bankruptcy Can Tara recover from Young? Strategy:  The answer depends on which standard the court applies Result:  Young would not be liable under the Ultramares doctrine because Young did not know Tara It could certainly foresee that investors would rely on the financial statements, so it would be liable under the foreseeable doctrine Young would not be liable to Tara under the Restatement doctrine because it did not know that Tara would rely and she was not in the same class as someone who Young knew would rely The statements were prepared for the company, not for Tara 27-3b Fraud Under common law, courts consider fraud to be much worse than negligence because it is intentional Therefore, the penalty is heavier An accountant who commits fraud is liable to any foreseeable user of the work product who justifiably relied on it This rule applies in all jurisdictions, even those that have adopted the Ultramares doctrine TechDisk manufactured computer components When customers placed more orders than the company could fill, executives feared that, if investors found out, the stock price would fall So they boosted their sales numbers by shipping out bricks wrapped up to look like components Copyright 2019 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part WCN 02-200-203 Copyright 2019 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it www.downloadslide.net 680 Unit Additional CPA Topics Nigel Paul Monckton/Shutterstock.com Company accountants deliberately altered the financial statements to pretend that the bricks were indeed computer parts These accountants would be liable to any foreseeable users—including investors, creditors, and customers 27-3c Liability for Qualified Opinions Hard to confuse these with computer parts Auditors can, under some circumstances, protect themselves from liability by issuing a less than clean opinion; that is, a qualified, adverse, or disclaimer of opinion To avoid liability, the less than clean opinion must be issued for the right reasons If the auditor indicates that it has issued a qualified opinion because of uncertainty about environmental litigation, then it is not liable when that lawsuit bankrupts the company But if the company runs into financial trouble because of inventory thefts that the auditors should have caught, the auditors would be liable 27-3d Securities Act of 1933 Due diligence A reasonable investigation of a registration statement Third parties who have been injured by an accountant’s error often file suit under the securities laws Chapter 37 on securities regulation provides a general overview of the liability provisions for both the Securities Act of 1933 (1933 Act) and the Securities Exchange Act of 1934 (1934 Act) This chapter offers a summary of these liability provisions as they affect accountants The 1933 Act requires an issuer to register securities before offering them for sale to the public To this, the issuer files a registration statement with the SEC This registration statement must include audited financial statements Under §11 of the 1933 Act, auditors are liable for any material misstatement or omission in the financial statements that they prepare for a registration statement To prevail under §11, the plaintiff must prove only that (1) the registration statement contained a material misstatement or omission and (2) she lost money Ernst & Young served as the auditor for FP Investments, Inc., a company that sold interests in tax shelter partnerships These partnerships were formed to cultivate tropical plants in Hawaii The prospectus for this investment neglected to mention that the partnerships did not have enough cash on hand to grow the plants A jury found that Ernst & Young violated §11 and awarded damages of $18.9 million to the investors.14 However, auditors can avoid liability under §11 by showing that they made a reasonable investigation of the financial statements and had reasonable grounds to believe the statements did not contain material omissions or misstatements This investigation is called due diligence Typically, auditors will not be liable if they can show that they complied with GAAP and GAAS 27-3e Securities Exchange Act of 1934 A company that is subject to the 1934 Act must file with the SEC an annual report containing audited financial statements and quarterly reports with unaudited financials Liability for Inaccurate Disclosure in a Required Filing Under §18 of the 1934 Act, an auditor who makes a false or misleading statement in a required filing is liable to any buyer or seller of the stock who has acted in reliance on the statement The auditors can avoid liability by showing that they acted in good faith and did not know the information was misleading 14Hayes v Haushalter, 1994 U.S App LEXIS 23608 (9th Cir 1994) Copyright 2019 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part WCN 02-200-203 Copyright 2019 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it www.downloadslide.net Chapter 27 Accountants’ Liability 681 Fraud Primary Liability.  Most securities litigation against accountants is brought under §10(b) and Rule 10b-5 of the 1934 Act because it is easier for investors to win under these provisions than under §18 Under §18, the plaintiff must show that he actually relied on the misrepresentation when purchasing the stock This burden is hard to meet Under §10(b), the courts are willing to assume reliance if the misstatement was material or it affected the price of the stock Under §10(b), an auditor is liable for making (1) a misstatement or omission of a material fact (2) knowingly or recklessly with the intent to deceive, manipulate, or defraud (3) that the plaintiff relies on in purchasing or selling a security This is called primary liability because the accountants are liable for statements that they make themselves Note that accountants are liable only if they have acted knowingly or recklessly with an intent to deceive, manipulate, or defraud This requirement is called scienter Because this concept is so important, we present two cases—one in which there was scienter and another one in which there was not As you read the following case, you might ask yourself why Grant Thornton accountants were willing to what they did Scienter An action is done knowingly or recklessly with an intent to deceive, manipulate, or defraud Gould v Winstar Communs., Inc 692 F.3d 148 United States Court of Appeals for the Second Circuit, 2011 Facts:  Grant Thornton (GT) audited Winstar, a broadband communications company that provided businesses with wireless internet connectivity Winstar was one of GT’s largest and most important clients, but only 12 percent of the company’s fees came from auditing, the rest were for consulting projects Winstar asked that the partner in charge of its audit be replaced and also threatened to fire GT In response, Winstar assigned two auditors who had no experience with telecommunications companies When Winstar’s real revenues fell, it began to report fake ones For example, at the end of the fiscal year, it reported that a large percentage of its revenue was from equipment sales to Lucent Technologies, a strategic partner Equipment sales were not part of Winstar’s core business and there was little documentation that these sales had taken place Winstar also reported revenue for a feasibility study for Lucent, which had not yet been performed and promotional credits purchased by Lucent for services not yet rendered Rather than spreading out the revenue over the life of various leases, it reported most revenue when the document was signed It also engaged in roundtrip transactions in which it overpaid other companies for goods and services and, in return, those companies bought unneeded equipment from Winstar These transactions were material to Winstar’s results These practices violated GAAP and SEC rules At first, GT warned that the transactions were red flags and warranted further examination But GT ultimately allowed the revenues and issued an unqualified audit opinion A year later, Winstar filed for bankruptcy protection Companies that had purchased stock in Winstar after GT issued its clean opinion filed suit against the accounting firm alleging securities fraud under §10(b) GT filed a motion for summary judgment, which the trial court granted on the grounds that the firm had not acted with scienter Plaintiffs appealed Issues:  Did GT violate §10(b)? Did it act with scienter? Excerpts from Judge Lohier’s Decision:  Plaintiffs may satisfy the scienter requirement by producing evidence of conscious misbehavior or recklessness Scienter based on conscious misbehavior, in turn, requires a showing of deliberate illegal behavior, a standard met when it is clear that a scheme, viewed broadly, is necessarily going to injure Scienter based on recklessness may be demonstrated where a defendant has engaged in conduct that was highly unreasonable, representing an extreme departure from the standards of ordinary care to the extent that the danger was either known to the defendant or so obvious that the defendant must have been aware of it Recklessness may be established where a defendant failed to review or check information that it had a duty to monitor, or ignored obvious signs of fraud Some evidence supports the Plaintiffs’ contention that GT consciously ignored Winstar’s fraud when it approved Winstar’s recognition of revenue for the suspicious Copyright 2019 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part WCN 02-200-203 Copyright 2019 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it www.downloadslide.net 682 Unit Additional CPA Topics transactions This evidence goes beyond a mere failure to uncover the accounting fraud There is also evidence that GT failed to confirm Winstar’s representations regarding these transactions or to retain and review documents evidencing each transaction Broadly speaking, there was admissible evidence that in the course of its audit GT learned of and advised against the use of indisputably deceptive accounting schemes, but eventually acquiesced in the schemes by issuing an unqualified audit opinion At this stage, the Plaintiffs have proffered enough facts constituting evidence of conscious misbehavior or recklessness to survive summary judgment We note that in granting summary judgment in GT’s favor, the District Court placed particular emphasis on the magnitude of GT’s audit work, both in time spent and documents reviewed The number of hours spent on an audit cannot, standing alone, immunize an accountant from charges that it has violated the securities laws [A] jury reasonably could determine that the audit was so deficient as to be an extreme departure from the standards of ordinary care to the extent that the danger was either known to GT or so obvious that GT must have been aware of it For the foregoing reasons, we VACATE the District Court’s grant of summary judgment, and we REMAND for further proceedings In the following case, auditors issued a clean opinion to a fraudulent company, but were not liable because there was no scienter The same judge wrote the opinion in both of these scienter cases Advanced Battery Techs., Inc v Bagell 781 F.3d 638 United States Court of Appeals for the Second Circuit, 2015 Facts:  ABAT was a Delaware corporation operating in China that designed and manufactured lithium batteries for use in consumer products Because its stock was listed on a U.S stock exchange, ABAT was required to file financial statements with both the U.S Securities and Exchange Commission (SEC) and China’s State Administration of Industry and Commerce (AIC) For four years, ABAT’s SEC filings reported increased revenues and profits while, at the same time, its AIC filings showed significant losses For example, at the same time that ABAT told the SEC that it had revenues of $31.9 million and a profit of $10.2 million, it reported to AIC revenues of $145,000 and a loss of $1 million (Differences between U.S and Chinese reporting requirements could not explain the discrepancies: If anything, Chinese accounting rules permit more generous revenue recognition than GAAP in the United States.) When financial websites reported these discrepancies, the price of ABAT shares plunged by almost half Ruble Sanderson and other ABAT shareholders sued the company’s auditors, Bagell, Josephs, Levine & Co., because the firm had issued clean audit opinions under GAAP The trial court granted Bagell’s motion to dismiss Sanderson’s complaint because it did not allege conduct that was reckless or intentional enough to constitute scienter Sanderson appealed Issues:  Did Bagell commit securities fraud? Did it act with scienter? Excerpts from Judge Lohier’s Decision:  In determin- ing whether the facts alleged in the Complaint establish the requisite strong inference of scienter, a court must consider plausible, nonculpable explanations for the defendant’s conduct In other words, the inference of scienter must be at least as compelling as any opposing inference one could draw from the facts alleged Sanderson argues that the Complaint adequately alleges facts that constitute strong circumstantial evidence of conscious recklessness In the securities fraud context, recklessness must be conduct that is highly unreasonable, representing an extreme departure from the standards of ordinary care And for an independent auditor, the conduct must, in fact, approximate an actual intent to aid in the fraud being perpetrated by the audited company, for example, when a defendant conducts an audit so deficient as to amount to no audit at all, or disregards signs of fraud so obvious that the defendant must have been aware of them Mere allegations of GAAP violations or accounting irregularities, or even a lack of due diligence, will not state a securities fraud claim absent evidence of corresponding fraudulent intent Copyright 2019 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part WCN 02-200-203 Copyright 2019 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it www.downloadslide.net Chapter 27 Sanderson argues that the Complaint [is sufficient because] it alleges that when Bagell audited ABAT’s SEC filings, it had access to ABAT’s conflicting AIC filings and financial information, and no reasonable auditor would have failed to obtain ABAT’s AIC filings We agree with the District Court that these allegations fail to constitute strong circumstantial evidence of recklessness As Sanderson conceded at oral argument, none of the accounting standards on which he relies—the Generally Accepted Auditing Standards or GAAP—specifically requires an auditor to inquire about or review a company’s foreign regulatory filings Sanderson alternatively argues that the Auditor Defendants had a duty to review ABAT’s AIC filings in view of ABAT’s unusually high profit margins reported in its SEC filings [I]n our view, ABAT’s report of high profit margins in its SEC filings triggered, at most, a duty to perform a more rigorous audit of those filings They did not obligate Bagell to review ABAT’s AIC filings And the fact Accountants’ Liability 683 that Bagell did not automatically equate record profits with misconduct cannot be said to be reckless Nor are we persuaded to infer recklessness from the allegations that Bagell had access to and presumably relied on the raw financial data underlying ABAT’s AIC filings in China but failed to see that the data contradicted ABAT’s SEC filings Sanderson urges that the only nonspeculative inference to be drawn from these allegations is that Bagell’s failure to spot the discrepancies was reckless We disagree: a somewhat more compelling inference is that ABAT maintained two sets of data for its Chinese regulators and another for its regulators in the United States—and fed Bagell false data to complete its audits For these reasons we agree that Bagell’s failure to detect ABAT’s fraudulent reporting is not conduct approximating an actual intent to aid in the fraud being perpetrated by the audited company We AFFIRM the judgment of the District Court Aiding and Abetting.  For a primary violation of §10(b), the defendant must have made a knowing or reckless omission or misstatement It is clear that the SEC also has the right to sue anyone who aids and abets others in making untrue statements in connection with the purchase or sale of a security.15 Historically, it was unclear whether injured private parties could recover from aiders and abettors The Stoneridge case, discussed in Chapter 37, involved two suppliers, not accountants, but it indicates the Supreme Court’s general hostility toward aiding and abetting cases brought by private parties.16 As a result, accountants will likely lose less sleep over this type of liability Whistleblowing Under §10A of the 1934 Act, auditors who suspect that a client has committed an illegal act must ensure that the client’s board of directors is notified If the board fails to take appropriate action, the auditors must issue an official report to the board If the board receives such a report from its auditors, it must notify the SEC within one business day and send a copy of this notice to the auditors If the auditors not receive this copy, they must notify the SEC themselves The scope of §10A is broad, covering insider trading, price fixing, and any other violations of state and federal law While doing an audit of the Cronos Group, Arthur Andersen questioned a $1.5 million “disbursement.” When the shipping company refused either to provide an explanation or to investigate this mysterious payment, the accounting firm filed an official report with the board of directors and resigned as Cronos’s auditor Cronos then filed the Andersen report with the SEC, which investigated the incident Not surprisingly, many auditors are unenthusiastic about this statute It is not a pretty choice—the wrath of the SEC if they fail to cooperate or the anger of their clients if they comply 15Private Securities Litigation Reform Act, Pub L No 104-67, 109 Stat 737 (1995) 16Stoneridge Investment Partners, LLC v Scientific-Atlanta, Inc., 552 U.S 148 (S Ct 2008) Copyright 2019 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part WCN 02-200-203 Copyright 2019 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it www.downloadslide.net 684 Unit Additional CPA Topics Joint and Several Liability Joint and several All members of a group are liable They can be sued as a group, or any of them can be sued individually for the full amount owing But the plaintiff may not recover more than 100 percent of her damages Traditionally, liability under the 1934 Act was joint and several When several different participants were potentially liable, a plaintiff could sue any one defendant or any group of defendants for the full amount of the damages If a company committed fraud and then went bankrupt, its accounting firm might well be the only defendant with assets Even if the accountants had caused only, say, percent of the damages, they could be liable for the full amount Congress has amended the 1934 Act to provide that accountants are liable jointly and severally only if they knowingly violate the law Otherwise, the defendants are proportionately liable, meaning that they are liable only for the share of the damages that they themselves caused 27-4 Criminal Liability Thus far, this chapter has focused on civil liability The penalty for a civil offense is the payment of monetary damages However, some offenses are criminal acts for which the punishment is a fine and imprisonment: • The Justice Department has the right to prosecute willful violations under either the 1933 Act or the 1934 Act • The Internal Revenue Code imposes various criminal penalties on accountants for wrongdoing in the preparation of tax returns • Many states prosecute violations of their securities laws EXAMStrategy Question:  When Benjamin hired Howard to prepare financial statements for American Equities, he gave Howard a handwritten sheet of paper entitled “Pro Forma Balance Sheet.” It contained a list of real estate holdings and the balance sheets of two corporations that Benjamin claimed were owned by American Equities From this one piece of paper, and without any examination of books and records, Howard prepared an Auditor’s Report for the company Benjamin used the Auditor’s Report to sell stock in American Equities Has Howard committed a criminal offense? Strategy:  Willful violations of the securities laws are criminal offenses Result:  A court held that Howard’s actions were willful He was found guilty of a criminal violation 27-5 OTHER ACCOUNTANT–CLIENT ISSUES 27-5a The Accountant–Client Relationship SEC rules require accountants to maintain independence from the companies they audit The accountant must be “capable of exercising objective and impartial judgment on all issues….”17 To this general guideline, the SEC has also added specific rules An auditor 17CFR §210.2-01(b) Copyright 2019 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part WCN 02-200-203 Copyright 2019 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it www.downloadslide.net Chapter 27 Accountants’ Liability or her family must not, for example, maintain a financial or business relationship with a client SEC rules on independence specifically prohibit accountants or their families from owning stock in a company that their firm audits To take one woeful example, the SEC discovered that most of PricewaterhouseCoopers’ partners were in violation of this rule, including half of the partners who were charged with enforcing it All told, firm employees had committed more than 8,000 violations Although the firm had been caught violating the same rule only a few years before, it nonetheless had a trifecta in place: Many partners pleaded ignorance of the rule, the firm made little effort to enforce it, and, as a result, violations were widespread In response to this second infraction, the firm fired ten employees, including five partners The SEC notified 52 of the firm’s clients that there were potential concerns about the integrity of their financial statements and even requested that some of the companies select a new auditor The SEC may ban any accountant who engages in “unethical or improper professional conduct” from auditing any publicly traded company for some period of time 27-5b Accountant–Client Privilege Traditionally, an accountant–client privilege did not exist under federal law Accountants were under no obligation to keep confidential any information they received from their clients In one notorious case, the IRS suspected that the owner of a chain of pizza parlors was underreporting his income The agency persuaded the owner’s CPA, James Checksfield, to spy on him for eight years (The IRS agreed to drop charges against Checksfield, who had not paid his own taxes.) Thanks to the information that Checksfield passed to the IRS, his client was indicted on criminal charges of evading taxes Then Congress passed the Internal Revenue Service Restructuring and Reform Act which provides limited protection for confidential communications between accountants and clients That is the good news The bad news is the word “limited.” This privilege applies only in civil cases involving the IRS or the U.S government It does not apply to criminal cases, civil cases not involving the U.S government, or cases with other federal agencies such as the SEC Nor does it apply to the preparation of tax returns Thus, this new accountant–client privilege would not have protected Checksfield’s client because he was charged with a criminal offense Some states recognize an accountant–client privilege, but a state privilege applies only to issues of state law and provides no protection against federal charges The Checksfield case took place in Missouri, which does have an accountant–client privilege However, because the IRS filed suit, federal law applied and Checksfield’s information could be used in court In the end, however, the IRS dropped the tax evasion charges out of concern that a jury would not believe Checksfield’s testimony Ironically, Checksfield suffered worse punishment than his client—the Missouri state board of accountancy revoked his CPA license for violating state law Working Papers When working for a client, accountants use the client’s own documents and also prepare working papers of their own—notes, memoranda, and research In theory, each party owns whatever it has prepared itself Thus, accountants own the working papers they have created In practice, however, the client controls even the accountant’s working papers The accountant (1) cannot show the working papers to anyone without the client’s permission (or a valid court order) and (2) must allow the client access to the working papers Under SOX, accountants for public companies must keep all audit work papers for at least seven years Copyright 2019 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part WCN 02-200-203 Copyright 2019 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 685 www.downloadslide.net 686 Unit Additional CPA Topics Chapter Conclusion Accountants serve many masters and, therefore, face numerous potential conflicts Clients, third parties, and the government all rely on their work Privy to clients’ most intimate financial secrets, accountants must decide which of these secrets to reveal and which to keep confidential The wrong decision may destroy the client, impoverish its shareholders, and subject its auditors to substantial penalties EXAM REVIEW THE PUBLIC COMPANY ACCOUNTING OVERSIGHT BOARD (PCAOB)  The PCAOB regulates public accounting firms THE SARBANES-OXLEY ACT (SOX): • Requires an accounting firm to make regular and complete reports to the audit committees of its clients • Prohibits accounting firms that audit public companies from providing consulting services to those companies on certain topics, such as bookkeeping, financial information systems, human resources, and legal issues (unrelated to the audit) • Prohibits an accounting firm from auditing a company if one of the company’s top officers has worked for the firm within the last year and was involved in the company’s audit • Provides that a lead audit partner cannot work for a client in any auditing role for a period of more than five years OPINIONS  After an audit is complete, the accountant issues an opinion that indicates how accurately the financial statements reflect the company’s true financial condition The auditor has four choices: • Unqualified opinion • Qualified opinion • Adverse opinion • Disclaimer of opinion LIABILITY TO CLIENTS FOR NEGLIGENCE  Accountants are liable to their clients for negligence if: • They breach their duty to their clients by failing to exercise the degree of skill and competence that an ordinarily prudent accountant would under the circumstances and • The violation of this duty causes harm to the client LIABILITY TO CLIENTS FOR FRAUD  Accountants are liable to their clients for fraud if: • They make a false statement of a material fact, Copyright 2019 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part WCN 02-200-203 Copyright 2019 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it www.downloadslide.net Chapter 27 Accountants’ Liability • They know it is not true or recklessly disregard the truth, • The client justifiably relies on the statement, and • The reliance results in damages CLIENT INFORMATION  Accountants have a legal obligation to: • Keep all client information confidential and • Use client information only for the benefit of the client FIDUCIARY DUTY  As a general rule, accountants not have a fiduciary duty to their clients However, accountants sometimes take on responsibilities that extend beyond the typical scope of an accountant–client relationship, such as when they serve as a financial advisor In these situations, they may have a fiduciary duty LIABILITY TO THIRD PARTIES FOR NEGLIGENCE  State law determines an accountant’s liability for negligence to third parties Most states follow one of the following three rules: • Ultramares doctrine Accountants who fail to exercise due care are liable to a third party only if they know the identity of the third party who: • Will see their work product and • Will rely on the work product for a particular, known purpose • Foreseeable doctrine Accountants who fail to exercise due care are liable to a third party if: • It is foreseeable that the third party will receive financial statements from the client and • The third party relies on these statements • Restatement doctrine Accountants who fail to exercise due care are liable to: • Anyone they knew would rely on the information and • Anyone else in the same class EXAMStrategy Question:  Krouse made errors in its audit of Summit Power Toro Co relied on Krouse’s faulty financial statements when making loans to Summit Krouse did not know that Toro would rely on these reports These events took place in a state that adheres to the Ultramares doctrine Is Krouse liable to Toro? Strategy:  Whenever there is an issue of liability to a third party, it is important to apply the correct rule because the outcome is very different under the various rules (See the “Result” at the end of this Exam Review section.) LIABILITY TO THIRD PARTIES FOR FRAUD  An accountant who commits fraud is liable to any foreseeable user of the work product who justifiably relies on it Copyright 2019 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part WCN 02-200-203 Copyright 2019 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 687 www.downloadslide.net 688 Unit Additional CPA Topics EXAMStrategy Question:  When Jeff said that he did not want to invest in Edge Energies, the general partner suggested he call Jackson, the partnerships’ accountant Jackson told Jeff that Edge partnerships were a “good deal,” that they were “good money makers,” and “they were expecting something like a two-year payoff.” In fact, Jackson knew that the operators were mismanaging these ventures and that the partnerships were bad investments Jeff relied on Jackson’s recommendation and invested in Edge He subsequently lost his entire investment Is Jackson liable to Jeff? Does it matter which negligence doctrine applies? Strategy:  Whenever there is intentional wrongdoing, think fraud (See the “Result” at the end of this Exam Review section.) 10 SECURITIES ACT OF 1933  Under §11 of the 1933 Act, auditors are liable for any material misstatement or omission in the financial statements that they provide for a registration statement if investors lose money EXAMStrategy Question:  To be successful in a civil action under §11 of the Securities Act of 1933 concerning liability for a misleading registration statement, the plaintiff must prove: Defendant’s Intent to Deceive Plaintiff’s Reliance on the Registration Statement (a) No Yes (b) No No (c) Yes No (d) Yes Yes Strategy:  Section 11 of the 1933 Act has a lower liability standard than the 1934 Act In other words, a successful plaintiff has to show less wrongdoing on the part of the accountant (See the “Result” at the end of this Exam Review section.) 11 SECURITIES EXCHANGE ACT OF 1934 ã Under Đ10(b), an auditor is liable for making (1) a misstatement or omission of a material fact (2) knowingly or recklessly with the intent to deceive, manipulate, or defraud (3) that the plaintiff relies on in purchasing or selling a security This requirement of intent is called scienter • The SEC can sue those who aid and abet others in making untrue statements in connection with the purchase or sale of a security ã Under Đ10A of the 1934 Act, auditors who suspect that a client has committed an illegal act must ensure that the client’s board of directors is notified • Accountants are liable jointly and severally only if they knowingly violate the law Otherwise, they are proportionately liable Copyright 2019 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part WCN 02-200-203 Copyright 2019 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it www.downloadslide.net Chapter 27 Accountants’ Liability 12 CRIMINAL LIABILITY • The Justice Department has the right to prosecute willful violations under the 1933 Act and the 1934 Act • The Internal Revenue Code imposes various criminal penalties on accountants for wrongdoing in the preparation of tax returns • Many states prosecute violations of their securities laws 13 CONFLICT OF INTEREST  An auditor or her family must not maintain a financial or business relationship with a client 14 ACCOUNTANT–CLIENT PRIVILEGE A limited accountant–client privilege exists under federal law for confidential communications between accountants and clients Some states also recognize this privilege and apply it in matters involving state law RESULTS 8.  Result:  Krouse was not liable because he did not know that Toro would rely on the reports 9.  Result:  Fraud is different from negligence, so it does not matter which negligence doctrine applies Jackson was liable to Jeff for fraud because Jeff was a foreseeable user of the information and justifiably relied on it 10.  Result:  (b) is the correct answer MULTIPLE-CHOICE QUESTIONS CPA QUESTION A CPA’s duty of due care to a client most likely will be breached when a CPA: (a) gives a client an oral instead of a written report (b) gives a client incorrect advice based on an honest error of judgment (c) fails to give tax advice that saves the client money (d) fails to follow GAAS CPA QUESTION One of the elements necessary to hold a CPA liable to a client for conducting an audit negligently is that the CPA: (a) acted with scienter or guilty knowledge (b) was a fiduciary of the client (c) failed to exercise due care (d) executed an engagement letter One of the elements necessary to hold a CPA liable under §10(b) is that the CPA: (a) (b) (c) (d) acted with scienter or guilty knowledge was a fiduciary of the client failed to exercise due care executed an engagement letter Copyright 2019 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part WCN 02-200-203 Copyright 2019 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 689 www.downloadslide.net 690 Unit Additional CPA Topics An accountant has a fiduciary duty: (a) (b) (c) (d) to a client when conducting an audit to an investor who buys stock in a company the accountant has audited to any third party that the accountant knows will be relying on an audit only for services that go beyond routine accounting work Accountants who commit fraud in the preparation of financial statements are liable to any third party who uses those statements if: (a) that person is a foreseeable user (b) the accountant knows that person’s identity (c) it is foreseeable that that person will receive the financial statements (d) that person is in the same class as someone who the accountant knew would rely on the statements CASE QUESTIONS After reviewing Color-Dyne’s audited financial statements, the plaintiffs provided materials to the company on credit These financial statements showed that Color-Dyne owned $2 million in inventory The audit failed to reveal, however, that various banks held secured interests in this inventory The accountant did not know that the company intended to give the financial statements to plaintiffs or any other creditors Color-Dyne went bankrupt Is the accountant liable to plaintiffs under the Restatement doctrine? The British Broadcasting Corp (BBC) broadcast a television program alleging that Terry Venables, a former professional soccer coach, had fraudulently obtained a £1 million loan by misrepresenting the value of his company Venables had been a sportscaster for the BBC but had switched to a competing network The source of the BBC’s story was “confidential working papers” from Venables’s accountant According to the accountant, the papers had been stolen Who owns these working papers? Does the accountant have the right to disclose the content of working papers? A partnership of doctors in Billings, Montana, sought to build a large office building When it decided to finance this project using industrial revenue bonds under a complex provision of the Internal Revenue Code, it hired Peat Marwick to the required financial work The deal was all set to close when it was discovered that the accountants had made an error in structuring the deal As a result, the partnership was forced to pay a significantly higher rate of interest When the partnership sued Peat for breach of contract, the accounting firm asked the court to dismiss the claim on the grounds that the client could only sue for the tort of negligence, not for breach of contract Peat argued that it had performed its duties under the contract The statute of limitations had expired for a tort case, but not for a contract case Should the doctors’ case be dismissed? James T Adams was a partner at Deloitte—a partner with a gambling issue He ended up borrowing tens of thousands of dollars from a casino—a casino that he was in charge of auditing Does he face any penalties? If so, what? Copyright 2019 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part WCN 02-200-203 Copyright 2019 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it www.downloadslide.net Chapter 27 Accountants’ Liability An accounting team’s worst nightmare might be to wake up one morning and discover that a company for which it had repeatedly issued clean opinions did not really exist In fact, the company had been stolen a few years earlier—its operations and related revenues all transferred away Shareholders sued the auditors under §10(b) but the court granted the accountants’ request for summary judgment Why? DISCUSSION QUESTIONS Are the SOX rules on consulting services sufficiently strict? Should auditing firms be prohibited from performing any consulting services for companies that they audit? Which of the three negligence doctrines—Ultramares, Foreseeable, or Restatement—is the most reasonable and appropriate? Accountants not have a fiduciary duty to their clients when performing accounting services Why not? Under the 1934 Act, accountants are only liable if they act with scienter Make an argument that they should be liable for negligence What you think is the right standard? ETHICS Wayne and Arlene Selden invested in Competition Aircraft, a fraudu- lent company that pretended to sell airplanes Accountant William Burnett had recommended the investment to several of his clients, who told the Seldens They were not clients of his After the company went bankrupt, the Seldens sought to recover from Burnett The court adopted the Restatement doctrine Is Burnett liable? Whether or not Burnett faces legal liability, was it a good idea for him to recommend investments to his clients? Does it create any potential conflicts of interest? Copyright 2019 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part WCN 02-200-203 Copyright 2019 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 691 www.downloadslide.net Copyright 2019 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part WCN 02-200-203 Copyright 2019 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it