Deck 4: Auditors Legal Liability

Question 1

Section 10 of the 1934 Securities Exchange Act is broad in scope because it applies to both public and private trading of securities.

Answer 1

True

Question 2

Under common law, primary beneficiaries are those who are named in the contract.

Answer 2

True

Question 3

The first shift away from Ultramares occurred in the form of judicial acceptance of the specifically unforeseen class concept.

Answer 3

False

Question 4

Section 18 of the 1934 Securities Exchange Act provides a defense when the auditor can show that he or she acted in good faith, or had no knowledge that the financial statements were false or misleading.

Question 5

When using the due care defense in a suit pertaining to an audit engagement, the auditor attempts to show that the audit was made in accordance with GAAP.

Question 6

The Private Securities Litigation Reform Act of 1995 instituted a system of proportionate liability under which defendants who are not found to have "knowingly committed a violation" of securities laws are liable based on the defendant's percentage of responsibility.

Question 7

Under the 1933 Securities Act, the burden of proof is on the auditor to show that he or
she was not negligent.

Question 8

Criminal indictments may be brought against auditors under the 1934 Act.

Question 9

In tort actions, the primary defenses available to the auditor are due care and contributory negligence.

Question 10

The Restatement (Second) of Torts extends the auditor's liability for ordinary negligence to a specific but unlimited group of users for whose benefit the auditor intends to supply the information.

Question 11

Lawsuits against auditors under the 1934 Act are normally based on Section 18(b).

Question 12

An accountant may be held liable to a client under either contract law or tort law.

Question 13

In most states, contributory negligence is a defense for the auditor only when the negligence directly contributes to the auditor's failure to perform.

Question 14

The 1136 Tenants case showed that the accountant's working papers cannot be used against him.

Question 15

An auditor would be guilty of gross negligence for delivery of a report past the agreed-upon date.

Question 16

The liability of an auditor is less extensive under statutory law than under common law.

Question 17

Based upon the Hochfelder case, scienter is now required for auditor liability under Section 10 of the 1934 Securities Exchange Act.

Question 18

Failure to use even slight care in the circumstances constitutes ordinary negligence.

Question 19

Under the 1934 Securities Exchange Act, accountants may be prosecuted for criminal liability.

Question 20

In the Continental Vending case (US v. Simon), the courts held that the "critical test" was fair presentation, not compliance with GAAP.

Question 21

A CPA is liable under RICO for ordinary negligence.

Question 22

The Securities Act of 1933 is also known as the :

A) Truth in Lending Act
B) Truth in Securities Act
C) Great Depression Act
D) Sale of Securities Act
E) Savings and Loan Act

Question 23

Under the 1977 Restatement of Torts, a party may recover for the auditor's ordinary negligence even when the auditor has no knowledge of the:

A) client's intent to distribute the financial statements.
B) names or identities of the expected users.
C) type of transaction the information is to be used to support.
D) fact that the client's management created fictitious transactions.
E) fact that the client's management had knowledge of material misrepresentations in the financial statements.

Question 24

Anyone identified to the auditor by name prior to the audit who is to be the principal recipient of the auditor's report is a

A) third party.
B) foreseen beneficiary.
C) primary beneficiary.
D) foreseeable party.
E) secondary beneficiary.

Question 25

Under the Rosenblum ruling, in order for parties to recover for ordinary negligence they must be:

A) foreseeable.
B) in privity.
C) named in the contract.
D) members of a foreseen group.
E) secondary beneficiaries.

Question 26

Individuals or entities whom the auditor either knew or should have known would rely on the audit report in making business and investment decisions are:

A) third parties.
B) foreseen beneficiaries.
C) primary beneficiaries.
D) secondary beneficiaries.
E) foreseeable parties.

Question 27

The Fund of Funds case illustrated that auditors could be found liable for failure to report wrong-doings discovered:

A) only on audit engagements for a particular client.
B) on any type of engagement for a particular client.
C) only on special fraud audits conducted under separate contract.
D) even on engagements for other clients.
E) even on engagements for consulting clients.

Question 28

Engagement letters provide the basis for the contractual agreements and maximize the risk of misunderstanding about the services that have been agreed on.

Question 29

Under the Ultramares ruling, in order for parties to recover for ordinary negligence they must be:

A) in privity.
B) members of a foreseen group.
C) named in the contract.
D) foreseeable.
E) secondary beneficiaries.

Question 30

Under the Rusch Factors ruling, in order for parties to recover for ordinary negligence they must be:

A) in privity.
B) named in the contract.
C) foreseeable.
D) members of a foreseen group.
E) secondary beneficiaries.

Question 31

The Securities Act of 1933 makes the auditor liable for:

A) fraud to all users and buyers of the statements.
B) gross negligence or fraud to all users of the statements.
C) gross negligence or fraud to all buyers of the securities.
D) ordinary negligence to all users of the statements.
E) ordinary negligence to all buyers of the securities.

Question 32

When courts adopt the "foreseeable parties" ruling, auditor liability for ordinary negligence is extended to:

A) all current and future creditors.
B) a distinct but unlimited class of users.
C) virtually all legitimate users of the financial statements.
D) all current and future investors.
E) a distinct but limited class of users.

Question 33

The term privity of contract refers to the contractual relationship that exists between two or more contracting parties.

Question 34

The auditor's working papers are of little importance in refuting charges for breach of contract and breach of duty in a tort action.

Question 35

Section 18 liability is relatively narrow in scope because it relates only to a false or misleading statement in documents "filed" with the:

A) FASB
B) IRS
C) SEC
D) AICPA
E) IMA

Question 36

Gross negligence can best be defined as:

A) failure to exercise due care.
B) misrepresentation.
C) failure to exercise even slight care.
D) criminal fraud.
E) collusion.

Question 37

The auditor's legal liability to third parties under common law extends to:

A) all third parties for all acts of negligence.
B) all third parties for acts of fraud; select third parties for gross and ordinary negligence.
C) select third parties for fraud, gross negligence, and ordinary negligence.
D) all third parties for all acts of willful misconduct.
E) all third parties for acts of fraud and gross negligence; select third parties for ordinary negligence.

Question 38

RICO was originally drafted as part of the 1980 Organized Crime Control Act.

Question 39

Which of the following is not a tort?

A) breach of contract
B) negligence
C) gross negligence
D) fraud
E) ordinary negligence

Question 40

Strict adherence to Statements on Auditing Standards is not required.

Question 41

The main reason a plaintiff would bring suit against the auditor under RICO instead of under the anti-fraud provisions of the 1934 Securities Exchange Act is:

A) the possibility of treble damages and attorneys' fees.
B) federal fraud action may be brought in state court.
C) the possibility of double damages.
D) prison terms may be provided along with civil damages.
E) it is easier to prove fraud than gross negligence.

Question 42

The Hochfelder Case is important because it limited auditor liability under:

A) the 1933 Securities Act.
B) the 1934 Securities Exchange Act.
C) common law.
D) RICO.
E) tort law.

Question 43

An auditor may be liable to a client for breach of contract under which of the following?

A) Issues a standard audit report when he or she has not made an audit in accordance with GAAS.
B) Does not deliver the audit report by the agreed-upon date.
C) Violates the client's confidential relationship.
D) All of the above.
E) None of the above.

Question 44

Consider the following three situations: X, Y, and Z.
X:Company X has had securities traded on the NYSE for many years.
Y:Company Y is preparing to have its securities traded on an organized national exchange for the first time.
Z:Company Z is preparing an initial public offering through the mails.
The 1934 Securities Exchange Act would apply to:

A) situation X only.
B) situations Y and Z.
C) situation Z only.
D) situations X, Y, and Z.
E) situations X and Y.

Question 45

Which one of the following establishes criminal liability for "willfully" and "knowingly" making false or misleading statements in reports filed under the 1934 Securities Exchange Act?

A) Section 32(a)
B) Section 18(a)
C) Section 10(b)
D) Section 11(b)
E) Section 17(a)

Question 46

Which one of the following is not true of Section 18 of the 1934 Securities Exchange Act?

A) allows recovery for simple negligence
B) requires the person sued to prove they acted in good faith
C) allows both buyers and sellers of the securities to recover
D) does not normally apply to annual reports issued to shareholders
E) plaintiff must be either a buyer or seller of the security

Question 47

Which of the following was not provided by the Private Securities Litigation Reform Act of 1995?

A) Requires plaintiffs to pay defendants reasonable attorney's fees and expenses directly related to litigation found by the court to be frivolous and unwarranted.
B) Provides for a stay of discovery during the period a motion to dismiss is pending, thereby reducing a cost that often forces innocent parties to settle frivolous class action suits.
C) Limits punitive damages by defining securities fraud as a basis for bringing action under the Racketeer Influenced and Corrupt Organization Act, which provides for treble damages.
D) Places limits on the rights of third parties to sue by limiting the number of times a plaintiff can be a lead plaintiff to no more than five class actions in any three-year period and by imposing stricter pleading standards to be met by plaintiffs.
E) Changes the manner in which the court appoints lead plaintiffs in class actions to favor institutional investors likely to have the largest financial stake in the relief sought and to mitigate the "race to the courthouse by professional plaintiffs" who hold minimal ownership interests.

Question 48

In order for a plaintiff to recover against an auditor under the 1933 Securities Act, he or she must normally prove:

A) reliance on the financial statements.
B) gross negligence on the part of the auditor.
C) the financial statements were materially false or misleading.
D) ordinary negligence on the part of the auditor.
E) reliance, misleading statements and ordinary negligence.

Question 49

Which of the following would be least likely to be considered an "other beneficiary" or unnamed third party to a contract?

A) creditors
B) competitors
C) stockholders
D) potential investors
E) banks

Question 50

Auditor liability under the 1933 Securities Act extends to the:

A) financial statement date.
B) auditor's report date.
C) filing date of the registration statement.
D) effective date of the registration statement.
E) due date of the registration statement.

Question 51

If a CPA recklessly abandons standards of due care and diligence while performing an audit, he or she may be held liable to unknown third parties for:

A) fraudulent misconduct.
B) gross misconduct.
C) ordinary negligence.
D) contributory negligence.
E) gross negligence.

Question 52

Which one of the following grants certain unnamed third parties rights against auditors for ordinary negligence?

A) the Private Securities Litigation Reform Act of 1995
B) the Securities Act of 1933
C) the Securities Exchange Act of 1934
D) both the 1933 and 1934 Acts
E) the Organized Crime Control Act of 1970

Question 53

Section 11 of the 1933 Securities Act uses the term "material fact" to limit the amount of information required. Under the Act, the standard used to determine the materiality of an item:

A) is the auditor's professional judgment.
B) has been established by the SEC as a percent of net income or of total assets.
C) can be found in pronouncements of the FASB.
D) is the average prudent investor.
E) can be found in pronouncements of the AICPA.

Question 54

In recent years, both the volume and cost of litigation related to alleged audit deficiencies reached alarming proportions. This important trend led to the:

A) Racketeer Influenced and Corrupt Organization Act.
B) Coalition to Eliminate Abusive Securities Suits.
C) Securities Act of 1993.
D) Private Securities Litigation Reform Act of 1995.
E) Securities Exchange Act of 1994.

Question 55

Which one of the following was not a characteristic of the court cases against auditors in the 1960s?

A) growth in the volume of cases
B) extension of the concept of auditor's criminal liability
C) use of RICO against auditors
D) extension of auditor liability to third parties
E) extension of auditor liability for ordinary negligence

Question 56

The auditor's position under Section 18 of the 1934 Act is essentially the same as under:

A) the Restatement (Second) of Torts.
B) the Rosenblum Ruling in common law.
C) the Natelli Ruling in criminal law.
D) the Ultramares Ruling in common law.
E) Section 11 of the 1933 Act.

Question 57

Action under RICO requires a "pattern" of racketeering activity. Under this law, a pattern exists with commission of the racketeering act at least:

A) 5 times in 5 years.
B) 5 times in 2 years.
C) 3 times in 3 years.
D) 2 times in 10 years.
E) 2 times in 5 years.

Question 58

When financial statements are determined to be false or misleading, the auditor's best defense against a plaintiff bringing suit under the 1933 Securities Act would be:

A) lack of intent.
B) lack of privity.
C) contributory negligence.
D) no contest.
E) due diligence.

Question 59

All of the following are true with respect to the plaintiff in a suit under the 1933 Securities Act except the plaintiff:

A) may be any person acquiring securities described in the registration statement, whether or not he or she is a client of the auditor.
B) must establish that his or her loss resulted in whole or in part from causes other than the false or misleading statements.
C) must base the claim on an alleged material false or misleading financial statement contained in the registration statement.
D) does not have to prove reliance on the false or misleading statement or that the loss suffered was the proximate result of the statement if purchase was made before the issuance of an income statement covering a period of at least twelve months following the effective date of the registration statement.
E) does not have to prove that the auditors were negligent or fraudulent in certifying the financial statements involved.

Question 60

Consider the following three situations: X, Y, and Z. X:Company X has had securities traded on the NYSE for many years.
Y:Company Y is preparing to have its securities traded on an organized national exchange for the first time.
Z:Company Z is preparing an initial public offering through the mails.
The 1933 Securities Act would apply to:

A) situation X only.
B) situations Y and Z.
C) situation Z only.
D) situations X, Y, and Z.
E) situations X and Y.

Question 61

1.Distinguish between the following:
(a) primary versus other beneficiaries and (b) foreseen group versus foreseeable parties. Identify the principal cases that extended the accountant's liability for ordinary negligence to each of the parties identified in (b) above.

2.Contrast the terms "contributory negligence" and "due diligence defense."

3.Explain the essence of Section 10 and Rule 10b-5 of the Securities Exchange Act of 1934. Indicate the landmark case pertaining to this rule and the findings of the court in the case.

4.Why is it advantageous for a plaintiff to bring suit under the Racketeer Influenced and Corrupt Organization Act (RICO)? May a CPA be liable under RICO for ordinary negligence? Explain.

Question 62

Explain why there is such a misconception as to the number of audit failures relative to the total number of audits performed.

Question 63

Explain the responsibilities of the plaintiff and the defendant in a 1933 Act suit.

Question 64

Which of the following would be an example of a foreseeable party?

A) all creditors
B) stockholders
C) present investors
D) future investors
E) all of the above