Auditing & Assurance Services 6th Edition by Timothy Louwers

Exercise 203

Liability under the Securities Acts. Orange is a public entity whose shares are traded on a national exchange. A Public Company Accounting Oversight Board inspection revealed a deficiency in audits conducted by Orange's auditor, LeGrow. LeGrow had failed to perform important auditing procedures; after performing these procedures in response to the inspection, LeGrow identified several material misstatements and requested that Orange restate its financial statements. These restatements had the effect of reducing Orange's reported income and cash flow from operations and increasing its liabilities.
Upon the disclosure of these restatements, Orange's stock price declined over 40 percent. Angered over this decline, investors are contemplating bringing legal action against LeGrow for failing to detect the misstatements.
Required:
a. Assume that investors are bringing suit under the Securities Act of 1933. What would investors need to demonstrate to bring suit against LeGrow under this act?
b. What is LeGrow's potential liability to investors if LeGrow's audit was characterized as demonstrating (1) ordinary negligence, (2) gross negligence, or (3) fraud?
c. Repeat (a) and (b), assuming that investors are bringing suit under the Securities Exchange Act of 1934.
d. What are the primary differences in LeGrow's liability to investors under the Securities Act of 1933 and the Securities Exchange Act of 1934?