Auditing & Assurance Services 6th Edition by Timothy Louwers

Exercise 425

Rule 10( b )-5 Liability under the Securities Exchange Act of 1934. Gordon Groton (G G), CPAs, were auditors of Bank Company, a brokerage firm and member of a national stock exchange. G G examined and reported on the financial statements of Bank, which were filed with the Securities and Exchange Commission.
Several of Bank's customers were swindled by a fraudulent scheme perpetrated by Bank's president, who owned 90 percent of the voting stock of the company. The facts establish that G G failed to perform the audit with the appropriate level of professional care but neither participated in the fraudulent scheme nor knew of its existence.
The customers are suing G G under the antifraud provisions of section 10( b ) and Rule 10 b -5 of the Securities Exchange Act of 1934 for aiding and abetting the president's fraudulent scheme. The customers' suit for fraud is predicated exclusively on G G's failure to conduct a proper audit, thereby failing to discover the fraudulent scheme.
Required:
Answer the following, setting forth reasons for any conclusions stated.
a. What is the probable outcome of the lawsuit?
b. What might be the result if plaintiffs had sued under common law for ordinary negligence? Explain.