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.

Accepted Answer

Section 10 of the 1934 Securities Exchange Act applies to all trading of securities, regardless of whether the trading is public or private.

Question 2

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

Accepted Answer

Primary beneficiaries are individuals or entities explicitly named in a contract, such as a will or insurance policy, to receive benefits or assets.

Question 3

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

Accepted Answer

The first shift away from Ultramares occurred through the acceptance of the "foreseeable class" concept, not the "unforeseen class" concept. This meant that accountants could be held liable to a broader group of people who could reasonably be foreseen to rely on their financial statements, rather than only those with whom they were in direct contractual relationship.

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.

Accepted Answer

The answer of Section 18 of the 1934 Securities Exchange...

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.

Accepted Answer

The due care defense in an audit engagement involves the auditor attempting to show that the audit was conducted in accordance with Generally Accepted Auditing Standards (GAAS), not Generally Accepted Accounting Principles (GAAP). GAAS provides a framework for the quality and performance of the audit process, while GAAP refers to the accounting principles.

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.

Accepted Answer

The Private Securities Litigation Reform Act of 1995 indeed introduced a system of proportionate liability, where defendants not found to have knowingly violated securities laws are liable only for their percentage of responsibility, rather than joint and several liability for all damages.

Question 7

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

Accepted Answer

Under the 1933 Securities Act, auditors are presumed liable for any misstatements in a registration statement unless they can prove they conducted a reasonable investigation and had reasonable grounds to believe the statements were true, effectively placing the burden of proof on them.

Question 8

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

Accepted Answer

Under the Securities Exchange Act of 1934, auditors can face criminal indictments if they willfully violate the act's provisions or rules, including fraud or deceit in their auditing practices.

Question 9

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

Accepted Answer

Due care and contributory negligence are indeed primary defenses available to the auditor in tort actions. Due care refers to the auditor's effort to adhere to the standards of the auditing profession, showing they acted appropriately and with the necessary skill and caution. Contributory negligence involves proving that the plaintiff (the party suing) also had a part in the fault or loss, thereby reducing or eliminating the auditor's liability.

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.

Accepted Answer

The Restatement (Second) of Torts extends the auditor's liability for ordinary negligence to a limited group of users who the auditor knows will rely on the information, not an unlimited group.

Question 11

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

Accepted Answer

Lawsuits against auditors under the 1934 Act are normally based on Section 10(b) and Rule 10b-5, which deal with fraud and misrepresentation in the sale of securities, not Section 18(b).

Question 12

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

Accepted Answer

An accountant can be held liable to a client under contract law if they breach the terms of their agreement, and under tort law if they commit negligence or fraud that causes harm to the client.

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.

Accepted Answer

Contributory negligence can be used as a defense if the client's negligence directly impacts the auditor's ability to perform their duties, potentially reducing or eliminating the auditor's liability.

Question 14

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

Accepted Answer

The 1136 Tenants case established that an accountant's working papers, including prepared financial statements and audit programs, can indeed be subpoenaed and used as evidence in court, indicating that these documents are not protected from disclosure under the accountant-client privilege.

Question 15

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

Accepted Answer

Delivering a report past the agreed-upon date may constitute a breach of contract or professional negligence, but it does not automatically amount to gross negligence. Gross negligence typically involves a severe lack of care or diligence that suggests a reckless disregard for the safety or rights of others, which is a higher threshold than merely missing a deadline.

Question 16

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

Accepted Answer

Under statutory law, auditors may have specific responsibilities and liabilities explicitly defined by legislation, which can extend or be more specific than the general duties and liabilities established under common law. Statutory laws can impose stricter standards and penalties.

Question 17

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

Accepted Answer

The Supreme Court in Ernst & Ernst v. Hochfelder established that scienter, or a wrongful state of mind, is required for a violation of Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder, thereby necessitating proof of intent to deceive, manipulate, or defraud for auditor liability.

Question 18

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

Accepted Answer

Ordinary negligence refers to the failure to use reasonable care, not just the absence of slight care, under the circumstances to avoid causing harm or risk to another person.

Question 19

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

Accepted Answer

The 1934 Securities Exchange Act allows for the prosecution of accountants (and others) for willful violations of its provisions, including fraudulent misrepresentation in financial statements, which can lead to 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.

Accepted Answer

In the Continental Vending case (US v. Simon), the court indeed emphasized that the critical test for the financial statements was whether they fairly presented the financial position of the company, rather than strict compliance with Generally Accepted Accounting Principles (GAAP).

Quiz 4: Auditors Legal Liability