Sleek Corporation is a public corporation whose stock is traded on several provincial securities exchanges. Sleek engaged Garson & Garson CPAs to audit Sleek's financial statements. Sleek was planning a business expansion program and needed the audit in order to obtain financing through borrowing and making a public stock offering.
Before the engagement began, Fred Hedge, the president of Sleek, told Garson's managing partner that the audited financial statements would be submitted to Sleek's banks to obtain the necessary loans. During the course of the audit, Garson's managing partner found that Hedge and other Sleek officers had embezzled substantial amounts of money from the corporation. These embezzlements threatened Sleek's financial stability.
When these findings were brought to Hedge's attention, Hedge promised that the money would be repaid and begged that the auditor not disclose the fraud. Hedge also told Garson's managing partner that several friends and relatives of Sleek's officers had been advised about the projected business expansion and proposed stock offering, and had purchased significant amounts of Sleek's stock based on this information.
Garson submitted an unqualified opinion on Sleek's financial statements, which did not include adjustments for or disclosures about the embezzlements and insider stock transactions. The financial statements and audit report were submitted to Sleek's regular banks including Knox Bank. Knox, relying on the financial statements and Garson's report, gave Sleek a $2,000,000 loan. Sleek's audited financial statements were also incorporated into a prospectus. The prospectus filed by Sleek with the OSC offered 100,000 shares of its common stock at $100 per share. An OSC investigation of Sleek disclosed the embezzlements and the insider trading. Trading in Sleek's stock was suspended and Sleek defaulted on the Knox loan. As a result, the following legal actions were taken:
1. Knox sued Garson.
2. The general public purchasers of Sleek's stock offering sued Garson.
Required:
A. Knox would recover from Garson for fraud. The elements of fraud are:
a. the misrepresentation of a material fact Garson issued an unqualified opinion on misleading financial statements. Garson's opinion did not include adjustments for or disclosures about the embezzlements and insider stock trading.
b. a loss was sustained
c. by Knox as a direct result of Sleek's default on the loan.
A. Would Knox recover from Garson for fraud?
B. The general public purchasers of Sleek's stock offerings would recover from Garson for the same reasons.
a. Under the facts presented, Garson could not establish a due diligence defence because they knew that the prospectus failed to disclose material facts. Garson's knowledge that the prospectus failed to disclose a material fact, such as the insider trading and the embezzlements, is considered a fraudulent action. The omission was material.
b. Garson's action was intentional or, at a minimum, a result of gross negligence or recklessness (scienter).
c. These purchasers relied on Garson's opinion on the financial statements and incurred a loss.
B. Would the general public purchasers of Sleek's stock offerings recover from Garson?

Question

Quizplus · Accepted Answer

The Answer of Sleek Corporation is a public corporation whose stock is traded on several provincial securities exchanges. Sleek engaged Garson & Garson CPAs to audit Sleek's financial statements. Sleek was planning a business expansion program and needed the audit in order to obtain financing through borrowing and making a public stock offering.
Before the engagement began, Fred Hedge, the president of Sleek, told Garson's managing partner that the audited financial statements would be submitted to Sleek's banks to obtain the necessary loans. During the course of the audit, Garson's managing partner found that Hedge and other Sleek officers had embezzled substantial amounts of money from the corporation. These embezzlements threatened Sleek's financial stability.
When these findings were brought to Hedge's attention, Hedge promised that the money would be repaid and begged that the auditor not disclose the fraud. Hedge also told Garson's managing partner that several friends and relatives of Sleek's officers had been advised about the projected business expansion and proposed stock offering, and had purchased significant amounts of Sleek's stock based on this information.
Garson submitted an unqualified opinion on Sleek's financial statements, which did not include adjustments for or disclosures about the embezzlements and insider stock transactions. The financial statements and audit report were submitted to Sleek's regular banks including Knox Bank. Knox, relying on the financial statements and Garson's report, gave Sleek a $2,000,000 loan. Sleek's audited financial statements were also incorporated into a prospectus. The prospectus filed by Sleek with the OSC offered 100,000 shares of its common stock at $100 per share. An OSC investigation of Sleek disclosed the embezzlements and the insider trading. Trading in Sleek's stock was suspended and Sleek defaulted on the Knox loan. As a result, the following legal actions were taken:
1. Knox sued Garson.
2. The general public purchasers of Sleek's stock offering sued Garson.
Required:
A. Knox would recover from Garson for fraud. The elements of fraud are:
a. the misrepresentation of a material fact Garson issued an unqualified opinion on misleading financial statements. Garson's opinion did not include adjustments for or disclosures about the embezzlements and insider stock trading.
b. a loss was sustained
c. by Knox as a direct result of Sleek's default on the loan.
A. Would Knox recover from Garson for fraud?
B. The general public purchasers of Sleek's stock offerings would recover from Garson for the same reasons.
a. Under the facts presented, Garson could not establish a due diligence defence because they knew that the prospectus failed to disclose material facts. Garson's knowledge that the prospectus failed to disclose a material fact, such as the insider trading and the embezzlements, is considered a fraudulent action. The omission was material.
b. Garson's action was intentional or, at a minimum, a result of gross negligence or recklessness (scienter).
c. These purchasers relied on Garson's opinion on the financial statements and incurred a loss.
B. Would the general public purchasers of Sleek's stock offerings recover from Garson?

Sleek Corporation Is a Public Corporation Whose Stock Is Traded