Business Law and the Regulation of Business Chapter 44: Accountant’s Legal Liability

1. Business Law and the Regulation of BusinessChapter 44: Accountant’s Legal Liability By Richard A. Mann & Barry S. Roberts

2. Topics Covered in this Chapter A. Common Law B. Federal Securities Law

3. Common Law • Contract Liability - the employment contract between an accountant and her client is subject to the general principles of contract law. • Explicit Duties - the accountant is bound to perform all the duties she expressly agrees to provide. • Implicit Duties - the accountant impliedly agrees to perform the contract in a competent and professional manner.

4. Contract Liability • Beneficiaries - contract liability extends to the client/contracting party and to third-party beneficiaries (noncontracting parties intended by the contracting parties to receive the primary benefit under the contract). • Breach of Contract - general contract law principles apply.

5. Tort Liability • A tort is a private or civil wrong or injury other than a breach of contract. • Negligence - an accountant is liable for failing to exercise the degree of care a reasonably competent accountant would exercise under the circumstances; most courts have extended an accountant's liability for negligence beyond the client and third-party beneficiaries to foreseen third parties.

6. Accounts’ Liability to Third Parties for Negligent Misrepresentation Reasonably Foreseeable Plaintiffs Foreseen Users Privity(Primary Benefit Test) Third parties intended by the account and client to receive primary benefit under contract Those who the accountant knew would use the work or those who use the work for a purpose known to the accountant Third parties who reasonably and foreseeably rely

7. Tort Liability • Fraud - an accountant who commits a fraudulent act is liable for both compensatory and punitive damages to any person who he should have reasonably foreseen would be injured; a fraudulent act is a false representation of fact that is material, is made with knowledge of its falsity and with the intention to deceive, and is justifiably relied on.

8. Criminal Liability • State law imposes criminal liability on accountants for willfully certifying false documents, altering or tampering with accounting records, using false financial reports, giving false testimony, and committing forgery.

9. Client Information • Working Papers - an accountant is considered the owner of his working papers but may not disclose their contents unless the client agrees or a court orders the disclosure. • Accountant–Client Privilege - not recognized generally by the common law or Federal law, although some States have adopted statutes granting some form of privilege; accountants authorized to practice before the IRS have privilege for tax advice given their client-taxpayers with respect to Internal Revenue Code matters.

10. Federal Securities Law 1933 Act • Civil Liability - Section 11 imposes express civil liability upon accountants if the financial statements they prepare or certify for a registration statement contain any untrue statement or omit any material fact, unless the accountant proves her due diligence defense, which requires that the accountant had, after reasonable investigation, reasonable grounds to believe and did believe that the financial statements were true, complete, and accurate.

11. Federal Securities Law 1933 Act • Criminal Liability - a willful violator of Section 11 is subject to fines of not more than $10,000 and/or imprisonment of not more than five years.

12. 1934 Act • Section 18 - imposes express civil liability on an accountant who knowingly makes any false or misleading statement about any material fact in any report, document, or registration filed with the SEC. • Rule 10b–5 - an accountant is civilly liable under this rule if he acts with scienter in making oral or written misstatements or omissions of material fact in connection with the purchase or sale of a security.

13. 1934 Act • Criminal Liability - a willful violator of either Section 18 or Rule 10b–5 is subject to fines of not more than $1 million and/or imprisonment of not more than ten years. • Audit Requirements - auditors must establish procedures capable of detecting material illegal acts, identifying material related party transactions, and evaluating whether there is a substantial doubt about the issuer's ability to continue as a going concern during the next fiscal year.

14. Accountants’ Liability under Federal Securities Law