PROFESSIONAL LIABILITY

1
PROFESSIONAL LIABILITY
2
COMMON LAW LIABILITY

• Breach of Contract
• Defines Duty
• Limits liability
• Tort liability
• Negligence
• Standard of care Accountant must posses the
  skills that an ordinarily prudent accountant
  would have and must exercise the degree of care
  that an ordinarily prudent accountant would
  exercise.
• GAAP
• GAAS
• Qualified Opinions and disclaimers

3
Qualified Opinions and Disclaimers

• After performing an independent audit, the
  accountant certifies the financial statements by
  issuing an opinion letter
• Unqualified opinion means there has been
  compliance with GAAS and GAAP

4
Qualified Opinion

• Qualified opinion
• Accountants will be relieved from any
  responsibility for major changes in the clients
  financial position due to an unfavorable event if
  he clearly states his qualification in an opinion
  letter

5
Disclaimer

• Adverse opinion
• An accountant may avoid liability for
  irregularities by discovering them and issuing an
  adverse opinion
• Disclaimer
• An accountant may conduct a limited audit and
  feel unable to offer an opinion as to the
  accuracy of the financial statements
• The accountant will still be liable for any
  irregularities the limited audit should have
  revealed

6
COMMON LAW LIABILITY

• Tort liability
• Fraud Actual Constructive
• misrepresentation of material fact has occurred
• intent to deceive exists
• innocent party must have been injured

7
COMMON LAW LIABILITY

• Duty to Third Parties
• Must prove
• tort occurred
• owed a duty to third party
• Ultramares
• Near Privity
• Restatement
• Reasonably foreseeable users
• Balancing

8
Common Law Liability to Third Persons

• Fraud
• Accountants liability for fraud extends to all
  forseeable uses of their work product who suffer
  damages proximately caused by the accountants
  fraud
• Accountant must act with special type of intent
  called scienter
• Duty to Disclose New Information
• Accountants have a duty to disclose the
  unreliability of earlier reports to anyone who
  they know are relying on it

9
STATUTORY LIABILITY OF ACCOUNTANTSAND OTHER
PROFESSIONALS

• Sarbanes-Oxley Act of 2002
• Securities Act of 1933, Sections 11 12(2)
• Securities Exchange Act of 1934, Sections 10(b)
  and 18
• Internal Revenue Code

10
PREPARER PENALTIES UNDER THE I.R.C.

• 6694(a) negligent understatement of tax -
  greater of 1,000 or 50 percent of the income
  derived (or to be derived) by the tax return
  preparer with respect to the return or claim.
• 6694(b) willful understatement of tax - greater
  of
• (A) 5,000, or
• (B) 50 percent of the income derived (or to be
  derived)
• 6701 aiding abetting the understatement of tax
  - 1000 per return
• 7206 making a false return or aiding in the
  preparation of false return - fine up to
  100,000 (500,000 for corporation), imprisonment
  up to 3 years, or both

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TAXPAYER PENALTIES

• Preparer may be liable to taxpayers for these
  penalties.
• 6651 failure to pay taxes - 0.5 percent of the
  amount of such tax if the failure is for not more
  than 1 month, with an additional 0.5 percent for
  each additional month or fraction thereof during
  which such failure continues, not exceeding 25
  percent in the aggregate (as of 1/1/09)
• 6662 negligence penalty - 20 of the taxes due.
  This includes failure to make a reasonable effort
  to comply with the Code and careless disregard of
  the rules of the IRS.
• 6663 fraud - up to 75 of fraudulent tax
  underpaid

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PEOPLE V. ZIMBELMAN

• Knox and Zimbelman each owned ½ of the stock in
  Balto Industries, Inc. Knox was in poor health
  and desired to sell his share of the business so
  that he could retire.
• Zimbelman prepared financial statements and a
  general report on the company, which he presented
  to Knox in conjunction with an offer to buy
  Knoxs shares.
• Zimbelman misstated the position of the company
  and otherwise committed fraud in these reports.
• After the sale was completed, Knox died. His
  family discovered the fraudulent representations
  that Zimbelman had made and filed civil and
  criminal charges against Zimbelman for fraud.
• In the criminal proceeding, the state of Colorado
  called Hook as a witness. Hook had prepared
  financial statements and had audited the books of
  Balto shortly before the reports were prepared by
  Zimbelman.
• Colorado statutes provide for an
  accountant-client privilege, and Zimbelman
  asserted this privilege in an effort to prevent
  Hook from testifying.

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Protection of Accountants Papers

• Working Papers
• The working papers that an accountant prepares in
  making an audit belong to the accountant, not the
  client
• Accountant-Client Privilege
• Many states have statutes that grant protection
  to accountants working papers and also to
  conversations, letters, and memorandums between
  accountants and their clients

14
Credit Alliance Corporation et al., Respondents,
v. Arthur Andersen Co., Appellant European
American Bank and Trust Company, Respondent, v.
Strauhs Kaye et al., AppellantsCourt of
Appeals of New York65 N.Y.2d 536 483 N.E.2d
110 493 N.Y.S.2d 435 1985 N.Y. LEXIS 15157

• May an accountant may be held liable, absent
  privity of contract, to a party who relies to his
  detriment upon a negligently prepared financial
  report?In Credit Alliance Corp. v Andersen
  Co. ("Credit Alliance"), plaintiffs are major
  financial service companies engaged primarily in
  financing the purchase of capital equipment
  through installment sales or leasing agreements.
  Defendant, Arthur Andersen Co. ("Andersen"), is
  a national accounting firm.

15

• Plaintiffs' complaint and affidavit allege that
  prior to 1978, plaintiffs had provided financing
  to L. B. Smith, Inc. of Virginia ("Smith"), a
  capital intensive enterprise that regularly
  required financing.
• During 1978, plaintiffs advised Smith that as a
  condition to extending additional major
  financing, they would insist upon examining an
  audited financial statement.
• Accordingly, Smith provided plaintiffs with its
  consolidated financial statements, covering both
  itself and its subsidiaries, "For The Years Ended
  December 31, 1977 and 1976" (the "1977
  statements").
• These statements contained an auditor's report
  prepared by Andersen stating that it had examined
  the statements in accordance with generally
  accepted auditing standards ("GAAS") and found
  them to reflect fairly the financial position of
  Smith in conformity with generally accepted
  accounting principles ("GAAP").
• In reliance upon the 1977 statements, plaintiffs
  provided substantial amounts in financing to
  Smith through various extensions of credit.
• Thereafter, in 1979, as a precondition to
  continued financing, plaintiffs requested and
  received from Smith the consolidated financial
  statements "For The Years Ended February 28, 1979
  and December 31, 1977" (the "1979 statements").

16

• Again, Andersen's report vouched for its
  examination of the financial statements and the
  financial position of Smith reflected therein.
  Relying upon these certified statements,
  plaintiffs provided additional substantial
  financing to Smith.
• It is alleged that both statements overstated
  Smith's assets, net worth and general  financial
  health, and that Andersen failed to conduct
  investigations in accordance with proper auditing
  standards, thereby failing to discover Smith's
  precarious financial condition and the serious
  possibility that Smith would be unable to survive
  as a going concern. Indeed, in 1980, Smith filed
  a petition for bankruptcy. By that time, Smith
  had already defaulted on several millions of
  dollars of obligations to plaintiffs.

17
JTD HEALTH SYSTEMS, INC., ET AL.,
PLAINTIFFS-APPELLEES v. PRICEWATERHOUSE COOPERS,
LLP, DEFENDANT-APPELLANT141 Ohio App. 3d 280
2001 Ohio 2141 750 N.E.2d 1177 2001 Ohio App.
LEXIS 331

• Coopers was hired by plaintiff-appellee JTD
  Health Systems, Inc. ("JTD") to perform an audit
  of the financial statements for 1995. Coopers had
  been performing these audits for approximately 20
  years.
• In 1995, JTD hired Tammy Heiby as accounting
  coordinator. Heiby was overwhelmed by the
  position and failed to make payroll tax deposits.
  She then hid these failures by falsifying journal
  entries.
• In December of 1995, Heiby wrote three checks
  totaling 1.7 million to Society Bank from the
  cash account. These three checks were manually
  written out of sequence and appeared on the 1995
  outstanding check review summary prepared by
  Coopers. Coopers never questioned the checks.

18

• During Cooper's audit, Coopers was unable to
  reconcile the cash account or explain the
  approximately 30,000 surplus funds in the
  account. Coopers reported to JTD that the surplus
  was due to changes in Medicaid/Medicare direct
  deposit procedures.
• Coopers determined that no investigation was
  needed because the cash account was reconciled to
  within "an immaterial difference." Later, it was
  learned that Heiby had underestimated the
  payments due for payroll taxes by this
  amount.In 1996, Heiby continued to miss tax
  payments. On November 15, 1996, JTD received a
  call from the IRS concerning the missed payments
  for 1995. This amount totaled 645,000 once
  interest and penalties were added. On November
  22, 1996, JTD requested a complete transcript of
  all 1996 payments from the IRS.
• The IRS complied with this request on January 6,
  1997, and advised JTD that payments had been
  missed in 1996. The IRS waived penalties and
  interest for the 1995 taxes, but declined to do
  so for the 1996 taxes. JTD did not request that
  Coopers investigate the payment of the taxes for
  either 1995 or 1996.On January 19, 1999, JTD
  filed a complaint against Coopers alleging
  professional negligence for failure to discover
  the lack of tax payments made.