Legal Liability

1
Legal Liability

• A brief introduction

2
Legal Crisis in Accounting?

• Auditors are potentially liable to many parties
• Legal action often results from business failure
• Audit firms have deep pockets
• Settling may be less expensive than fighting,
  even when innocent
• Vicious cycle!

3
Audit Failure?

• Audit Failure is when the auditors failed to
  follow GAAS and failed to find misstatements or
  fraud
• Business failure is when a company goes bankrupt
• Audit failure is not the same as business
  failure!
• Often business failure is unfairly blamed on
  audit failure

4
Key Sources of Liability

• Common Law
• Liability to clients
• Liability to 3rd parties
• Liability to investors
• Statutory liability

5
Prudent Person Concept

• Auditor expected to exercise due care
• Standard is what a prudent person would do
• Generally relies on expert witnesses
• Good faith and integrity, not infallibility
• Prudent auditor will not generally be held liable
• Imprudent auditor will

6
Liability for Acts of Others

• Must be aware of partnership laws
• Form of business is crucial
• Conviction of Arthur Anderson casts doubt on the
  future

7
Confidentiality

• Remember auditors should maintain confidentiality
• However, auditors do not have privileged
  communication in most states or at federal level.

8
Types of Negligence

• Ordinary negligence
• Gross negligence
• Constructive fraud
• Fraud

9
Statutes Related to Auditing

• Securities Act of 1933
• Securities Exchange Act of 1934
• Litigation reform Act of 1998
• Sarbanes Oxley

10
Securities Act of 1933

• Deals with registrations and prospectuses
• First line of defense, therefore stringent on
  auditors
• Auditor is liable for contents of statements
  until date of registration
• Burden of proof is on auditor
• Claimant must only prove
• Purchased securities
• Statements were false
• Auditors only defense is due diligence

11
Securities Exchange Act of 1934

• Focuses on annual reports
• Burden of proof is on claimant and is higher
• Claimant must prove reliance
• Hochfelder case requires intent to deceive
• However, recklessness is often viewed as
  intentional
• Some states have different case law

12
Criminal Liability

• Various federal statutes make it illegal to
  knowingly sign off on false statements
• Obstruction of Justice
• Complicity with fraud
• Accepting a bribe

13
Litigation Reform Act

• Changed full and several liability to
  proportionate liability
• Ends some of the deep pocket cases