Presented By:

Creative and Curious

P
resentation on………..

Legal Liability
uri us 1
 What is
legal
liability?
 Legal liability
Legal liability is the responsibility of the auditors (an
independent person) to the client and third parties
relying on the accountants work accountant can be sued
for fraud negligence in performance of duties.
 growing awareness of the
responsibilities
 increased consciousness
 complex accounting and
auditing
 lack of knowledge of the
court
Business failure, Audit failure,
Audit risk

Audit failure

Business failure

Audit risk
 It occurs when a business is
unable to repay its lenders or
Business meet the expectations of its
failure investors because of
economic or business
conditions.
 It occurs when the auditor
issues an erroneous audit
opinion as the result of an
Audit underlying failure to comply
failure with the requirements of
generally accepted auditing
standards.
 It represents that the auditor
will conclude that the financial
statements are fairly stated
Audit risk and an unqualified opinion
can be issued when, in fact,
they are materially misstated.
 Several legal concept apply
Legal to lawsuits against CPAs.
These are the
concepts Prudent person concept
 liability for the act of
affecting others
 lack
liabilities of
communication
privileged
 Prudent
person concept

A legal maxim restricting the discretion in a client's account to

nvestments that a prudent person seeking reasonable income
and preservation of capital might buy for his or her own
portfolio.

Also called the "prudent man rule".

 the partners or the shareholders in
the case of a professional
corporation, are jointly liable for
Legal liability for the civil actions against any owner.
The partners may also be liable for
the act of others the work on they relay on.
 CPAs do not have the right under
common law to withhold information
Lack of from the courts on the grounds that the
privileged information is privileged confidential
discussion between the client and the
communication auditor can not be withheld from the
courts.
Types of
law..

Common law Contract law Trot law

 Under Common
Law..

It does require that the CPA perform special

professional service with due care
 Under
Contract law

Generally through contract law

for breach of contract

Under Trot
Law

Ordinary negligence

Gross negligence

Fraud
Liability to clients…

The most common law

suits against CPA firms is
from clients
Under common law
and contract law

Auditors are expected to

fulfill contractual
responsibilities to client

Auditors can be held liable

to clients under common
law or under contract law
for the breach of contract.

Auditors can be sued under

the concept of negligence ,
gross negligence, or fraud.
Breach of contract occurs when
auditor fails to perform a
contractual duty.
  Failing to complete the
engagement within the
agreed upon time
 Withdrawing from the
engagement without
Breach of sufficient justification
contract  Violating client
include confidentiality

 Failing to provide
quality professional
work
 A client may seek these remedies for the
breach of contract

Specific performance

general monetary damages for losses

incurred as a result of the breach; and
consequential damages that occur indirectly
as a result of the breach.
  Existence &  Financial
amount of statements were
damages
Client materially
misleading

 plaintiff relied
Must
Auditor’s
on the financial Prove misconduct
statements
order auditors to fulfill the
contract (specific performance)

 issue injunction to prohibit

the auditor from continuing
the breach

 order auditor to pay

compensatory (actual)
damages
Auditor’s auditor did not
breach the contract
defense client was
contributory
negligent
client losses were not
caused by the breach
Negligence

Ordinary negligence

Gross negligence
 Absence of reasonable
care that can be expected
of a person in a set of
circumstances. For
auditors, it is in items of
what other competent
Ordinary auditors would have
Negligence done in the same
situation
 Lack of even slight care,
tantamount to reckless
behavior , that can be
Gross expected of a person.
Negligence
Elements of Auditor liability of Negligence
A duty to conform to a
required standard of
care
A failure to act in
accordance with that duty

Actual loss or damage to the client

 Existence &  Reliance on
amount of Loss auditor’s
Client opinion

Must
 Auditor’s  proximate
negligence Prove cause
Auditor’s Lack of duty to perform
Absence of misstatements
defense Contributory negligence
Absence of causal
connections
No damages
 expensive Consume time

Effects of
lawsuits on
audit firm

Monetary loss reputation

L TP
iability to hird

(Under Common Law)

arties
 Shareholders

TP
hird arties
Vendors Bankers

Employers Customers
 When a third party can sue against a
Auditor?

 The third party must prove that the auditor had a duty to exercise
due care.

 The third party must prove that the auditor breached that duty
knowingly.

 The third party must prove that the auditor's breach was the direct
reason for the loss.

 The third party must prove that they suffered an actual loss.
 When Accountants will be Liable?

Ultramares Doctrin

Foreseen Users
 Ultramares Corporation Vs Touche(1931)

An accountant is liable only for negligence to third

parties who are in privity of contract or a privity-
like relationship with the accountant. Provides the
narrowest standard for holding accountants liable to
third parties for negligence.
 Auditor is liable to all third parties in
which their reliance is foreseen even if
the auditor doesn't know the third party.
 Different Approaches of Foreseen Users

Credit Alliance approch

Restatement of Trots

Foreseeable User
 Credit Alliance Vs. Arthur Andersen & Co.
(1986)

1. An auditor must know and intend that his or her

work product would be used by the plaintiff third
party for a specific purpose.

2. The knowledge and intend must be evidence by the

auditor’s conduct.
 Rusch Factors Vs. Levin (1968)

1. An authoritative compendium of legal principles.

2. Foreseen Users must be members of a reasonably

limited and identifiable group of users that have relied
on CPA’s work.
 Billy Vs. Urther Young (1992)

Any user that the auditor should have reasonable been

able to foresee as being likely users of financial
statements have the same rights as those with privity
of contract
 Non negligent Performance

A Lack of Duty Defense

Absence of Casual Connection

 Criminal
liability

CPAs can be found guilty for criminal action

under both the federal & state law
 Occurs if…..

 Gross negligence
 Deliberate
Proceeds of Crime
Legislation

Guilty if auditor accepts property if they know or

should know that property was obtained illegally
Participating in money laundering is illegal
Selected Case
United States v. Simon (Continental
Vending) (1969)--A highly publicized case in
which auditors were held criminally liable for
gross negligence. Two audit partners and a
manager were convicted of filing false
statements with a government agency, mail
fraud, and violating Section 32 (a) of the
Securities Exchange Act of 1934. This case also
was largely responsible for the development of
required disclosure of related party transactions
(originally issued as SAS No. 6, and now
contained in FASB Statement No. 57).
United States v. Arthur Andersen (2002)—
Arthur Andersen was accused of the wholesale
destruction of documents relating to the Enron
Corporation collapse. The jury found, based
primarily on an email message that an Arthur
Andersen attorney advised a partner to revise a
memo to omit certain information, including a
comment that an Enron press release that
included an earnings announcement was
misleading. Loss of this case effectively put
Arthur Andersen out of business. The
conviction was overturned by the U.S. Supreme
Court
 Preventing Litigation
 place emphasis within the firms
 Retain legal counsel
 investigate prospective clients
 Obtain a through knowledge
 Use engagement letters
 Asses the risk