Business Law Study Set 13

Business

Quiz 47 :

Accountants Liability and Malpractice

Quiz 47 :

Accountants Liability and Malpractice

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is the difference between the standards for auditor liability in a civil action by investors against the auditor vs. auditor liability for violation of securities laws?
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An auditor's liability in civil action by investor is based on tort. This may be that the investor relied on the auditing report that was misrepresented and the investor sues for negligent misrepresentation.
However, auditor's liability for violation of securities laws is based on violation of statutes. For example, if an auditor fails to comply with security regulations.

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almost 13 years, Touche Ross had prepared the annual audit of Buttes Gas and Oil Co. Buttes wanted to obtain a loan from Dimensional Credit Corp. (DCC) and showed DCC its most recent annual audit. DCC made the loan on the basis of what it learned from the audit. The loan was not repaid, and DCC then realized that it had been misled by negligent statements about Buttes's financial condition that appeared in the annual statement prepared by Touche Ross. Would DCC be able to recover against Touche Ross for its negligence in preparing this report?
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The accountant may not be liable to the bank a third party using its auditing reports. The bank is barred from suing because it would be unknown that the audit would be used by them.
In order to sue the accountant, the bank needed to be a foreseeable user of their reports. But this may not have been the case. There was no information that the bank contacted the auditing firm directly or alluded to the firm that they would be using this information.

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auditing firm of Timm, Schmidt Co. prepared annual financial statements for Clintonville Fire Apparatus, Inc. (CFA). CFA showed these statements to Citizens State Bank and asked for loans. On the basis of the financial statements, Citizens loaned CFA approximately $380,000. Timm later discovered that the financial statements overvalued CFA by more than $400,000. Citizens demanded repayment of the loans. CFA could not pay the balance, and Citizens sued Timm and its malpractice liability insurer. They raised the defense that the suit was barred by lack of privity and the fact that no one in the Timm firm knew that CFA intended to use the financial statements to obtain loans from anyone. Is the lack of privity a defense? [Citizens State Bank v Timm, Schmidt Co., 335 NW2d 361 (Wis)]
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Refer to the case Citizens State Bank v Timm, Schmidt Co. to answer question as below:
Facts to this case
• An accounting firm made misstatements on a client's financial statements.
• A bank relied on the accounting's financial statements to lend money to the client.
• The bank was unable to receive payment on their loans and sued the accounting firm for malpractice.
Case Issue
The issue is whether the accounting firm is liable to the bank for their misstatement. Note that the debtor hired the accounting firm for their services; the bank is a third party which used the financial statements.
Relevant Terms, Laws, and Cases
Malpractice - is when a professional, such as doctor, lawyer, or accountants, work which results in an injury to another.
Analysis and Conclusion
The court held for the bank. They argued that:
• Historically, accounting firms are not liable to third parties for damages due to the accountant's work.
• However, the court found recent arguments that professionals should be liable to injured third parties to promote the duty of care of the professional in their service.
• The third parties that may sue for damages are those that the accountant may foresee to have received the accountant's work.
• Testimony reviewed that the accounting firm's employee had expected creditors of their client to review these statements.
Thus, the bank can sue for malpractice.

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Equisure, Inc., was required to file audited financial statements when it applied for a listing on the American Stock Exchange (AMEX). Stirtz, Equisure's auditor, issued a favorable audit opinion used for the AMEX application. Stirtz also issued "clean" opinions on Equisure's required SEC filings, such as its 10k. Noram, a securities broker, loaned $900,000 in margin credit to purchasers of Equisure's stock based on the firm's audited financials. AMEX stopped trading on Equisure's stock because of allegations of insider trading and stock manipulation, and Noram was left without collateral for $2.5 million in loans. Stirtz resigned as Equisure's auditor, and Noram filed suit against Stirtz. The trial court granted Stirtz summary judgment. Noram appealed. Who is liable here? Was the court's decision correct? [Noram Investment Services, Inc. v Stirtz Bernards Boyden, 611 NW2d 372 (Minn App)]
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Henry Hatfield, CPA, was hired to prepare audited financial statements for Happy Campers, a nonprofit organization providing summer camp scholarships for inner-city, low-income children. The executive director of Happy Campers was embezzling but falsified records that Hatfield used in his audit. First Bank gave Happy Campers a $100,000 loan based on Hatfield's certified financials. The embezzlement was discovered, and Happy Campers defaulted on the loan. Can First Bank recover its loss from Hatfield?
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David S. Talesnick served as the accountant for Kenneth Ronson and his wife as well as for Ronson's company, performing accounting and tax services for all. From 1980 to 1983, Ronson, his wife, and his company invested in the White Rim Oil Gas, Pine Coal, and Winchester Coal limited partnerships. During those years, the Ronsons and his company were able to report losses on their income tax returns because of these investments. However, the IRS determined that the limited partnerships were not qualified investments under the tax code and disallowed the loss deductions. The Ronsons and his company all owed back taxes, interest, and penalties as a result. The Ronsons disputed the finding and asked Talesnick how they might appeal the ruling and not have the interest clock ticking on what they owed. Talesnick wrote a letter and advised them to post a bond of $91,300, the amount then due. Talesnick was incorrect in his advice on payment and accrual of interest, and by the time the final determination was made against the Ronsons and Ronson's company, they owed $235,063 with interest. The Ronsons sued Talesnick for malpractice. Could they recover? How much? [Ronson v Talesnick, 33 F Supp 2d 347 (DNJ)]
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Hicks, the president and manager of Intermountain Merchandising, wanted to sell the business to Montana Merchandising, Inc. To provide a basis for the transaction, he retained Bloomgren, an accountant, to make an audit of Intermountain. Bloomgren knew that Montana would use the audit report in making the purchase of the business from Intermountain. Bloomgren's audit report showed the Intermountain business as profitable. Thayer, Montana's president, relied on this report in agreeing to purchase the business of Intermountain and in agreeing to the terms of the purchase. Sometime later, it was discovered that the accountant had made a number of mistakes and that the business that was sold was actually insolvent. Thayer and Montana Merchandising sued Hicks and Bloomgren for damages. The suit claimed that the accountant had negligently misrepresented the facts. The accountant defended on the basis that Thayer was not in privity of contract with him and therefore could not sue him. Was he right? [Thayer v Hicks, 793 P2d 784 (Mont)]
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Parente, Randolph, Orlando Associates (Parente) is an accounting firm that had done auditing work for Sparkomatic for nearly 20 years. On June 14, 1993, Sparkomatic entered into a Memorandum of Intent with Williams Controls to sell Williams assets from Sparkomatic's Kenco division. The sale price was to be the "audited book value" of the assets, and the book value would be based on the June 30, 1993, balance sheet (which Parente did not prepare). Sparkomatic then engaged Parente to audit the financial statements for December 31, 1990, 1991, and 1992 and to prepare an interim balance sheet for 1993. On August 1, 1993, Sparkomatic and Williams Controls entered into an asset purchase agreement, which required that Williams be furnished financials through June 1993 as prepared by "Sparkomatic's independent public accountant." Parente was not identified by name in the agreement. Parente did review the asset purchase agreement with Williams prior to commencing its work and knew that Williams would be using the information Parente prepared. Following the closing, additional information came to light indicating that Williams had overpaid for the assets of Kenco, and Williams filed suit against Parente for negligence, negligent misrepresentation, and breach of contract. Parente moved for summary judgment. What should the decision be and why? Discuss several possible theories. [Williams Controls v Parente, Randolph, Orlando, Associates, 39 F Supp 2d 517 (MD Pa)]
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certified public accounting partnership of James, Guinn, and Head prepared a certified audit report of four corporations, known as the Paschal Enterprises, with knowledge that their report would be used to induce Shatterproof Glass Corp. to lend money to those corporations. The report showed the corporations to be solvent when in fact they were insolvent. Shatterproof relied on the audit report, loaned approximately $500,000 to the four corporations, and lost almost all of it because the liabilities of the companies were in excess of their assets. Shatterproof claimed that James and other accountants had been negligent in preparing the report and sued them to recover the loss on the loan. The accountants raised the defense that they had been retained not by Shatterproof but by Paschal. Was this defense valid? [Shatterproof Glass Corp. v James, 466 SW2d 873 (Tex App)]
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