Quiz 35: Liability of Accountants and Other Professionals
Business
Q 1Q 1
Alpha Software, Inc., and Beta Products Corporation-both small firms-are competitors in the business of software research, development, and production.
Alpha and Beta form a joint venture to research, develop, and produce new software for a particular line of computers. Does this business combination violate the antitrust laws? If so, is it a per se violation, or is it subject to the rule of rea-son? Alpha and Beta decide to merge. After the merger, Beta is the surviving firm. What aspect of this firm's presence in the market will be assessed to decide whether this merger is in violation of any antitrust laws?
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Yes , this business combination violates the antitrust laws. Forming a joint venture is an effort to monopolize. It may be concluded as a creation of an unlawful monopoly where the joint venture dominates the market for a software research, development, and production. The joint venture may obtain market power by repressing competition with anticompetitive move, and not because its product is superior to others. Under Sherman Act of antitrust laws, all business contracts, or combinations that unreasonably constrain interstate and foreign trade violate the antitrust laws. This may further include agreements to fix prices among competitors, provide bids, and distribute customers. These are punishable offenses on as criminal grounds. A per se violation means no further investigation is required of a conduct's effects on the market competitiveness because its intentions are so clear and obvious. Joint venture between A and B is a per say violation as it involves contract or conspiracy that clearly violates the antitrust laws. The joint venture limits competition, and thus reduces productivity. The merger was formed by A and B where B was a surviving firm. If the resulting merger is likely to increase the price paid by the consumers for their goods and services, the merger would be held in violation of antitrust laws. Further, there would be violation of antitrust laws if the merger harms the competition in the market.
Q 2Q 2
Answers to the even-numbered questions in this For Review section can be found in Appendix F at the end of this text.
Under what common law theories may professionals be liable to clients?
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Professionals may be liable to clients under the following common law theories: (a)Breach of contract: Any failure of the professional to perform as per the terms and obligations of the contract may be held liable for the breach of contract and damages caused as a result of the same. (b)Negligence: A professional must perform his or her duties with the care, knowledge, and judgment usually used by the professionals in the same or similar situations. If a professional fails to do so, it will be considered as negligence. Any accountant's violation of (Generally Accepted Accounting Principles) and GAAS (Generally Accepted Auditing Standards) is prima fade evidence of negligence. An accountant can be held liable for revealing confidential information or the contents of working papers without the client's consent or any such malpractice. (c)Fraud: A professional's actual intent to misrepresent a material fact to a client, and the client believes the misrepresentation to his/her injury, is fraud. Gross negligence in performing professional duty is a constructive fraud.
Q 3Q 3
The Ultramares Rule.
Larkin, Inc., retains Howard Perkins to manage its books and prepare its financial statements. Perkins, a certified public accountant, lives in Indiana and practices there. After twenty years, Perkins has become a bit bored with generally accepted accounting principles (GAAP) and has adopted more creative accounting methods. Now, though, Perkins has a problem, as he is being sued by Molly Tucker, one of Larkin's creditors. Tucker alleges that Perkins either knew or should have known that Larkin's financial statements would be distributed to various individuals. Furthermore, she asserts that these financial statements were negligently prepared and seriously inaccurate. What are the consequences of Perkins's failure to follow GAAP? Under the traditional Ultramares rule, can Tucker recover damages from Perkins? Explain.
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Generally accepted accounting principles are a general framework of conventions, rules, and procedures for financial accounting. Perkins failure to abide by generally accepted accounting principles may hold him liable for the damages caused to the client, Tucker. His negligence in preparing financial statement resulted in seriously inaccurate results. As a consequence, Perkins will be liable for the losses suffered by Tucker. Ultramares Rule states that liability will be imposed only in the presence privity or near privity of the third party with the accountant. Yes , Tucker can recover damages from Perkins. Molly Tucker, being Larkin's creditors, was a third party whose relationship with Perkin was "so close as to approach that of privity".
Q 4Q 4
What did the majority conclude on the central question in this case, and what points supported this conclusion?
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Q 5Q 5
Superior Wholesale Corporation planned to purchase Regal Furniture, Inc., and wished to determine Regal's net worth. Superior hired Lynette Shuebke, of the accounting firm Shuebke Delgado, to review an audit that had been prepared by Norman Chase, the accountant for Regal. Shuebke advised Superior that Chase had performed a high-quality audit and that Regal's inventory on the audit dates was stated accurately on the general ledger. As a result of these representations, Superior went forward with its purchase of Regal. After the purchase, Superior discovered that the audit by Chase had been materially inaccurate and misleading, primarily because the inventory had been grossly overstated on the balance sheet. Later, a former Regal employee who had begun working for Superior exposed an e-mail exchange between Chase and former Regal chief executive officer Buddy Gantry The exchange revealed that Chase had cooperated in overstating the inventory and understating Regal's tax liability Using the information presented in the chapter, answer the following questions.
1. If Shuebke's review was conducted in good faith and conformed to generally accepted accounting principles, could Superior hold Shuebke Delgado liable for negligently failing to detect material omissions in Chase's audit? Why or why not?
2. According to the rule adopted by the majority of courts to determine accountants' liability to third parties, could Chase be liable to Superior? Explain.
3. Generally, what requirements must be met before Superior can recover damages under Section 10(b) of the Securities Exchange Act of 1934 and SEC Rule 10b-5? Can Superior meet these requirements?
4. Suppose that a court determined that Chase had aided Regal in willfully understating its tax liability What is the maximum penalty that could be imposed on Chase?
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Q 6Q 6
The following multiple-choice question is representative of the types of questions available in one of the four sections of ThomsonNOW for Business Law Today. ThomsonNOW also provides feedback for each response option, whether correct or incorrect, and refers to the location within the chapter where the correct answer can be found. The Restatement (Second) of Torts states that accountants will be liable to third parties for their negligent acts
A) when the third party is a foreseen, or known, user.
B) at no time.
C) whenever any third party relies on the accountant's statements or reports.
D) only when the third parties were clients.
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Q 7Q 7
Alpha Software, Inc., and Beta Products Corporation-both small firms-are competitors in the business of software research, development, and production.
To market its products profitably, Beta considers a number of advertising and labeling proposals. One proposal is that Beta suggest in its advertising that one of its software products has a certain function without indicating on the packaging that the product does not actually have that capability. Another suggestion is that Beta sell half of a certain program in packaging that misleads the buyer into believing the entire program is included. To obtain the entire program, customers would need to buy a second product. Can Beta implement these suggestions or otherwise market its products any way it likes? If not, why not?
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Q 8Q 8
Answers to the even-numbered questions in this For Review section can be found in Appendix F at the end of this text.
What are the rules concerning an auditor's liability to third parties?
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Q 9Q 9
Question with Sample Answer-The Ultramares Rule.
The accounting firm of Goldman, Walters, Johnson Co. prepared financial statements for Lucy's Fashions, Inc. After reviewing the financial statements, Happydays State Bank agreed to loan Lucy's Fashions $35,000 for expansion. When Lucy's Fashions declared bankruptcy under Chapter 11 six months later, Happydays State Bank filed an action against Goldman, Walters, Johnson Co., alleging negligent preparation of financial statements. Assuming that the court has abandoned the Ultramares approach, what is the result? What are the policy reasons for holding accountants liable to third parties with whom they are not in privity?
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Q 11Q 11
Alpha Software, Inc., and Beta Products Corporation-both small firms-are competitors in the business of software research, development, and production.
The production part of Beta's operations generates hazardous waste. Gamma Transport Company transports the waste to Omega Waste Corporation, which owns and operates a hazardous waste-disposal site. At the site, some containers leak hazardous waste, and the Environmental Protection Agency (EPA) cleans it up. From whom can the EPA recover the cost of the clean-up?
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Q 12Q 12
Answers to the even-numbered questions in this For Review section can be found in Appendix F at the end of this text.
How might an accountant violate federal securities laws?
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Q 13Q 13
Accountants Liability under Rule 10b-5. In early 1995, Bennett, Inc., offered a substantial number of new common shares to the public. Harvey Helms had a long-standing interest its Bennett because his grandfather had once been president of the company. On receiving a prospectus pm-pared and distributed by Bennett, Helms was dismayed by the pessimism it embodied. Helms decided to delay purchasing stock in the company. Later, Helms asserted that the prospectus prepared by the accountants was overly pessimistic and contained materially misleading statements. Discuss fully how successful Helms would he in bringing a cause of action under Rule 10b-5 against the accountants of Bennett, Inc.
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Q 14Q 14
POLITICAL DIMENSIONS. To reach its conclusion, did the majority have to agree with the legislature's decision to exempt most private clubs from the smoking ban? Why or why not?
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Q 15Q 15
Alpha Software, Inc., and Beta Products Corporation-both small firms-are competitors in the business of software research, development, and production.
Beta provides health insurance for its two hundred employees, including Dan. For personal medical reasons, Dan takes twelve weeks' leave. During this period, can Dan continue his coverage under Beta's health-insurance plan? If so, at whose expense? After Dan returns to work, Beta doses Dan's division and terminates the employees, including Dan. Can Dan continue his coverage under Beta's health-insurance plan? If so, at whose expense?
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Q 16Q 16
Answers to the even-numbered questions in this For Review section can be found in Appendix F at the end of this text.
What crimes might an accountant commit under the Internal Revenue Code?
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Q 17Q 17
Accountant's Liability to Third Parties. In June 1993, Sparkomatic Corp. agreed to negotiate a sale of its Kenco Engineering division to Williams Controls, Inc. At the end of July, Sparkomatic asked its accountants, Parente, Randolph, Orlando, Carey Associates, to audit Kenco's financial statements for the previous three years and to certify interim and closing balance sheets to be included with the sale's closing documents. All of the parties knew that these documents would serve as a basis for setting the sale price. Within a few days, Williams signed an "Asset Purchase Agreement" that promised access to Parente's records with respect to Kenco. The sale closed in mid-August. In September, Williams was given the financial statements for Kenco's previous three years and the interim and closing balance sheets, all of which were certified by Parente. Williams's accountant found no errors in the closing balance sheet but did not review any of the other documents. The parties set a final purchase price later, how-ever, Williams filed a suit in a federal district court against Parente, claiming negligent misrepresentation, among other things, in connection with Parente's preparation of the financial documents. Parente responded with a motion for summary judgment, asserting that the parties lacked privity. Under the Restatement (Second) of 'lions, Secton 552, how should the court rule? Explain. [Williams Controls, Inc. v. Parente, Randolph, Orlando, Carey Associates, 39 F.Supp.2d 517 (M.D.Pa. 1999)]
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Q 18Q 18
ECONOMIC DIMENSIONS. What arc the likely economic effects of the outcome in this case? Explain.
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Q 19Q 19
Alpha Software, Inc., and Beta Products Corporation-both small firms-are competitors in the business of software research, development, and production.
Beta has a policy against sexual harassment that includes specific procedures for reporting, investigating, and resolving incidents of alleged harassment. Kay, a Beta employee, believes that she has been the object of her supervisor's sexual comments on the job and she perceives these comments as offensive. She reports the incident, and Beta follows up with an investigation but decides that there is no basis for disciplining the supervisor. Kay subsequently quits her job and eventually files a suit against Beta. What must Kay prove to win her case? What is Beta's best defense?
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Q 20Q 20
Answers to the even-numbered questions in this For Review section can be found in Appendix F at the end of this text.
What constrains professionals to keep communications with their clients confidential?
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Q 21Q 21
Case Problem with Sample Answer. In October 1993, Marilyn Greenen, a licensed certified public accountant (CPA), began working at the Port of Vancouver, Washington (the Port), as an account manager. She was not directly engaged in public accounting at the Port, but she oversaw the preparation of financial statements and supervised employees with accounting duties. At the start of her employment, she enrolled her husband for benefits under the Port's medical plan. Her marriage was dissolved in November, but she did not notify the Port of the change. In May 1998 and April 1999, the Port confronted her about the divorce, but she did not update her insurance information. After she was terminated, she reimbursed the Port for the additional premiums it had paid for unauthorized coverage for her former spouse. The Washington State Board of Accountancy imposed sanctions on Greenen for "dishonesty and misleading representations" while, in the words of an applicable state statute, "representing oneself as a CPA." Greenen asked a Washington state court to review the case. What might be an appropriate sanction in this case? What might be Greenen's best argument against the board's action? On what reasoning might the court uphold the decision? [Greenen v. Washington State Board of Accountancy, 824 WashApp. 126, 110 P.3d 224 (Div. 2 2005)]
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Q 22Q 22
IMPLICATIONS FOR EMPLOYERS. What does the ruling in this else suggest to employers who are not yet subject to the smoking ban at issue?
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Q 23Q 23
Alpha Software, Inc., and Beta Products Corporation-both small firms-are competitors in the business of software research, development, and production.
Beta hires a certified public accountant, Aaron Schleger, to prepare its financial reports and issue opinion letters based on those reports. One year, Beta falls into serious financial trouble, but this is not reflected in Schleger's reports and opinion letters. Relying on Schieger's portrayal of the company's fiscal health, Beta borrows substantial amounts to develop a new product. The bank, in lending funds to Beta, relies on an opinion letter from Schleger, and Schleger is aware of the bank's reliance. Assuming that Schleger was negligent but did not engage in intentional fraud, what is his potential liability in this situation? Discuss fully.
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Q 24Q 24
Accountant's Liability. In 1995, TM Health Systems, Inc., hired Tammy Heiby as accounting coordinator. Apparently overwhelmed by the duties of the position, Heiby failed to make payroll tax payments to the Internal Revenue Service (IRS) in 1995 and 1996. Heiby tried to hide this omission by falsifying journal entries and manually writing three checks out of sequence, totaling $1.7 million and payable to a bank, from JTD's cash account (to dispose of excess funds that should have been paid in taxes). JTD hired Pricewaterhouse Coopers, LLP, to review JTD's internal accounting procedures and audit its financial statements for 1995. Coopers's inexperienced auditor was aware that the cash account had not been balanced in months and knew about the checks but never questioned them. The auditor instead mistakenly explained that the unbalanced account was due to changes in Medicaid/Medicare procedures and recommended no further investigation in 1996, the IRS asked JTD to remit the unpaid taxes, plus interest and penalties. JTD filed a suit in an Ohio state court against Coopers, alleging common law negligence and breach of contract. Should Coopers be held liable to JTD on these grounds? Why or why not? [JTD Health Systems, Inc. v. Pricewaterhouse Coopers, LLP, 141 Ohio App.3d 280, 750 N.E.2d 1177 (Ohio App. 3 Dist. 2001)]
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Q 25Q 25
Accountant's Liability under the Private Securities Litigation Reform Act. Solucorp Industries, Ltd., a corporation head-quartered in New York, develops and markets products for use in environmental clean-ups. Solucorp's financial statements for the six months ending December 31, 1997, recognized $1.09 million in license fees payable by smart International, Ltd. The fees comprised about 50 percent of Solucorp's revenue for the period. At the time, however, the parties had a license agreement only "in principle," and Smart had made only one payment of $150,000. Glenn Ohlhauser, an account-ant asked to audit the statements, objected to the inclusion of the fees. In February 1998, Solucorp showed Ohlhauser a license agreement backdated to September 1997 but refused to provide any financial information about Smart. Ohlhauser issued an unqualified opinion on the 1997 statements, which were included with forms filed with the Securities and Exchange Commission (SEC). The SEC sued Ohlhauser. What might be the basis in the Private Securities Litigation Reform Act for the SEC's suit? What might be Ohlhauser's defense? Discuss. [Securities and Exchange Commission v. Solucorp Industries, Ltd., 197 F.Supp.2d 4 ($.D.N.Y. 2002)]
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Q 26Q 26
Confidentiality and Privilege. Napster, Inc., offered a service that allowed its users to browse digital music files on other users' computers and download selections for free. Music industry principals filed a suit in a federal district court against Napster, alleging copyright infringement. The court ordered Napster to remove from its service files that were identified as infringing. Napster failed to comply and was shut down in July 2001. In October, Bertelsmann AG, a German corporation, loaned Napster $85 million, to fund its anticipated transition to a licensed digital music distribution system. The terms allowed Napster to spend the loan on "general, administrative and overhead expenses." In an e-mail, Hank Barry, Napster's chief executive officer, referred to a "side deal" under which Napster could use up to $10 million of the loan to pay litigation expenses. Napster failed to launch the new system before declaring bankruptcy in June 2002. Some of the plaintiffs filed a suit in a federal district court against Bertelsrmann, charging that by its loan, it prolonged Napster's infringement. The plaintiffs asked the court to order the disclosure of all attorney-client communications related to the loan. What principle could Bertelsmann assert to protect these communications? What is the purpose of this protection? Should this principle protect a client Who consults an attorney for advice that will help the client commit fraud? Should the court grant the plaintiffs' request? Discuss. [In re Napster, Inc. Copyright Litigation, 479 Rid 1078 (9th Cir. 2007)]
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Q 27Q 27
A Question of Ethics-Securities Laws.
Portland Shellfish Co. processes live shellfish in Maine. As one of the firm's two owners, Frank Wetmore held 300 voting and 150 nonvoting shares of the stock. Donna Holden held the other 300 voting shares. Donna's husband, Jeff, managed the company's daily operations, including production, procurement, and sales. The board of directors consisted of Frank and Jeff. In 2001, disagreements arose over the company's management. The Holdens invoked the "Shareholders' Agreement," which provided that "[i]n the event of a deadlock, the directors shall hire an accountant at [MacDonald, Page, Schatz, Fletcher Co., LLC] to determine the value of the outstanding shares.... [E]ach shareholder shall have the right to buy out the other shareholder(s)' interest." MacDonald Page estimated the stock's "fair market value" to be $1.09 million. Donna offered to buy Frank's shares at a price equal to his proportionate share. Frank countered by offering $1.25 million for Donna's shares. Donna rejected Frank's offer and insisted that he sell his shares to her or she would sue. In the face of this threat, Frank sold his shares to Donna for $750,705. Believing the stock to be worth more than twice MacDonald Page's estimate, Frank filed a suit in a federal district court against the accountant. [Wetmore v. MacDonald, Page, Schatz, Fletcher Co., LLC, 476 F.3d 1 (1st Cir. 2007)]
1. Frank claimed that in valuing the stock, the accountant disregarded "commonly accepted and reliable methods of valuation in favor of less reliable methods." He alleged negligence, among other things. MacDonald Page filed a motion to dismiss the complaint. What are the elements that establish negligence? Which is the most critical element in this case?
2. MacDonald Page evaluated the company's stock by identifying its "fair market value," defined as "[t]he price at which the property would change hands between a willing buyer and a willing seller, neither being under a compulsion to buy or sell and both having reasonable knowledge of relevant facts." The accountant knew that the shareholders would use its estimate to determine the price that one would pay to the other. Under these circumstances, was Frank's injury foreseeable? Explain.
3. What factor might have influenced Frank to sell his shares to Donna even if he thought that MacDonald Page's "fair market value" figure was less than half what it should have been? Does this factor represent an unfair, or unethical, advantage? Why or why not?
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Q 28Q 28
Critical Legal Thinking. In cases in which third parties suffer losses in reliance on negligent misrepresentation in account-ants' financial reports, the courts apply different standards to assess liability. Some courts impose liability only when there is privity between the accountant and the party who seeks recovery. Other courts impose liability under a foreseeability rule. What do you see as the implications of imposing liability on accountants for losses suffered by third parties on the basis of foreseeability rather than privity?
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Q 29Q 29
Video Question. Go to this text's Web site at vomv.thomsonedu.com/westbuslaw/bIt and select "Chapter 35." Click on "Video Questions" and view the video titled Accountant's Liability: Then answer the following questions.
1. Should Ray prepare a financial statement that values a list of assets provided by the advertising firm without verifying that the firm actually owns these assets?
2. Discuss whether Ray is in privity with the company interested in buying Laura's advertising firm.
3. Under the Ultramares rule, to whom does Ray owe a duty?
4. Assume that Laura did not tell Ray that she intended to give the financial statement to the potential acquirer. Would this fact change Ray's liability under the Ultramares rule? Explain.
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