P A R T
10
Corporations
History & Nature of Corporations
Organizational and Financial
Structure of Corporations
Management of Corporations
McGraw-Hill/Irwin Business Law, 13/e
© 2007 The McGraw-Hill Companies, Inc. All rights reserved.
P A R T
10
Corporations
Shareholders’ Rights & Liabilities
Securities Regulation
Legal & Professional Responsibilities
of Auditors, Consultants, and
Securities Professionals
McGraw-Hill/Irwin Business Law, 13/e
© 2007 The McGraw-Hill Companies, Inc. All rights reserved.
C H A P T E R
46
Legal and Professional Responsibilities
of Auditors, Consultants, and Securities
Professionals
“Madness in great ones must not
unwatched go.”
William Shakespeare, Hamlet, Act. 3, Scene 1
Learning Objectives
General standard of performance
 Professional liability to clients
 Professionals’ liability to third persons
 Conflicts of interest
 Limiting professionals’ liability
 Audit requirements
 Professional-client privilege

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Elements of the General Duty

Securities professionals, auditors, and
consultants owe their clients a general duty
of performance: skill and care
 Professional must have skill of ordinarily
prudent person in her profession
 Professional must act as carefully as
would the ordinarily prudent person in
her profession
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Contractual Liability

Professional contracts with client to perform
as agreed with implied duty of skill and care

Professional may not delegate duty without
client’s consent
If professional fails to perform as agreed,
s/he may be liable for compensatory
damages and consequential damages
 Professional not liable for breach of contract
if client obstructs performance

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Tort Liability
Professional is negligent if s/he breaches
duty to act skillfully and carefully and
proximately causes damages to the client
 No specific duty for accountant to uncover
employee fraud or embezzlement


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An accountant is negligent if s/he fails to
uncover employee fraud or embezzlement
when ordinarily prudent accountant would
have discovered it
Tort Liability
Courts generally prevent a professional from
escaping liability merely because client also
acted negligently (contributory negligence)
 Professional may be liable to client for fraud
if s/he misstates or omits facts in client
communications and acts with scienter


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Scienter: knowledge of the falsity of
statement or reckless disregard for truth
Breach of Trust

Professionals owe a duty of trust to clients


Information and assets entrusted by client to
professional may be used only to benefit
client; information must remain confidential
Sarbanes–Oxley Act banned most services by
audit firms for audit clients to avoid conflictof-interest claims and SEC requires analyst
research reports to include certification of
accuracy and compensation
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Third Parties & Liability
Other persons besides a professional’s clients
may use a professional’s work product
 If a professional prepares documents that
prove to be incorrect, nonclients who relied
on the documents may suffer damages
 Nonclients may sue professionals for
common law negligence, common law fraud,
and violations of the securities laws

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Section 11 & Professionals
Section 11 of the Securities Act of 1933 states
that an auditor or underwriter may be liable
to a purchaser of securities issued pursuant
to a defective registration statement
 Auditors and underwriters may raise a due
diligence defense by proving s/he made a
reasonable investigation and had reasonable
belief no misstatements or omissions of
material fact occurred

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Sections 12(a)(2) & 17(a)
Section 12(a)(2) of 1933 Act imposes liability
on anyone who misstates or omits a material
fact in connection with security offer or sale
that is part of a general distribution of
securities by an issuer
 Under Section 17(a) of 1933 Act, accounting
or securities professional may incur liability
only if purchaser of security proves reliance
on misstatement or omission of material fact

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Section 18 & Rule 10b-5
Section 18 of 1934 Act imposes liability on
persons who furnish misleading and false
statements of material fact in any report or
document filed with the SEC
 Rule 10b–5 prohibits anyone from making a
misstatement or omission of material fact in
connection with securities purchase or sale

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Other Legislation
Private Securities Litigation Reform Act of
1995 Act imposes significant public duties on
independent auditors that audit the financial
statements of public companies
 Sarbanes-Oxley, Section 404 requires public
issuers to include in annual reports an
“internal control report” acknowledging
management responsibility to maintain
“adequate internal control structure and
procedures for financial reports”

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The Opinion Letter

A professional’s opinion
letter generally expresses
an unqualified opinion
(e.g., compliance with
GAAS and GAAP), but
sometimes professional
will issue a qualified
opinion, disclaimer of
opinion, or an adverse
opinion
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Professionals & Criminal Liability
1933 Act imposes criminal liability for willful
violations of any section, rule or regulation
 1934 Act imposes criminal penalties for
willful violations of any section, rule or
regulation
 Professionals face discipline, including
suspension of a professional license, by
federal and state agencies if they engage in
illegal or unethical conduct

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Ownership of Working Papers
A client’s personal records, such as
accounting records, are the property of the
client and the professional must return the
records at end of job
 Material created by a professional, such as
working papers produced by independent
auditors, belong to the professional


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Client has a right of access to working papers
Document Retention

Arthur Andersen LLP case highlights rules
about document retention



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All professional firms have rules about document
retention and destruction
Federal law requires all audit or review working
papers to be retained for seven years
No requirement to retain documents that prove
professional’s or client’s guilt, as long as they do
not destroy documents (i.e., evidence) with the
intent to obstruct a criminal prosecution
Professional-Client Privilege

Many states have enacted an accountantclient privilege of confidentiality that
protects communications between a client
and an accountant as well as accountants’
working papers


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The privilege belongs to the client
Federal courts do not recognize the privilege in
matters involving federal questions, including
antitrust and criminal matters
Test Your Knowledge

True=A, False = B




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Two elements compose the general duty of
performance: skill and quality of results.
A professional must act as carefully as the
ordinarily prudent person in her profession.
Organizing a professional business as a
corporation will protect professionals from
personal liability for professional misconduct.
Professionals are guarantors of the accuracy
of their work.
Test Your Knowledge

True=A, False = B



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Audit firms may develop the financial
information system design for the client and
also audit the firm’s systems.
An accountant’s opinion letter for an audit
always expresses a qualified opinion.
Working papers produced by independent
auditors belong to the client at the end of the
job.
Test Your Knowledge

Multiple Choice

Which of the following events would make a
professional liable to the client:
(a) If the professional fails to perform as
agreed in the contract
 (b) If the professional, acting with scienter,
misstates facts in client communications
 (c) If the professional shows client information
to another client without first client’s consent
 (d) All of the above

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Test Your Knowledge

Multiple Choice

Which of the following is not true about the
Private Securities Litigation Reform Act?
(a) It applies to underwriters only
 (b) It limits the liability of most professionals
to the amount of an investor’s loss for which
defendant is responsible
 (c) It imposes significant public duties on
independent auditors auditing public
companies

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Thought Questions
Joseph Berardino testified
in an Enron hearing (Dec.
12, 2002) that, “We made a
professional judgment about
the appropriate accounting
treatment that turned out to
be wrong.”
 What is your opinion of the
Enron and Anderson cases?

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