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Accountant liability from a state law perspective.



Prior to Congress' passage of the Private Securities Reform Act of 1995, the focus of litigation An action brought in court to enforce a particular right. The act or process of bringing a lawsuit in and of itself; a judicial contest; any dispute.

When a person begins a civil lawsuit, the person enters into a process called litigation.
 for accountants was often in federal courts under the Securities Act of 1933 and the Securities Exchange Act of 1934. Now, however, the focus of that litigation may shift from federal to state courts. While federal securities litigation tended to involve larger accounting firms and audits of publicly held companies, state litigation is of concern to all accountants. Neither the size of their firms nor the nature of their practices is particularly relevant. The purpose of this article is to highlight some of the risks of litigation for accountants from a state law perspective and to consider the effect of recent state tort reform and court decisions on that risk.

Common Law

An example:

An expanding company appears to have excellent prospects. Unknown to either management or its auditors, the chief financial officer and former employee of the auditor establishes a subsidiary accounting system for tracking and payment of floor plan financing but never integrates this system into the regular computerized accounting system. Several years pass. By now the floor plan liability has grown to a substantial number but remains undetected by the auditors. A bank, relying upon audited but erroneous financial statements, makes a loan to the company. Subsequently, upon disclosure of the floor plan liability, the company is forced to file for bankruptcy. The bank and the company sue the auditor.

Typically, as this opening example illustrates, accountants are sued by former clients or third parties seeking to recover damages because they claim that either they relied on erroneous or negligently prepared financial statements, the accountants failed to discover defalcations by the former clients' employees or the accountants negligently advised the former clients on tax matters. While a former client may bring an action in contract, either the former client or the third party may bring an action in tort. Regardless of its characterization, the action will claim that the accountant breached the duty to perform services with the expected degree of professional skill and care - i.e., malpractice malpractice, failure to provide professional services with the skill usually exhibited by responsible and careful members of the profession, resulting in injury, loss, or damage to the party contracting those services. . In some instances, however, the accountant's risk of litigation has been limited by recent state tort reform and court cases.

Joint and Several Liability

Over the last 10 years, much legislation has been enacted to reform state tort law A body of rights, obligations, and remedies that is applied by courts in civil proceedings to provide relief for persons who have suffered harm from the wrongful acts of others. . As with the Private Securities Reform Act of 1995, one focus of that reform has been the concept of joint and several liability under which each defendant is liable for all damages awarded to the plaintiff regardless of the degree of responsibility a particular defendant bears for the harm. Thirteen states have abolished common-law joint and several liability. Twenty-two states have modified it.

In spite of this reform, the question remains: Has the accountant's risk of litigation been reduced? To answer this question, consider the accountant's risk in the opening example when the bank, who is a third part and not a client, relied on the accountant's work.

The majority of states have adopted the Restatement Restatement

A revision in a company's earlier financial statements.

Notes:
The need for restating financial figures can result from fraud, misrepresentation, or a simple clerical error.
 (Second) of Torts, which provides that an accountant may be sued by a third party or a class of third parties to whom the accountant either intends to make available or knows will use the financial information for substantially the same purpose as the actual client. If accountants in the opening example knew about the bank, the rules of joint and several liability as they existed prior to reform will allow the bank to fully recover from an accountant who was found liable in tort for negligence.

In those 13 states that have abolished joint and several liability, the accountant's risk of liability is substantially reduced. In the majority of states that have only modified joint and several liability, the accountant's [TABULAR tab·u·lar
adj.
1. Having a plane surface; flat.

2. Organized as a table or list.

3. Calculated by means of a table.



tabular

resembling a table.
 DATA FOR TABLE 1 OMITTED] risk either remains the same or is uncertain. Using the preceding example with the bank as the plaintiff, Table 1 analyzes four representative states and shows the status of this risk in those states that have not abolished joint and several liability.

States that have excluded non-economic damages (i.e., pain and suffering) from joint liability do not reduce the accountant's risk because, generally, the damages imposed on accountants are economic. Alternatively, in states that have eliminated joint liability for economic damages if the accountant's fault is below a minimum level, the accountant's liability is uncertain. This modification will reduce the accountant's liability only if the accountants are successful in raising the issue of the plaintiff's or client's contributory negligence contributory negligence

In law, behaviour that contributes to one's own injury or loss and fails to meet the standard of prudence that one should observe for one's own good. Contributory negligence of the plaintiff is frequently pleaded in defense to a charge of negligence.
. In the past, accountants have not been particularly successful in raising a client's contributory con·trib·u·to·ry  
adj.
1. Of, relating to, or involving contribution.

2. Helping to bring about a result.

3. Subject to an impost or levy.

n. pl.
 or comparative negligence comparative negligence n. a rule of law applied in accident cases to determine responsibility and damages based on the negligence of every party directly involved in the accident.  as a defense.

Contributory or Comparative Negligence

In those few states that continue to recognize contributory negligence, this defense prevents a plaintiff from recovering any damages if even slightly at fault. Recently, the majority of states have moved to a comparative negligence standard that denies recovery to the plaintiff only if his or her negligence was "as great as" or "greater than" that of the defendant.

To understand the importance of this concept, return to the opening example. In the actual case from which the example was drawn, the court found that the client was neither contributorily negligent as a matter of law so as to prevent recovery by the client nor sufficiently negligent to decrease recovery under the comparative negligence.

Accountants who are retained to conduct audits succeed in raising this defense by showing that the client's negligence interfered with their performance or that a greater part of the client's loss resulted from the client's own mismanagement mis·man·age  
tr.v. mis·man·aged, mis·man·ag·ing, mis·man·ag·es
To manage badly or carelessly.



mis·manage·ment n.
. But if a corporate officer knowingly withholds information, the officer's actions are attributed to the corporate client only if the officer's failure to disclose was for corporate purposes. In the past, accountants who were retained to prepare tax returns based on records and information supplied by the client but who were not engaged to verify the correctness of the information provided have been successful in raising this defense. Today, accountants may expect less success because changes in the tax law make the preparer more responsible for soliciting information confirming the completeness and accuracy of the information provided by the client.

Arbitration

One means for accountants to reduce their risk of litigation is by contractually requiring arbitration of disputes. Concern in the past has arisen over the use of pre-dispute arbitration agreements, because many state laws have been hostile to these agreements. In 1995, however, the United States Supreme Court United States Supreme Court: see Supreme Court, United States. , in Allied-Bruce Terminix Cos. v. Dobson dob·son  
n.
See hellgrammite.



[Probably from the name Dobson.]

Noun 1. dobson - large brown aquatic larva of the dobsonfly; used as fishing bait
hellgrammiate
, applied the Federal Arbitration Act In United States law, the Federal Arbitration Act is a statute that provides for judicial facilitation of private dispute resolution through arbitration. It appears that the Federal Arbitration Act was intended to apply only in federal courts, but following a controversial Supreme  in reversing the Supreme Court of Alabama and held that a written, pre-dispute arbitration agreement is enforceable regardless of a conflict with Alabama law. The United States Supreme Court reiterated that the Federal Arbitration Act applied to both federal and state courts and that its purpose was to overcome judicial hostility to arbitration agreements.

To apply the Federal Arbitration Act to the states, the Court broadly defined what involvement with interstate commerce interstate commerce

In the U.S., any commercial transaction or traffic that crosses state boundaries or that involves more than one state. Government regulation of interstate commerce is founded on the commerce clause of the Constitution (Article I, section 8), which
 is required. Using this broad definition, most accountants should find that their arbitration agreements are protected by the Act even though their state laws may remain hostile. At a minimum, accountants should now begin to include arbitration clauses in contracts with high-risk clients.

Statutory Law

Historically, federal statutes have been the focus for much accountant litigation. State statutes, however, provide similar causes of action. With the foreclosure foreclosure

Legal proceeding by which a borrower's rights to a mortgaged property may be extinguished if the borrower fails to live up to the obligations agreed to in the loan contract.
 of many of these federal causes of action, state statutes such as the mini-RICO statutes, blue sky laws blue sky laws n. laws intended to protect the public from purchasing stock in fraudulent companies that lack substance, such as those selling swamp land, non-existent gold strikes and dry oil wells, or who have no assets besides a post office box.  and deceptive trade practices may provide a new focus for litigation. While each of these state statutes are patterned after federal acts, they are not affected by the recent reforms adopted in the Private Securities Reform Act of 1995. For instance, those states that have adopted mini-RICO statutes must amend their statutes, just as the federal statute was amended, if fraud in the sale of securities is to be eliminated as a basis for claims against accountants. Until they do so, the RICO RICO n. .  exposure remains at the state level.

The risk presented by the state blue sky laws and deceptive trade practices is particularly onerous because these regulations apply a negligence standard rather than one of fraud. The success potential of litigation under these statutes is uncertain because few state court cases have applied these statutes to accountants.

State Blue Sky Laws

Although every state has its own securities laws, commonly known as "blue sky laws," the Uniform Securities Act served as the model in 36 states and the District of Columbia District of Columbia, federal district (2000 pop. 572,059, a 5.7% decrease in population since the 1990 census), 69 sq mi (179 sq km), on the east bank of the Potomac River, coextensive with the city of Washington, D.C. (the capital of the United States). . Even in those states that have not adopted the Uniform Securities Act, the principles involved apply.

Section 101 of the Uniform Securities Act is modeled after Rule 10b-5 and Section 10(b) of the Securities Exchange Act of 1934. Like its federal counterpart, the Uniform Securities Act requires full disclosure so that investors may make informed investment decisions. It prohibits "any person, in connection with the offer, sale or purchase of any security, directly or indirectly...to make any untrue statement of a material fact or to omit o·mit  
tr.v. o·mit·ted, o·mit·ting, o·mits
1. To fail to include or mention; leave out: omit a word.

2.
a. To pass over; neglect.

b.
 to state a material fact." This language is sufficiently broad to include accountants, and some courts have held that, unlike the Securities Exchange Act of 1934, this act does not apply a fraud standard. It does not require an intent to deceive TO DECEIVE. To induce another either by words or actions, to take that for true which is not so. Wolff, Inst. Nat. Sec. 356. . Rather, it requires only an indication of negligence.

State securities laws that have adopted Section 101 have no exemptions from its provisions. It applies to the offer, sale or purchase of any security. Exemptions applicable to the registration requirements do not apply, nor do transactional exemptions.

Section 101, however, does not expressly create a private civil right of action. While Section 410(h) of the Uniform Securities Act expressly prohibits a court from implying that right of action, many states have not adopted this portion of Section 410(h). As the focus of litigation shifts to the state courts, the risk of litigation for accountants will increase if a private civil right of action is found to exist.

State Deceptive Trade Practices Acts

Beginning in the mid-1960s, all states enacted deceptive trade practice legislation. Generally, they modeled their legislation after either the Federal Trade Commission Act (FTCA FTCA Federal Tort Claims Act
FTCA Federal Trade Commission Act
FTCA French Central Technical Armament Establishment
) or the Uniform Deceptive Trade Practices Act.

To prove deception under these state acts, a plaintiff must generally show a material misrepresentation misrepresentation

In law, any false or misleading expression of fact, usually with the intent to deceive or defraud. It most commonly occurs in insurance and real-estate contracts. False advertising may also constitute misrepresentation.
, omission or practice likely to mislead mis·lead  
tr.v. mis·led , mis·lead·ing, mis·leads
1. To lead in the wrong direction.

2. To lead into error of thought or action, especially by intentionally deceiving. See Synonyms at deceive.
 consumers acting responsibly under the circumstances. An intent to defraud To make a Misrepresentation of an existing material fact, knowing it to be false or making it recklessly without regard to whether it is true or false, intending for someone to rely on the misrepresentation and under circumstances in which such person does rely on it to his or  or misrepresent mis·rep·re·sent  
tr.v. mis·rep·re·sent·ed, mis·rep·re·sent·ing, mis·rep·re·sents
1. To give an incorrect or misleading representation of.

2.
 is not required. Negligence, as well as omissions, is sufficient to show deception. These statutes are particularly onerous because they generally recognize a private cause of action, including a private class action suit, and allow for recovery of attorney's fees attorney's fee n. the payment for legal services. It can take several forms: 1) hourly charge, 2) flat fee for the performance of a particular service (like $250 to write a will), 3) contingent fee (such as one-third of the gross recovery, and nothing if there is no  and multiple damages.

While some states have ruled that professional services (job) professional services - A department of a supplier providing consultancy and programming manpower for the supplier's products.  are not covered not covered Health care adjective Referring to a procedure, test or other health service to which a policy holder or insurance beneficiary is not entitled under the terms of the policy or payment system–eg, Medicare. Cf Covered.  by their deceptive trade practice act, other states, including Texas, Illinois and Minnesota, have applied these acts to accountants. Only as litigation moves into the state courts will the extent of the coverage of these acts be determined for accountants.

Conclusion

While recent amendments to the Securities Act of 1933 and the Securities Exchange Act of 1934 provide some litigation relief for accountants, risk of litigation to accountants under state law remains. While recent state tort reform in some states may very well reduce accountants' risk, uncertainty remains on many issues. Only as the focus of litigation shifts to the state courts will these uncertainties be resolved and, possibly, accountants' risks of litigation reduced.
Appendix A: Status of Joint and Several Liability

ABOLISHED                       MODIFIED

with limited     non-economic     defendant has
exceptions         damages        minimal fault     other reforms

Alaska           California       Florida           Louisiana
Arizona          Connecticut      Georgia           Michigan
Colorado         Florida          Hawaii            Mississippi
Idaho            New York         Iowa              Missouri
Illinois         Nebraska         Minnesota         Nebraska
Kentucky         Ohio             Montana           Oregon
Michigan                          New Jersey        Washington
Nevada                            New Hampshire
New Mexico                        South Dakota
North Dakota                      Texas
Utah                              Wisconsin
Vermont
Wyoming

Source: American Tort Reform Association, Washington, DC


Nancy J. Stara, JD, LLM LLM
abbr.
Latin Legum Magister (Master of Laws)


LLM Master of Laws [Latin Legum Magister]

Noun 1.
, CPA (Computer Press Association, Landing, NJ) An earlier membership organization founded in 1983 that promoted excellence in computer journalism. Its annual awards honored outstanding examples in print, broadcast and electronic media. The CPA disbanded in 2000. , is an associate professor in the school of accountancy at the University of Nebraska in Lincoln.

Timothy R. Engler, Esq. specializes in commercial litigation for Harding, Shultz and Downs in Lincoln, Nebraska The City of Lincoln is the capital and the second most populous city of the U.S. state of Nebraska. Lincoln is also the county seat of Lancaster County and the home of the University of Nebraska. .
COPYRIGHT 1997 National Society of Public Accountants
No portion of this article can be reproduced without the express written permission from the copyright holder.
Copyright 1997 Gale, Cengage Learning. All rights reserved.

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Author:Stara, Nancy; Engler, Timothy
Publication:The National Public Accountant
Date:Jan 1, 1997
Words:2007
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