Gaining a new balance in the courts: some of the liability burden has disappeared - but a heavy weight remains.
On April 19, 1994, the U.S. Supreme Court decision in Central Bank of Denver v. First Interstate Bank of Denver ended aider and abettor One who commands, advises, instigates, or encourages another to commit a crime. A person who, being present, incites another to commit a crime, and thus becomes a principal. To be an abettor, liability lawsuits by investors and other private parties under section 10B of the Securities and Exchange Act of 1934. This decision is long overdue and very welcome news to a profession that has suffered staggering liability judgments and paid huge settlements. Accountants have been sued in significant numbers since the 1960s under the aiding and abetting a·bet
tr.v. a·bet·ted, a·bet·ting, a·bets
1. To approve, encourage, and support (an action or a plan of action); urge and help on.
2. liability theory in lawsuits that frequently pursue remote defendants not actively or primarily involved in fraudulent activities. The Central Bank decision may mean diminished legal liability for CPAs.
Whenever a large business fails, it seems inevitable that lawsuits are filed against the 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. firm that performed the audit. The public expects and the legal system frequently delivers full accountability. Such lawsuits are having a devastating dev·as·tate
tr.v. dev·as·tat·ed, dev·as·tat·ing, dev·as·tates
1. To lay waste; destroy.
2. To overwhelm; confound; stun: was devastated by the rude remark. effect on CPAs. Recent estimates suggest there are approximately $30 billion in damage claims facing the profession. Given the costs 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. , the fear of jury trials, aider and abettor liability and negative publicity, many CPAs prefer to settle such disputes rather that litigate them even when they believe they have done nothing wrong.
The U.S. Supreme Court has had numerous opportunities to review aiding and abetting cases over the last 27 years but repeatedly has refused to review attempted appeals. To get a perspective on Central Bank's impact on accountants' professional liability, we must examine the case itself as well as the legal theories under which the profession currently is most commonly held liable. The most common theories asserted against the profession are violations of responsibilities under the 1933 and 1934 securities acts and common law lawsuits for fraud, breach of contract and negligence (see exhibit 1 on page 43).
CPA LIABILITY UNDER SECURITIES LAWS
The Securities Exchange Act of 1934 addresses the trading or resale of securities. Accountant liability under this act typically arises under either section 18 or section 10B. CPAs are liable under section 18 if they file with the Securities and Exchange Commission documents that contain material false or misleading statements. CPAs can avoid liability by showing they acted in good faith and had no knowledge any statement was false or misleading.
Section 10B provides for a much broader scope of liability, setting out wide-scope antifraud provisions involving the purchase or sale of securities. Rule 10B-5 protects investors by outlawing any schemes designed 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 them, but the rule goes even further. It also covers liability for trading on nonpublic information Nonpublic information
Information about a company that is not known by the general public, which will have a definite impact on the stock price when released. See: Insider trading. and for omissions.
CPAs or CPA firms can be held liable under section 10B or rule 10B-5 if they intentionally or recklessly 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. information intended for third-party use. In such instances, the accountant is a primary wrongdoer and rightfully incurs liability.
Before Central Bank, though, CPAs or firms were held liable not as primary wrongdoers but, rather, as "aiders and abettors" of a primary wrongdoer and were deemed just as responsible as those wrongdoers. Plaintiffs used the approach because CPAs often were the only solvent defendants remaining in securities fraud cases.
The interpretation of aiding and abetting never was clear. Courts struggled for many years to define it, with different definitions prevailing in different circuits. Most courts required substantial assistance by the aider-abettor, but in some courts silence or inaction in·ac·tion
Lack or absence of action.
lack of action; inertia
Noun 1. by an accountant was sufficient. The Central Bank decision eliminated aiding and abetting liability altogether.
THE END OF THE ROAD
This landmark case landmark case Law & medicine A civil or, far less commonly, criminal action that has had an impact on a particular area of medicine. did not include an accountant or CPA firm, but the decision clearly will affect the profession. The case involved a default on $25 million in bonds sold to finance public improvements at a Colorado residential and commercial development. First Interstate Bank of Denver and an investor, which had purchased $2.1 million of the bonds, sued Central Bank of Denver, the indenture An agreement declaring the benefits and obligations of two or more parties, often applicable in the context of Bankruptcy and bond trading.
The term indenture primarily describes secured contracts and has several applications in U.S. law. trustee for the bond issuance. The Court of Appeals found Central Bank was aware of concerns about the accuracy of land appraisals and knew purchasers were using the old appraisals to evaluate the bond collateral. The court believed Central Bank genuinely was reckless and that it was reasonable to conclude the bank had rendered substantial assistance by delaying a review by an independent appraiser A person selected or appointed by a competent authority or an interested party to evaluate the financial worth of property.
Appraisers are frequently appointed in probate and condemnation proceedings and are also used by banks and real estate concerns to determine the market .
The U.S. Supreme Court, however, held that rule 10B does not allow investors to file lawsuits based on aiding and abetting, which was the basis of the case against Central Bank. It traced the history of aiding and abetting, noting it was not specifically included in the language of section 10B. Lawyers, accountants or banks that manipulate investors or make material misstatements or omissions on which securities purchasers or sellers rely still may be liable as primary violators, however.
In his dissent, Justice Stevens said the majority opinion "gives short shrift short shrift
1. Summary, careless treatment; scant attention: These annoying memos will get short shrift from the boss.
2. Quick work.
a. to a long history of aider and abettor liability under 10B." Although the ruling appears to close a major litigation avenue that investors and other private parties have used for decades to sue accountants, it does not free CPAs from liability concerns; it only negates investors' ability to sue for aiding and abetting under the 1934 act. A major remaining question is whether the SEC can sue for aiding and abetting. The decision doesn't affect criminal prosecutions for violations of section 10B under rule 10B-5.
In addition, there are other significant liability threats affecting CPAs, such as those under the Securities Act of 1933 and the common law theories of fraud, breach of contract and negligence. Central Bank does not end CPAs' potential liability under these theories, which must be thoroughly understood if practitioners are to protect themselves from unwarranted lawsuits. Here is a brief review of these theories and how they affect CPAs.
The Securities Act of 1933. This act continues to pose a major threat to the profession in connection with initial public offerings. Accountants typically incur liability when financial statements they audited are included in registration statements and prospectuses. Accountants can be held liable for mere negligence. In addition, a plaintiff need not show 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. and the CPA may be liable even if the investors did not rely on his or her work.
Defenses under this act are limited. Liability can be avoided if the CPA can show that any misstatement mis·state
tr.v. mis·stat·ed, mis·stat·ing, mis·states
To state wrongly or falsely.
mis·statement n. was not material or that he or she acted with "due diligence Research; analysis; your homework. This term has caught on in all industries, because it sounds so "wired." Who would want to do analysis or research when they can do due diligence. See wired. ," but the latter is difficult to establish. The statute of limitations A type of federal or state law that restricts the time within which legal proceedings may be brought.
Statutes of limitations, which date back to early Roman Law, are a fundamental part of European and U.S. law. under the 1933 act is one year, but the year does not commence until the misstatement is discovered or should have been discovered.
Fraud. Under common law, fraud is defined as a false representation of material fact, made with knowledge of falsity. There must be an intent to deceive and the plaintiff must have relied on the CPA's representation. Accountants who engage in fraud are fully liable to anyone who suffers a loss; lack of privity A close, direct, or successive relationship; having a mutual interest or right.
Privity refers to a connection or bond between parties to a particular transaction. Privity of contract is the relationship that exists between two or more parties to an agreement. is no defense (privity is an express relationship between two or more contracting parties). It is important to note that in most states, extreme recklessness or gross negligence An indifference to, and a blatant violation of, a legal duty with respect to the rights of others.
Gross negligence is a conscious and voluntary disregard of the need to use reasonable care, which is likely to cause foreseeable grave injury or harm to persons, property, or is treated as the equivalent of fraud.
Breach of contract and negligence. When a firm enters into an audit contract, it agrees by implication to act as a reasonably prudent professional under the circumstances. If it fails to do so, it can be sued for either breach of contract or negligence. In this area, lawsuits by nonclients have been the most devastating.
For over 60 years, the Years, The
the seven decades of Eleanor Pargiter’s life. [Br. Lit.: Benét, 1109]
See : Time legal system has struggled to define liability due to negligence affecting third-party users of financial statements. Potential audit report and financial statement users include all entity stakeholders Stakeholders
All parties that have an interest, financial or otherwise, in a firm-stockholders, creditors, bondholders, employees, customers, management, the community, and the government. , such as owners, lenders, suppliers, potential investors, creditors, customers, financial analysts and advisers as well as the public in general. To what extent should an accountant be held liable when providing an unqualified opinion Unqualified opinion
An independent auditor's opinion that a company's financial statements comply with accepted accounting procedures. Antithesis of qualified opinion.
See clean opinion. on the financial statements of a company that subsequently declares bankruptcy? The public expects all financial information to be accurate, reliable and free from fraud or misstatements. Many in the profession believe it is not equipped to detect every possible misstatement and cannot realistically insure the accuracy of all information.
However, third-party users are anxious to seek recovery from a solvent accounting firm rather than absorb a loss. The judicial system uses three basic approaches in addressing third-party liability. States that follow a specific one are identified in exhibit 2 on page 44.
1. Credit Alliance. In 1986, the New York New York, state, United States
New York, Middle Atlantic state of the United States. It is bordered by Vermont, Massachusetts, Connecticut, and the Atlantic Ocean (E), New Jersey and Pennsylvania (S), Lakes Erie and Ontario and the Canadian province of Court of Appeals decided the case of Credit Alliance v. Arthur Andersen For the U.S. Supreme Court case commonly known as Arthur Andersen, see .
Arthur Andersen LLP, based in Chicago, was once one of the "Big Five" accounting firms (the other four are PricewaterhouseCoopers, Deloitte Touche Tohmatsu, Ernst & Young and KPMG), performing & Co. The court held that an accountant was not liable for negligence to third parties unless the accountant was aware that the third party intended to rely on the auditor's opinion and the accompanying financial statements. The third party must have been specifically identified to the auditor, who must also acknowledge the third party's right to rely in order for liability to attach. For example, if a client hired the accountant and asked that the accountant forward the result to a specific bank for loan purposes, then the accountant could be sued by the bank for negligence. Obviously, if the bank contracted with the accountant for services, then the bank could rightfully sue for negligence. This approach permits the accountant to advise a third party that his or her reliance may be misplaced mis·place
tr.v. mis·placed, mis·plac·ing, mis·plac·es
a. To put into a wrong place: misplace punctuation in a sentence.
b. and is supported by Judge Cardozo's famous observation in Ultramares v. Touche: "If liability for negligence exists, a thoughtless slip or blunder, the failure to detect a theft or forgery forgery, in art
forgery, in art, the false claim to authenticity for a work of art. The Nature of Forgery
Because the provenance of works of art is seldom clear and because their origin is often judged by means of subtle factors, art beneath the cover of deceptive entries, may expose accountants to a liability in an indeterminate That which is uncertain or not particularly designated.
INDETERMINATE. That which is uncertain or not particularly designated; as, if I sell you one hundred bushels of wheat, without stating what wheat. 1 Bouv. Inst. n. 950. amount for an indeterminate time to an indeterminate class."
Currently, nine states follow this approach or some variation of it.
2. Restatement Restatement
A revision in a company's earlier financial statements.
The need for restating financial figures can result from fraud, misrepresentation, or a simple clerical error. of torts. This approach takes a middle ground, permitting recovery by foreseen third parties even if they are not specifically identified. Under this approach, an accountant who knows that the audit report or financial statement will be delivered to an unidentified creditor or limited group of creditors, financiers or investors will be subject to negligence claims by these third parties. For example, if a client tells its accountant that it intends to use the accountant's report to obtain a specific bank loan, the CPA could be held liable for negligence to an unidentified bank providing the bank made a similar loan.
This approach subjects accountants to greater liability than the Credit Alliance approach because the accountant may be held liable to third-party users even if there is no contact between the accountant and the third party. The accountant must only be aware that the audit results or financial statements will be forwarded to some third party.
3. Reasonably foreseeable user. This approach holds the broadest liability for accountants because it allows potential liability to all parties that are reasonably foreseeable recipients of financial statements for business purposes, provided they rely on the accountant's statements. The privity requirement is abandoned altogether and the accounting profession is treated as a public watchdog against corporate fraud.
The majority of states use the restatement of torts approach. However, the lack of uniformity is confusing and there is no indication consistency can be expected soon.
Joint and several liability. An overlying overlying
suffocation of piglets by the sow. The piglets may be weak from illness or malnutrition, the sow may be clumsy or ill, the pen may be inadequate in size or poorly designed so that piglets cannot escape. factor in all of the above acts and theories is the concept of joint and several liability. If there are multiple defendants in a lawsuit, the successful plaintiff is allowed to collect its entire judgment against any defendant regardless of how much fault is attributable to that defendant. This principle has a tremendous impact on accountants' liability. For example, assume a CPA firm audits a manufacturing company and issues an unqualified opinion. The company later fails because of criminal activities by the officers and directors. Investors sue the company and the accounting firm for their losses. If the jury awards a $900,000 judgment and assesses the company's fault at 90% and the accounting firm's at 10%, the plaintiffs may be allowed to collect the full $900,000 from the accounting firm. This was the case in the 1992 lawsuit involving Price Waterhouse and the British bank Standard Chartered PLC. The jury's verdict was vacated by the trial court judge, but initially the plaintiffs were awarded $338 million, citing negligence in an investor-originated lawsuit. Price's audit fees totaled only $280,000.
The CPA firm is allowed to recover proportionately from the client company, but if the company is bankrupt, the firm has no recourse. The threat of joint and several liability often forces defendants to enter into settlement agreements even in meritless cases. Although it is reasonable to argue that each defendant should be responsible for no more than its own share, joint and several liability is a common law principle deeply ingrained in·grained
1. Firmly established; deep-seated: ingrained prejudice; the ingrained habits of a lifetime.
2. in our legal system. Courts are reluctant to discard such long-standing doctrines, so relief likely will come only from state or federal legislation.
WHAT DOES THE FUTURE HOLD?
Although the U.S. Supreme Court ruling offers hope for the accounting profession, continued liability under the 1933 securities act, the lack of clarity about SEC--initiated suits under the 1934 act and common law liability leave CPAs vulnerable. The aiding and abetting theory is a very significant litigation avenue now closed to investors, but others remain.
The Central Bank case has created a flurry in Congress, where efforts are under way to overrule The refusal by a judge to sustain an objection set forth by an attorney during a trial, such as an objection to a particular question posed to a witness. To make void, annul, supersede, or reject through a subsequent decision or action. the decision by changing the 1934 act to protect aiding and abetting lawsuits. The only certainty in the future of accountants' liability is that the legal profession will pursue other litigation approaches against CPAs if the aiding and abetting theory remains closed. For the time being, the elimination of this liability is good news for the profession but does not free CPAs from litigation concerns.
* A U.S. SUPREME COURT decision ended aider and abettor liability lawsuits by investors and other private parties under section 10B of the Securities Exchange Act of 1934. This is long overdue and very welcome news to a profession that has suffered staggering liability judgments and has paid huge settlements.
* CPAs HAVE BEEN HELD LIABLE as aiders and abettors of a primary wrongdoer in some cases. The approach has been popular with plaintiffs because CPAs often are the only solvent defendants remaining in securities fraud cases.
* ALTHOUGH THIS AVENUE of litigation has been closed, CPAs should be aware that they remain vulnerable under other commonly used laws and theories, including the 1933 securities act and common law suits for fraud, breach of contract and negligence.
Summary of CPAs' liability exposure
Federal securities laws 1933 act-initial public offering of a security
* Section 11 imposes civil liability for false statements or omissions in a registration statement. It imposes criminal liability for a willful Intentional; not accidental; voluntary; designed.
There is no precise definition of the term willful because its meaning largely depends on the context in which it appears. violation, resulting in a fine of not over $1 0,000, up to five years' imprisonment Imprisonment
See also Isolation.
former federal maximum security penitentiary, near San Francisco; “escapeproof.” [Am. Hist.: Flexner, 218]
German prison ship in World War II. [Br. Hist. or both.
* Section 1 2 imposes civil and criminal liability if securities are sold without a prospectus or if the prospectus is outdated or contains misinformation mis·in·form
tr.v. mis·in·formed, mis·in·form·ing, mis·in·forms
To provide with incorrect information.
mis . The section also contains a broad antifraud provision.
* Sections 17 and 24 contain antifraud provisions with civil and criminal liability. 1934 act--regulating purchases and sales
* Section 1 8 imposes civil liability for accountants who make false or misleading statements of material fact filed with the Securities and Exchange Commission.
* Section 10B and rule 10B-5 impose civil liability if an accountant intends to deceive others through oral or written misstatements or omissions of material fact in connection with a securities sale or purchase. Before the U.S. Supreme Court decision in Central Bank, section 10B included aiding and abetting liability. A willful violator is subject to criminal liability resulting in fines of not more than 1 million, imprisonment of not more than 10 years or both.
There is an express contract between accountant and client. The accountant is bound to perform all contract terms or face breach of contract liability.
Tort liability (joint and several liability for damage assessments)
* Negligence: A CPA is liable if he or she fails to exercise the degree care a reasonably competent accountant would exercise under similar circumstances. The most common approach extends liability beyond the client to foreseen third parties. Plaintiffs may recover a monetary judgment.
* Fraud: An accountant is liable for both compensatory and punitive damages Monetary compensation awarded to an injured party that goes beyond that which is necessary to compensate the individual for losses and that is intended to punish the wrongdoer. if he or she commits a fraudulen't act or knowingly makes a false representation of a material fact, with intent to deceive, that is justifiably relied on.
An accountant is subject to criminal sanctions if he or she willfully willfully adv. referring to doing something intentionally, purposefully and stubbornly. Examples: "He drove the car willfully into the crowd on the sidewalk." "She willfully left the dangerous substances on the property." (See: willful) certifies false documents, alters or tampers with records, forges, etc. Sanctions include fines, jail terms, probation and community service.
States that use one of the three main third-party liability approaches
Credit Alliance Restatement Reasonable foreseeable user approach approach approach Arkansas Alabama Mississippi Idaho California New Jersey Illinois Florida Wisconsin Kansas Georgia (California allowed this approach Montana Iowa until 1992) Nebraska Kentucky New York Louisiana Pennsylvania Michigan Utah Minnesota Missouri New Hampshire North Carolina North Dakota Ohio Rhode Island Tennessee Texas Washington West Virginia
RANDALL K. HANSON, JD, LLM LLM
Latin Legum Magister (Master of Laws)
LLM Master of Laws [Latin Legum Magister]
Noun 1. , is associate profess pro·fess
v. pro·fessed, pro·fess·ing, pro·fess·es
1. To affirm openly; declare or claim: "a physics major of business law at the University of North Carolina-Wilmington and a recipient of the university's Cameron Fellowship. He is a member of the American Bar Association American Bar Association (ABA), voluntary organization of lawyers admitted to the bar of any state. Founded (1878) largely through the efforts of the Connecticut Bar Association, it is devoted to improving the administration of justice, seeking uniformity of law and the Academy of Legal Studies in Business The Academy of Legal Studies in Business is an American-based professional society for lawyers teaching in commercial and business departments and faculties at tertiary level. It was founded in 1924, and now has an international membership. . JOANNE W. ROCKNESS, CPA, PhD, is the Cameron Professor of Accounting at the University of North Carolina-Wilmington. She is a member of the American Institute of CPAs, the American Accounting Association, the North Carolina North Carolina, state in the SE United States. It is bordered by the Atlantic Ocean (E), South Carolina and Georgia (S), Tennessee (W), and Virginia (N). Facts and Figures
Area, 52,586 sq mi (136,198 sq km). Pop. Association of CPAs and the Institute of Management Accountants The Institute of Management Accountants (IMA) is a professional organization headquartered in Montvale, New Jersey consisting of over 70,000 members worldwide. The IMA is dedicated to advancing the role of the management accountant and financial manager within the business .