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Alabama Supreme Court rules on privity.

In a reversal of a previous precedent, the Alabama Supreme Court ruled that it no longer will apply a strict privity standard in interpreting accountants' liability to third parties. Rather, it will look to the more liberal interpretation set forth in section 552 of the Restatement of Torts. Under the Restatement test, liability is limited to loss suffered (1) by the person or one of a limited group of people for whose benefit and guidance the accountant intends to supply information or knows the recipient intends to supply it and (2) through reliance on such information in a transaction that the accountant intends the information to influence or knows that the recipient so intends, or in a substantially similar transaction. This test strikes a balance between the accountant's unlimited liability to all third parties and no liability on the part of the accountant to any third parties.

This case began when Arthur Andersen & Co. was sued by two Secor Bank shareholders, who sued on their own behalf rather than suing derivatively on behalf of the corporation [the bank].

The two alleged Andersen had failed to disclose three years of losses resulting from millions of dollars in the bank's bad commercial loans. They claimed Andersen knew of these material losses and liabilities but failed to disclose them during three annual audits.

The trial court dismissed the shareholders' claim, stating it saw no evidence of Andersen's understanding that they were relying on the results of Andersen's work.

In arguments before the state supreme court, the plaintiffs said that, to their detriment, (1) they had relied on inaccurate financial reports certified by Andersen, (2) Andersen was aware the bank's annual reports were directed to shareholders and (3) the purpose of disseminating the annual report was to communicate to shareholders the corporation's financial condition.

Andersen argued that the only remedy that applies was a derivative action by the shareholders on behalf of the corporation, since Andersen owed no direct duty to individual shareholders.

In reversing the trial court's decision and ruling for the plaintiffs, the Alabama Supreme Court wrote that Andersen was aware the annual reports it was certifying were directed specifically to the bank's shareholders and these reports were relied on by shareholders as stating the true and correct financial status and condition of the bank.

In this case, the supreme court said, the plaintiffs were shareholders, a group Andersen knew would be relying on the annual reports to make investment decisions. (Samuel H. Boykin, Jr. v. Arthur Andersen & Co. 639 So. 2d 504)
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Article Details
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Title Annotation:Boykin v. Arthur Andersen & Co.
Author:Baliga, Wayne
Publication:Journal of Accountancy
Article Type:Brief Article
Date:Dec 1, 1994
Previous Article:FASB proposes delay in effective date of interpretation 40.
Next Article:Ohio trial court rules for accounting firm.

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