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Auditor has duty to disclose client's financial condition.

The Eighth Circuit Court of Appeals ruled an auditor has a duty to demand note holders to disclose the true financial condition of its client.

The Farmer's Cooperative of Arkansas and Oklahoma purchased a gasohol plant previously run by the co-op's general manager. The manager had obtained loans from the co-op of approximately $4 million to built the plant. the co-op purchased the plant after the general manager and the co-op's accountant were indicted for tax fraud.

The co-op retained Arthur Young & Company to perform its 1981 audit. Young concluded the co-op should be constructed as owner of the plant from its inception, and therefore the plant could be alued at its $4.5 million fixed asset value. If Young had viewed this transaction as a purchase instead of as original ownership by the co-op, its value would have been fair market value--considerably lower than fixed asset value.

Significantly, had Young valued the plant at less than $1.5 million, the o-op's net worth would have been negative. Young did not inform the client of its decision to value the plant as a fixed asset instead of at market value. The co-op distributed to its creditors summary financial statements, which reported the plant as a $4.5 million asset, without mentioning how Young had arrived at the valuation.

The co-op failed in 1984 and suit was brought by the note holders against Young. A jury ruled in favor of the creditors and Young appealed to the eighth circuit, which in turn ruled that Young had a duty to disclose the financial condition of the plant.

The court noted Young was aware of but did not disclose the essential information that if the co-op had been valued at less than $1.5 million, the co-op would have had a negative net worth. Young's knowledge of significant information regarding the plant's valuation and its failure to disclose this information was a sufficient basis for creditors to sustain a securities action. (Arthur Young and Co. v. Reves, Federal Securities Law Reporter 96060, 6/27/91.)

Editor's note: Special thanks to Patricia Young, Esq., of Berman and Clark, for the Lyne v. Andersen case.

Edited by Wayne Baliga, CPA, JD, vice-president, AON Corp.
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Title Annotation:Arthur Young & Co
Author:Baliga, Wayne J.
Publication:Journal of Accountancy
Date:Jan 1, 1992
Words:369
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