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What every accountant should know about securities law.


Stephen M. Quinlivan, CPA, JD, an attorney practicing corporate law in New York City, offers a warning about traps for CPAs involved in client negotiations.

The scene at first is positive and familiar and then turns into a legal nightmare. A CPA is helping a client in the sale of a business. The client finds a buyer, and they agree on a stock transfer. The CPA attends meetings at which the client makes aggressive representations about various facts. The practitioner doesn't know if they are true or false and makes no investigations. After the sale, a problem arises and the buyer sues the CPA and the client under the securities acts. Is the CPA liable? As this article will show, it is unclear to what extent a CPA can participate in negotiations without becoming liable. However, a passive observer would not incur liability.


The analysis begins by investigating how a security is defined under the 1933 and 1934 securities acts. This is important for two reasons.

1. Securities must be registered with the Securities and Exchange Commission before they are offered for sale, unless the transaction qualifies for an exemption. Sales of securities without a public offering is one type of exemption.

2. The antifraud provision of the securities acts applies even if the transaction is exempt. That means those involved with the transaction can be sued under those provisions.

The analysis then examines the various antifraud provisions and their applicability to those not actually transferring the security, such as a CPA. CPAs must understand the analysis so they can identify transactions in which lawsuits are possible and take steps to protect themselves.


The U.S. Supreme Court defined the term "stock" in Landreth Timber Co. v. Landreth. In this case, a father and son offered 100% of a timber company's stock for sale. Fire subsequently damaged the mill, but the company promised potential investors it would make repairs. When the mill did not live up to buyers' expectations, they sued under the 1933 and 1934 securities acts. The sellers asserted the term "stock," as used in the securities acts, did not include the transfer of 100% of the stock of a closely held company.

The Court rejected the sellers' interpretations. It ruled any instrument that is called stock and bears the usual characteristics falls under the securities acts. It called stock "the quintessential security" and said stock purchasers normally expect the securities acts to apply. As such, the acts must be considered whenever stock is transferred.

More recently, the Court defined the term "note" for the purposes of the securities acts. In Reeves v. Ernst & Young, it adopted the "family resemblance test" to decide if a note falls under the securities acts. This test compares the note in question with a family of typical transactions that fall outside the securities acts. This family includes consumer financing notes, home mortgages, short-term business notes secured by assets or an open account debt incurred in the normal course of business. Notes that closely resemble the family are not securities.

Reeves noted the family of nonsecurity transactions can be expanded. Factors to consider are

* An assessment of the buyer's and seller's motivations to enter the transaction.

* The means by which the purchaser will acquire the instrument.

* Whether some factor (such as another regulatory mechanism) reduces the instrument's risk, making application of the securities laws unnecessary.

Generally, any transaction used to obtain long-term capital for a business falls under the securities acts. Short-term borrowing to smooth cash flow, such as commercial paper, generally isn't covered by the acts.

Other business interests also may be securities. Limited partnership interests fall under the acts, as do some exotic vehicles, such as franchise arrangements and rental condominiums, but general partnerships don't. A complete listing isn't possible, but the point is that CPAs should know which transactions are covered by the acts because they may be subject to lawsuits under the antifraud provisions even if the transaction is exempt.


Section 12(1) of the Securities Act of 1933 imposes liability for the sale of unregistered securities that are not exempt. An accountant not involved in transfer of the securities may be liable under that provision. In Pinter v. Dahl, the Supreme Court ruled liability extends to those who solicit a purchase and are motivated in part by a desire to serve their own financial interests or those of the securities owner.

The extent to which an accountant can participate in negotiations without being considered liable under this ruling isn't clear. However, the Court appears willing to protect accountants who have done nothing more than provide traditional accounting services.

Under section 12(1), there is no liability for the sale of an unregistered security pursuant to an exemption. Ordinarily, a regulation D exemption can be perfected with advance planning at little expense. Regulation D is a series of common exemptions that permit the sale of unregistered securities in carefully defined circumstances.

It is a serious mistake, however, to assume a transaction is exempt because there is no public offering of a security. A public offering occurs when securities are offered to anyone, even one person, who needs the securities acts' protection and who doesn't have access to the kind of information a prospectus would reveal.

Even if a transaction is exempt, other antifraud provisions apply. Foremost is rule lob-5 under the Securities Exchange Act of 1934, which forbids a false statement of material fact or an omission of a necessary fact in connection with the purchase or sale of any security. A misstatement that is intentional or reckless (made without knowing if it's true or false) can incur liability.

A CPA may be the target of a civil lob-5 action even if he or she didn't make misstatements or omissions of fact. Aiding and abetting a rule lob-5 violation will result in liability. The most generally accepted test of aiding and abetting is

* A securities law violation by someone who is otherwise liable.

* Knowledge of the violation.

* Substantial assistance in the violation.

It is unclear precisely how these tests can be used against an accountant. It is clear that a CPA is more likely to be held liable if he or she becomes involved in negotiations and departs from traditional services to become involved in negotiations. In these cases, recklessness in the presence of a securities violation may fulfill the knowledge requirement. Additionally, the accountant's failure to disclose facts may be considered substantial assistance.

Finally, an accountant may be held liable under section 12(2) of the 1933 act whether or not the transaction is exempt. Section 12(2) is similar to rule lob-5. The extent of third-party liability under the section is notoriously unclear. Probably the best interpretation is liability extends to all who satisfy the Pinter test.


Is the CPA in the opening example liable? Under the Landreth interpretation, the stock transferred was a security and the antifraud provisions apply. The CPA is liable under the securities acts if the transaction wasn't exempt and his or her efforts could be considered solicitation under Pinter. Even if it was exempt, the practitioner may be liable for aiding and abetting a rule lob-5 violation if he or she was reckless about misstatements of fact and substantially assisted the violation.

There are two lessons to be learned. The CPA was liable simply for helping a client transfer a security. In such situations, CPAs should encourage clients to consult their attorneys. Second, the CPA's exposure rose due to the departure from traditional services and the active involvement in negotiations. CPAs who make such departures should be aware of the consequences.


* A CPA ASSISTING a client negotiate the sale of a closely held business can be liable if the client is ultimately sued for a securities violation.

* THE 1933 AND 1934 securities acts and subsequent U.S. Supreme Court rulings consider stock of closely held companies to be securities and thus subject to the acts' antifraud provisions. The Court established a "family resemblance test" to see if notes can be considered securities.

* THE SUPREME COURT ruled liability extends to those who solicit a purchase and are motivated in part by a desire to serve their own financial interests or those of the securities owner Aiding and abetting a misstatement or omission of fact also can incur liability.

* IT'S NOT CLEAR what role CPAs can play in negotiations without being considered liable. However, the Court appears willing to protect CPAs who have done nothing more than provide traditional accounting services.
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Article Details
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Author:Quinlivan, Stephen M.
Publication:Journal of Accountancy
Date:Jul 1, 1992
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