This chapter described the legal environment of auditors, emphasizing legal liability under both common law and statutory law. To summarize:
Under common law, CPAs are liable to their clients for failure to exercise due professional care. Accordingly, ordinary negligence is a sufficient degree of misconduct to hold CPAs liable for damages caused to their clients.
Auditors' liability to third parties under common law varies from state to state. One way to summarize these differences is to consider three general approaches-(a) Ultramares (known user) approach, (b) Restatement (foreseen user) approach, and (c) Rosenblum (foreseeable user) approach. Under the Ultramares (known user) approach, CPAs are held liable for ordinary negligence only to third-party beneficiaries for whose benefit the audit was performed. Other third parties must prove gross negligence on the part of the auditors. Under the Restatement (foreseen user) approach, liability for ordinary negligence to third parties is extended to include any limited class of parties that could be foreseen to rely upon the financial statements. The Rosenblum (foreseeable user) approach extends the auditors' liability for ordinary negligence even further to include any third party the auditors could reasonably foresee as recipients of the financial statements.
Auditors may also be held liable to third parties under the federal securities laws, which allow class action lawsuits by purchasers or sellers of a company's securities. The Securities Act of 1933 is unique in that most of the burden of proof in litigation is shifted to the auditors, with the primary defenses available to the auditor consisting of (1) knowledge of the plaintiffs of the errors or omissions or (2) due diligence by the auditors. Due diligence is a difficult defense to establish.
CPAs are also subject to criminal prosecution for violation of various statutes, including criminal fraud in which their conduct was intentional or involved collusion with the client.
To protect themselves from the liability crisis of today, auditors strive to adhere to a high level of professional performance. They also attempt to avoid engagements that have a very high risk of litigation.
Describe the types of CPA liability.
Distinguish between CPAs' liability under common law and under statutory law.
Explain the proof requirements for clients and third parties seeking recovery from CPAs under common law and the defenses available to CPAs.
Explain the proof requirements for plaintiffs under statutory law and the defenses available to the auditors.
Compare the requirements for CPA liability under the Securities Act of 1933 with those under the Securities Exchange Act of 1934.
Describe CPA legal liability for accounting and review services.