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23 Cards in this Set

  • Front
  • Back
"Deep Pockets" Theory
Lawsuits are brought against auditors not b/c they are necessarily at fault, but in the case of client failure, they are the only party w/ resources against which recovery can be made.
Expectation Gap
Financial Statement Users' expectations can be very high. A gap can exist between the diligence that users expect and the diligence that auditors are able and required to provide.
Common Law
Use legal precedent to identify the fault and responsibility of parties where there is no violation of a written law or statute.
Statutory Law
Based on laws passed by legislative bodies and compiled in federal, state, and municipal codes. The primary basis for a decision is whether the party's actions have violated the law as written in the code.
Breach of Contract
A claim for accounting or auditing or auditing services were not performed in a manner described in the contract.
Tort
Actions cover other civil complaints (e.g., fraud, deceit, injury) arising from auditors' failure to exercise the appropriate level of professional care (substandard performance)
Constructive Fraud
A failure to provide any care in fulfilling a duty owed to another including a reckless disregard for the truth. Similar in nature to gross negligence.
Foreseeable Party
A wide range of individuals or organizations that might rely on auditors' work.
Foreseen Party
A limited class of individuals or organizations that could be reasonably expected to rely on auditors' work.
Fraud
Misrepresentations of fact that the individual knows to be false.
Gross Negligence
Breach of duty owed to another party due to the lack of minimal care.
Ordinary Negligence
Unintentional breaches of duty owed to another party due to a lack of reasonable care.
Plaintiff
The person or organization that initiates a lawsuit (client or 3rd party user of financial statements)
Primary Beneficiary
A person named in a contract for whom the services provided are intended who is known by name to auditors.
Privity of Contract
Situation in which parties have a contractual relationship.
Liability to Clients: When privity exists, plaintiffs must demonstrate all of the following:
1) They suffered an economic loss
2) Auditors did not perform in accordance w/ the terms of the contract (for breach of contract)
3) Auditors failed to exercise the approp. level of professional care (for tort actions)
4) The loss was caused by the breach of contract or failure to exercise the approp. level of professional care
Auditors' Defenses for Client Claims under Common Law: Auditors may attempt to mitigate claims through one of the following 3 defenses:
1) Auditors exercised the approp. level of professional care (tort) or performed the engagement according to the terms of the contract (breach)
2) The client's economic loss was caused by a factor other than auditors' failure to exercise appropriate levels of professional care or breach (the causation defense)
3) Actions on the part of the client were in part responsible for the loss (e.g., failure of the client to establish effective IC to prevent ebezzlement losses, contributory negligence (avail. to auditors in certain jurisdictions)
To bring a suit against auditors, 3rd parties must demonstrate all of the following:
1) They suffered an economic loss (normally, a decline in the value of an investment or failure to be repaid for a loan or other obligation)
2) Auditors failed to exercise the approp. level of professional care (ord. negligence, gross negligence or fraud)
3) The financial statements were materially misstated
4) The loss was caused by reliance on the materially misstated financial statements
Auditors' Defenses for Third-Party Claims in Common Law Action
1) The 3rd party did not have approp. standing to sue in that jurisdiction
2) The 3rd party's loss was caused by events other than the financial statements and auditors' examination (causation defense)
3) Auditors' work was performed in accordance w/ professional standards (e.g. GAAS for audits of financial statements) (ordinary negligence)
Auditors are exposed to liability under the Securities Act and the Securities Exchange Act when:
1) Investors purchase/sell securities
2) Investors suffer an economic loss
3) Financial statements contain material misstatements
Securities Act of 1933: Section 11 Major Implications
1) Auditors are liable for ordinary negligence
2) Auditors have potential liability to a large class of investors
3) Auditors (and not others) have the burden of proof (proving that reasonable investigation under 11(b)(B) was conducted.
Federal Statutes that provide sources of potential liability for auditors
1) Federal False Statements
2) Federal Mail Fraud
3) Federal Conspiracy
4) Securies Act of 1933
5) Securities Exchange Act 1934
6) SOX
Scienter
Auditors had knowledge of the misstatement and intentionally failed to disclose the misstatement in their reports.