Reg Accountants' Legal Responsibilities Cpafor Free

Front 1

If Pierce successfully sues Grant, Grant & Wall, CPAs, for damages under Section 11 of the Securities Act of 1933, what will be the measure of Pierce’s damages?


A The difference between the price paid for the securities and their value on the date suit was filed.
B The difference between the price paid for the securities and their value on the date of trial.
C Two times the difference between the price paid for the securities and their value on the date suit was filed.
D Two times the difference between the price paid for the securities and their value on the date of trial.

Back 1

The correct answer was A.

In a suit for damages under Section 11 of the Securities Act of 1933 damages are calculated as the difference between the price paid for the securities and their value on the date suit was filed.

Front 2

A CPA may be liable to a purchaser of securities for certifying financial statements which are included as part of a registration statement and which contain materially false information. Such a purchaser is most likely to recover damages under the provisions of


A The Sarbanes-Oxley Act.
B The Securities Exchange Act of 1934.
C The Securities Act of 1933.
D Regulation FD (Full Disclosure).

Back 2

The correct answer was C.

A registration statement is used in connection with the issuance of securities. Misstatements contained in a registration are governed by the provisions of the 1933 Securities Act.

Front 3

Harvest Services Corporation engaged Willet & Fund, CPAs, to conduct an audit of Harvest. Wren, president and CFO of Harvest, knowingly misled Willet & Fund, CPAs, in the course of their audit resulting in material misstatements of to company’s profitability. Young, who purchased Harvest common stock in reliance upon the financial statements, has filed suit against Willet & Fund, CPAs, under the anti-fraud provisions of the Securities Exchange Act of 1934 for losses sustained due to the errors contained in the audited financial statements. Which is correct?


A Willet & Fund, CPAs, may be held liable as “aiders and abettors” even if they acted in good faith.
B Young must prove reliance in order to recover.
C Mere negligence on the part of Willet & Fund, CPAs, in being misled by Wren will result in liability.
D Young may recover upon proof that Willet & Fund, CPAs, did not act with due diligence.

Back 3

The correct answer was B.

Under the provisions of Section 10(b) of the Securities Exchange Act of 1934, an accountant may be held liable for actions which are tantamount to common law fraud, or a slightly lesser standard, gross negligence which amounts to reckless disregard for the truth. There must be evidence of a material misstatement or omission knowingly (or recklessly) made, which the injured party relied upon to his or her detriment. Thus, answer B is correct since reliance is an element which must be proven. With regard to answer A, the U. S. Supreme Court, in Central Bank of Denver v. First Interstate Bank of Denver (1994), ruled that entities may not be held liable under the provisions of the Securities Exchange Act of 1934 for merely “aiding and abetting.”

Front 4

HHG Enterprises engaged Barrington & Associates, CPAs, to prepare financial statements. In reliance upon these financial statements, Folkes purchased 10,000 shares of HHG Enterprises common stock. Folkes later filed suit against Barrington & Associates, CPAs, under the provisions of Section 10(b) of the Securities Exchange Act of 1934 claiming that the financial statements prepared and certified by Barrington contained a misstatement as to certain contingent liabilities. For Folkes to succeed in his suit he must prove that


A Barrington & Associates, CPAs, failed to follow GAAP.
B Barrington & Associates, CPAs, acted negligently.
C The financial statements were contained in a registration statement.
D The misstatement regarding contingent liabilities was material.

Back 4

The correct answer was D.

Under the provisions of Section 10(b) of the Securities Exchange Act of 1934, a CPA may be held liable for actions which are tantamount to common law fraud, or a slightly lesser standard, gross negligence which amounts to reckless disregard for the truth. That the misstatement (or omission) was material is one of the elements which must be proven. There must be evidence of a material misstatement or omission knowingly (or recklessly) made, which the injured party relied upon to his or her detriment.

Front 5

Which of the following would constitute a valid defense by a CPA in an action for fraud where the plaintiff was NOT in privity of contract with the CPA?


A The engagement was ambiguous as to the CPA’s responsibilities.
B The CPA does not carry malpractice insurance which covers losses due to fraud.
C The CPA followed the instructions of his client.
D The plaintiff’s reliance was not reasonable.

Back 5

The correct answer was D.

To recover in an action for common law fraud, one must prove five elements: a misstatement or omission; of a material fact; knowingly made with an intent to deceive (scienter); relied upon by the complaining party; which results in damages. D is the best answer since proof or reliance is a necessary element to proving fraud, and proof that the reliance was not reasonable may defeat the plaintiff’s claim.

Front 6

In a suit by Clem against Price, CPA, for common law fraud, Price will prevail even if


A Clem can only prove negligence on the part of Price.
B Clem was NOT in privity of contract with Price.
C Clem did not actually rely on the work product generated by Price.
D Price’s error, though intentional, was minor in nature.

Back 6

The correct answer was B.

To recover in an action for common law fraud, one must prove five elements: a misstatement or omission; of a material fact; knowingly made with an intent to deceive (scienter); relied upon by the complaining party; which results in damages. Privity of contract may exist, but is not a necessary element. And, proof of mere negligence is not sufficient to establish scienter.

Front 7

One has fulfilled the general standard of care expected of an accountant if


A the accountant has faithfully follow the standards imposed by GAAP.
B the accountant has acted in good faith.
C the services provided by the accountant were provided with the level of skill ordinarily exercised under the circumstances.
D the accountant has exercised his best efforts in connection with the services provided.

Back 7

The correct answer was C.

An accountant must possess the skills that an ordinarily prudent accountant would have, and exercise the degree of care that an ordinarily prudent accountant would exercise. This standard of care, however, is dependent on the particular circumstances existing at the time the work is performed. An accountant is expected to exercise ordinary care and diligence, measured by the particular circumstances.

Front 8

With regard to the liability of a CPA in conducting an audit, which of the following statements is INCORRECT?


A A CPA who recklessly departs from the ordinary standard of care would be liable to third parties.
B A CPA’s failure to carry out the duties expressed in the engagement will result in liability only if the CPA was negligent or grossly negligent.
C In an action against the CPA based on constructive fraud, it must be proven that the CPA acted in a grossly negligent manner.
D A CPA only has liability to the client.

Back 8

The correct answer was D.

Constructive fraud by a CPA means that the CPA was more than merely negligent, but did not act with malice of with a specific intent to deceive, but was reckless or grossly negligent. A CPA’s failure to carry out the duty expressed in the engagement will result in liability for breach of contract regardless of negligence. (A CPA’s failure to carry out the duty expressed in the engagement may or may not have been a product of negligence.) And, CPAs are liable to third parties when they are aware that their work will be relied upon, such as for an extension of credit.

Front 9

Orth, a CPA, conducted an audit of Palladium Resources, Inc., and rendered an opinion as to the company’s financial condition. In a suit by Palladium Resources, Inc., against Orth for breach of contract and negligence, which of the following would be an INCORRECT statement as to the standard of care required of Orth?


A A violation of GAAP or GAAS will be evidence of the accountant’s negligence unless the accountant qualifies his/her opinion.
B An accountant must exercise the skills that an ordinarily prudent accountant would have exercised under the particular circumstances of the audit engagement.
C Orth will only be liable for breach of contract if he was grossly negligent.
D Orth is NOT required to detect all fraudulent schemes in existence at Palladium Resources, Inc.

Back 9

The correct answer was C.

An accountant will be liable for breach of contract if negligent in performing the contracted work. It is not necessary for a client to prove gross negligence or fraud. All of the other statements are generally correct with regard to an accountant’s liability to a client and the standard of acre generally imposed by common law.

Front 10

Javier, CPA, was engaged by Madison to prepare audited financial statements for Tracy Corporation. Javier was made aware at the time of the engagement that Tracy Corporation intended to submit the financial statements to several investment bankers who were considering purchasing a controlling interest in Tracy Corporation. Prime Reserve Fund ultimately purchased a controlling interest in Tracy Corporation based in part on the audited financial statements produced by Javier. Which of the following statements is correct?


A Javier, CPA, has no duty to any entity other than Tracy Corporation.
B In a majority of jurisdictions, Javier, CPA, would be liable for negligence to any foreseeable users of the audited financial statements.
C Javier, CPA, would be liable, in most jurisdictions, to Prime Reserve Fund for negligence committed in connection with the audits.
D Since Javier, CPA, is not in privity of contract with Prime Reserve Fund, Javier would have no liability to Prime for any wrongdoing.

Back 10

The correct answer was C.

With respect to negligence, an accountant is liable to his client and in most jurisdictions, to the intended users of his work product where the users are members of a limited class, such as the case here (“several investment bankers who were considering purchasing a controlling interest in Tracy Corporation”). In addition, if Javier’s wrongdoing was fraudulent or involved gross negligence (constructive fraud) his liability would extend to any third party injured thereby.

Front 11

Lipton Enterprises, considering a buyout of Moss & Co., demanded it be provided audited financial statements of the company. Lipton was presented with certified financial statements prepared by Drake & Drake, CPAs. The liabilities of Moss & Co. were grossly understated in the financial statements certified by the Drake firm. Lipton Enterprises suffered serious losses as a result of the merger which related the understatement of Moss & Co.’s liabilities. To recover against Drake & Drake, CPAs, Lipton Enterprises must prove: I. Drake & Drake CPAs was aware that a third party, such as Litpon Enterprises, would be relying on the financial statements; II. Lipton Enterprises actually relied on the financial statements; III. Drake & Drake, CPAs was negligent.


A I only
B I and II only
C I, II and III
D I and III only

Back 11

The correct answer was C.

For a third party to recover against a CPA, the third party must prove fraud or gross negligence on the part of the CPA, or, if the CPA is merely negligent, the third party may recover if it can be shown that the CPA knew the third party would be relying on the CPAS work product, and actually did rely.

Front 12

BrainTree Investments engaged PPL Associates, CPAs, to audit BrainTree’s financial statements. In the course of the audit, PPL Associates discovered an embezzlement scheme involving two of BrainTree’s top officers. With regard to a claim of accountant-client privilege,


A the accountant-client privilege is virtually identical to the attorney-client privilege.
B BrainTree Investments may waive the accountant-client privilege.
C no states have yet enacted an accountant-client privilege.
D an accountant-client privilege is only available in federal court.

Back 12

The correct answer was B.

A limited number of states have enacted laws granting varying degrees of accountant-client privilege, but the privilege is not as broad as the attorney-client privilege. Where such a privilege exists, only the client can wave the privilege.

Front 13

The Internal Revenue Service Restructuring and Reform Act of 1998 gives taxpayers a privilege regarding written or verbal tax advice from a CPA. Which statement would represent an INCORRECT interpretation of the Restructuring and Reform Act of 1998?


A The creation of the new privilege was not intended to modify, but rather to extend the attorney-client common law confidentiality privilege to other practitioners, such as CPAs.
B Information disclosed to a CPA for the purpose of preparing a return is privileged under the Reform Act.
C The preparation of tax accrual work papers is not considered tax advice when developed to evaluate a client’s contingent tax liabilities in connection with financial condition disclosures.
D The privilege does not extend to written tax advice to corporate clients concerning their corporations’ involvement in tax shelters.

Back 13

The correct answer was B.

Section 7525 provides: “With respect to tax advice, the same common law protections of confidentiality which apply to a communication between a taxpayer and an attorney shall also apply to a communication between a taxpayer and any federally authorized tax practitioner to the extent the communication would be considered a privileged communication if it were between a taxpayer and an attorney” but only with respect to “non criminal tax matter before the Internal Revenue Service and non criminal tax proceedings in Federal court brought by or against the United States.” In addition, the privilege does not extend to written tax advice to corporate clients concerning their corporations’ involvement in tax shelters.

Front 14

On February 1, Halsey commenced an action against Pound & Associates, CPAs for damages in connection with certified financial statements prepared by Pound & Associates. Pound & Associates has alleged lack of privity as a defense. Pound & Associates will prevail based on this defense if


A Halsey is the client of Pound & Associates.
B Halsey’s suit is based on common law fraud.
C the evidence presented at trial is of reckless disregard for the truth on the part of Pound & Associates, CPAs.
D Halsey, based on the financial statements, extended credit to Forte Corp. for whom Pound & Associates, CPAs, prepared and certified the financial statements.

Back 14

The correct answer was D.

A legal action may be successfully maintained against an accountant by a person not in privity of contract with the accountant only under certain circumstances. If the legal action is based upon fraud, or on gross negligence which amounts to a reckless disregard for the truth, lack of privity is no defense. Mere negligence by an accountant is actionable by an entity not in privity with the accountant only if the accounting work was intended for the plaintiff (or for a group which included the plaintiff). Of course, if Halsey is Pound & Associates’ client (answer A) they are in privity of contract with one another and alleging lack of privity would be contrary to the facts.

Front 15

To comply with the provisions of the Sarbanes-Oxley Act, members of an audit committee must ensure which of the following: I. Financial reports reflect all material correcting adjustments; II. Off–balance sheet transactions be disclosed; III. Companies disclose to the public on a rapid and current basis information concerning material changes in its financial condition.


A I only
B II and II only
C I, II and III
D II and III only

Back 15

The correct answer was C.

The Sarbanes-Oxley Act requires that financial reports reflect all material correcting adjustments; that off–balance sheet transactions be disclosed; and, that companies disclose to the public on a rapid and current basis additional information concerning material changes in financial condition or operations, in plain English. The Act further requires that each annual report include a discussion stating management’s responsibility for establishing effective internal controls and procedures for financial reporting, and provide an assessment of the effectiveness of such controls and procedures.

Front 16

Davidson & Co., CPAs failed to include certain charges against income in the financial statements which it prepared for its client, Bayliss Bros., Inc. Davidson & Co.’s unqualified opinion accompanied the financial statements as a part of a registration statement which was filed in connection with a public offering of nonvoting common stock by Bayliss Bros., Inc. In a suit by Lake, a purchaser of a significant portion of the initial public offering, against Davidson & Co., CPAs, for losses incurred when the shares dropped in value, Lake CANNOT prevail unless he can prove that


A the omission was material.
B he reviewed the financial statements.
C the omission was negligent.
D Davidson & Co., CPAs, acted with reckless disregard for the accuracy of the financial statements.

Back 16

The correct answer was A.

Pursuant to the 1933 Securities Act, a CPA will be liable for misstatements or omissions in financial statements which are part of a registration statement if the misinformation is material and results in damages. A purchaser (Lake) need not prove fraud, negligence or reliance in order to prevail.

Front 17

Brent, a CPA, was a lead accountant in the preparation of various financial information which was included in Fausst & Co.'s registration statement filed in connection with an initial public offering by Fausst. Under Section 11 of the Securities Act of 1933, Brent may be liable to purchasers of Fausst & Co. securities even though


A the purchaser cannot prove negligence by Brent.
B Brent is able to prove that he exercised due diligence.
C the misstatements alleged by the purchasers were not material.
D the value of the stock on the date suit is filed is greater than the price paid by the purchasers.

Back 17

The correct answer was A.

Under Section 11 of the Securities Act of 1933, a CPA may be liable, in connection with his work product, to purchasers of securities if the work product contains material misstatements or omissions, and damages were suffered. Plaintiffs need not prove negligence on the part of the CPA, but a CPA can avoid liability by proving the exercise of due diligence. The necessary element of materiality is absent in answer C and damages are absent in answer D.

Front 18

In an initial public offering by McKenny-Rice Management Group, LLC, Rice, a founding member and principal, was granted options to purchase 5% of the shares being offered to the public. Six months later, Rice exercised part of his options, purchasing a 1% stake in the company. McKenny-Rice Management Group, LLC, raised $12,000,000 in connection with the stock offering. Rice


A is in violation of SEC regulation 144.
B may resell the shares without restriction if a registration statement was in effect.
C holds restricted securities regardless of registration.
D holds shares which are exempt from any restrictions since he is not a controlling person.

Back 18

The correct answer was B.

The Securities Act of 1933 requires that, in a public offering exceeding $5,000,000 either a registration statement must be filed or resale of the securities within two years is restricted.

Front 19

Bastille Iron Works, Inc., wishes to make an offering of securities which will comply with the rules for exemption under Rule 505 of Regulation D of the Securities Act of 1933. To meet these requirements


A all purchasers must be accredited investors.
B a registration statement must be filed with the SEC, but need not be approved.
C share certificates must be marked with a legend indicating that resale is restricted.
D Bastille Iron Works, Inc., may advertise to the general public the availability of its securities, but may not advertise on the internet.

Back 19

The correct answer was C.

Rule 505 of regulation D permits a company to sell up to $5 million in securities over a 12 month period but prohibits general advertising, limits a sales to not more than 35 nonaccredited investors and restricts resale for two years.

Front 20

In general, the provisions of the Securities Act of 1933 accomplish the goal of stability in the marketplace for securities by


A generally assuring that prospective investors are provided information about an issuer of securities necessary to make an informed investment decision.
B providing a government guaranty as to the soundness of securities issued by private companies.
C establishing the Securities Assurance Fund to which investors may apply for full or partial reimbursement for losses sustained due to fraudulent securities schemes.
D guarantying the accuracy of information contained within any registration statement which has been approved by the SEC.

Back 20

The correct answer was A.

The Securities Act of 1933 imposes on companies who seek to raise capital in the marketplace a requirement that they first file a registration statement by which prospective investors are provided information about the company necessary to make an informed investment decision.

Front 21

Watson along with four other executives of PittWay, Inc., engaged over many years in a fraudulent scheme to grant undisclosed "in-the-money" options to themselves and to others by backdating stock options to coincide with historically low closing prices of PittWay common stock. Among other things, Watson created company records that falsely indicated that PittWay's compensation committee had approved a grant of stock options on a date when, in reality, no such corporate action took place. Pittway, Inc., is a publicly traded company. Watson's actions could result in


A a court order permanently enjoining Watson him from violating the antifraud and securities ownership-reporting provisions of the federal securities laws.
B civil monetary penalties.
C disgorgement of profits.
D all of the above.

Back 21

The correct answer was D.

Violations of the Section 17(a) of the Securities Act of 1933, and Sections 10(b) and 13(b)(5) of the Securities Exchange Act of 1934 can result in civil penalties,forfeiture of profits, including prejudgment interest, as well as a permanent injunction prohibiting future violations.

Front 22

Countdown Corporation issued $15,000,000 of new securities to finance expansion in overseas markets. The entire block of securities was sold to Magna Insurance and Pension Group without the filing of a registration statement. Resale of the securities by Magna to the general public


A is unrestricted.
B would be unlawful because the original sale to Magna was in violation of the Securities Act of 1933.
C may be made if a registration statement is first put into effect.
D can be made without restriction after one year from the original sale to Magna.

Back 22

The correct answer was C.

Rule 506 of regulation D permits a company to sell an unlimited amount of securities to accredited purchasers but limits immediate resale by imposing a two year waiting period.

Front 23

Krauss & Co., CPAs, certified the financial statements of Boardwalk Corporation. The financial statements of Boardwalk, which were included in company's registration statement, contained material misstatements. Under Section 11 of the Securities Act of 1933, Krauss & Co., CPAs, will NOT be liable to a purchaser of the securities


A who suffered no damages.
B if the purchaser exercised due diligence.
C unless the purchaser can prove intent or reckless disregard for the truth on the part of Krauss & Co., CPAs.
D unless there is privity between the purchaser and Krauss & Co., CPAs.

Back 23

The correct answer was A.

For a purchaser of original issue securities to hold liable experts who participated in the preparation of the registration statement, the purchaser must prove the existence of a material misstatement (or omission) in the financial statements, and damages. These are the only elements of 1933 Act fraud, unlike common law fraud which requires, in addition, scienter (intent to deceive) and reliance.

Front 24

Peter Phish is CEO and 50% owner of Phish & Assoc., a registered broker dealer. Phish served as underwriter for municipal bonds to finance the purchase of Marx Place, an office building. The bonds had a maturity of five years and were sold to buyers in several states. At the time the bonds were offered for sale, the state Motor Vehicle Department (MVD) occupied 70% of Marx Place. At the time he promoted the sale of the bonds, Phish knew that the MVD intended to move to a new location within 18 months. Occupancy of Marx Place by a state agency was critical to the tax exempt status of the bonds. Cautionary statements in the offering documents warned, in boldface capital letters: "Certain leases are scheduled to expire prior to the maturity of the bonds; there is no guarantee that the Motor Vehicle Department will renew its lease." Subsequent to the bond sale, the Department of Motor Vehicles vacated Marx Place and the bonds lost their tax exempt status. An action by purchasers of the bonds against Phish & Assoc. under the anti-fraud provisions of the 1933 Securities Act will


A NOT succeed because the cautionary statements negated any possible false representation by Phish relating to the MVD lease.
B NOT succeed because there is no evidence of a misstatement in the offering documents.
C succeed unless Phish & Assoc. can prove that the purchasers of the bonds did not rely on the offering documents.
D succeed because the cautionary statement was insufficient to negate the material omission by Phish that he actually knew that the MVD was vacating before the bond maturity date.

Back 24

The correct answer was D.

Material misstatements or omissions in connection with a sale of securities is a violation of the anti fraud provisions of the 1933 Securities Act. Proof reliance or intent are not necessary. Phish's omissions regarding MVD's known intention to vacate would have been of importance to investors. Phish's cautionary statements were so deficient he must have known investors would be misled by the offering documents. There is a critical distinction between disclosing the risk a future event might occur and disclosing actual knowledge the event will occur. Phish's cautionary language only disclosed a risk that the Motor Vehicle Department might leave Marx Place, not his knowledge that it actually planned to do so in the near future.

Front 25

Carter owns restricted securities which she received through a Regulation D offering. To sell these securities, Carter may comply with the safe harbor provisions of Rule 144. In general, Carter would be in compliance with Rule 144 if she: I. holds the stock for two year before selling. II. holds the stock for one year, then sells in small brokered transactions after confirming that the company has complied with the periodic reporting requirements of the Securities Exchange Act of 1934.


A I only is correct.
B II only is correct.
C I and II are both correct.
D Neither I nor II is correct.

Back 25

The correct answer was C.

Restricted securities are securities acquired in unregistered, private sales from the issuer or from an affiliate of the issuer. Investors typically receive restricted securities through private placement offerings, Regulation D offerings and employee stock benefit plans. Sale of restricted securities can be made by complying with the mandates of Rule 144. In general, this means holding the stock for two year before selling, or, holding the stock for one year, then selling in small brokered transactions. If the securities are not held for two years, there must be adequate current information available about the issuer. This generally means the issuer has complied with the periodic reporting requirements of the Securities Exchange Act of 1934.

Front 26

On April 9 Mal received a telephone call from Glotz, an employee of Charter Bank with whom Mal had previously worked at Charter. Glotz's department performed due diligence on banks which Charter sought to acquire. The day before Glotz called Mal, her supervisor had informed her that she would be conducting due diligence at an acquisition target. While she deliberately was not provided the target's identity, she learned through her own investigations that the due diligence was to take place in Lottsburg and that three banks were based there: Trust Bank, County Branch and A&B Bank. During the next 24 hours Mal purchased of stocks and options in the three banks. It was later disclosed that Charter Bank intended to acquire A&B Bank. Within a week, A&B Bank's stock increased in value significantly allowing Mal to sell his stock and options at a gain of $225,000. With regard to SEC sanctions for violation of insider trading rules


A Mal is not in violation of insider trading rules because he was not told the specific identity of Charter's acquisition target, and, in fact, could have lost money in the acquisitions.
B The SEC may seek to impose civil penalties against Mal of up to $675,000.
C Glotz's activities were in violation of the short swing profit rules of Section 16(b) of the Securities Exchange Act of 1934.
D Although Glotz is subject to civil penalties, including disgorgement of all profits, there are no criminal penalties since his gains were less than $250,000.

Back 26

The correct answer was B.

Section 10(b) of the 1934 Act, SEC Rule 10b-5, prohibits fraud related to securities trading, including trading on inside information. Mal traded on insider information and as a result is subject to both criminal and civil penalties. The Insider Trading Sanctions Act of 1984 and the Insider Trading and Securities Fraud Enforcement Act of 1988 provide for penalties for illegal insider trading to be as high as three times the profit gained or the loss avoided from the illegal trading. Mal was not in violation of Section 16(b) of the Securities Exchange Act of 1934, which prohibits short-swing profits (from any purchases and sales within any six month period) made by corporate directors, officers, or stockholders owning more than 10% of a firm's shares.

Front 27

Which if the following is correct regarding the 1934 Securities Exchange Act's regulation of proxy solicitations?


A A registered company must provide each stockholder with a proxy statement containing certain material, along with a form of proxy on which the shareholder may vote on each proposal to be presented at a shareholder meeting.
B Copies of the proxy statement and proxy form must be filed with the SEC when they are first mailed to security holders.
C The SEC may comment on but may not require changes in a proxy statement before mailing.
D Proxies relating to an annual meeting calling for election of directors must include a report containing financial statements covering the previous two fiscal years.

Back 27

The correct answer was D.

The 1934 Act regulates proxy solicitation, which is information that must be given to a corporation's shareholders prior to soliciting votes. Prior to every shareholder meeting, a registered company must provide each shareholder with a proxy statement containing certain material, along with a proxy form on which the shareholder may vote on each proposal to be presented at the meeting. For securities registered in the names of brokers, a company must attempt to determine the beneficial ownership of the securities and furnish sufficient copies of the proxy statement for distribution to all beneficial owners. Copies of the proxy statement and proxy form must be filed with the SEC when first mailed to shareholders. Under certain circumstances preliminary copies must be filed ten days before mailing. Although a proxy statement does not become "effective" in the same way as a statement registered under the 1933 Act, the SEC may comment on and require changes in the proxy statement before mailing. Proxies for an annual meeting calling for election of directors must include a report containing financial statements covering the previous two fiscal years. Special rules apply when a contest for election or removal of directors is scheduled.

Front 28

My-Gen is a defunct corporation whose stock was previously listed on the NASDAQ exchange. Exchange Services, a national securities broker, loaned Cargill, the majority owner of My-Gen, $10,000,000 secured by Cargill's shares in My-Gen which represented over 25% of My-Gen's outstanding shares. Shortly thereafter, Exchange Services called the Cargill loan, then sold all the My-Gen stock which it held as collateral. The stock's price plunged during this time. A class action suit was thereafter filed against Exchange Services in the state court of Redacre alleging civil conspiracy, violation of Redacre's securities laws, and tortious manipulation of markets. If Exchange Services seeks dismissal of the class action claim under Securities Litigation Uniform Standards Act (SLUSA) of 1998 it will


A prevail, but only if the class action was based on securities fraud.
B lose because SLUSA does not apply to state court class action suits.
C prevail since the suit is, in essence, a claim of market manipulation.
D lose since the suit did not specifically allege violations ot the Federal Securities laws.

Back 28

The correct answer was C.

SLUSA provides for preclusion of certain securities class actions brought under state law: No covered class action based upon the statutory or common law of any State may be maintained in any State or Federal court by any private party alleging-(A) a misrepresentation or omission of a material fact in connection with the purchase or sale of a covered security; or (B) that the defendant used or employed any manipulative or deceptive device or contrivance in connection with the purchase or sale of a covered security. SLUSA does not itself displace state law with federal law but makes some state-law claims nonactionable through the class action device in federal as well as state court.

Front 29

Trells has decided to make an offer to purchase the common stock of Tarrington, Inc., a company whose shares are listed on the New York Stock Exchange. Tarrington currently trades at $15.50 per share and Trells intends to offer $18.00 per share. If after the acquisition Trells would own 5% or more of Tarrington, Inc., the Securities Exchange Act of 1934 requires all of the following EXCEPT


A Trells must file a report with the SEC which includes the source of her funds.
B Trells must file a report with the SEC which includes the purpose of the purchase.
C If more shares are tendered than Trells is willing to purchase, Trells must withdraw her offer.
D Trells must notify Tarrington, Inc., of her intention.

Back 29

The correct answer was C.

The Williams Act of 1968 amended many sections of the 1934 Securities Exchange Act to address problems with tender offers. Pursuant to the Williams Act, persons making a tender offer that would result in ownership of more than 5 percent of a class of registered securities must first file with the SEC and furnish to each offeree a statement that includes the background of the person or group; the source of funds used and the purpose of the acquisition; the number of shares owned; and any relevant contracts, arrangements, or understandings. In addition, the offer must be made to all holders of the class of securities sought, and a uniform price must be paid to all tendering shareholders. A shareholder may withdraw tendered shares at any time while the tender offer remains open. If the person making the offer seeks fewer than all outstanding shares and the response is oversubscribed, shares will be taken up on a pro rata basis.

Front 30

Rienzi, Act II, LLC, a domestic U.S. company, promotes opera performances throughout the world. Which of the following would make Rienzi, Act II, LLC, subject to the reporting requirements of the Securities Exchange Act of 1934?


A Rienzi, Act II, LLC, with assets of less than $1,000,000, is listed on one of the national exchanges.
B Rienzi, Act II, LLC, has issued both common and preferred stock.
C Rienzi, Act II, LLC, has gross income in excess of $2,000,000 annually.
D There are between 350 and 400 shareholders of Rienzi, Act II, LLC.

Back 30

The correct answer was A.

Companies whose securities are traded on a national securities exchange or whose assets are in excess of $10,000,000 and which have equity securities held by more than 500 persons must register under the Securities Exchange Act of 1934 and comply with its provisions.

Front 31

Rake, Comptroller of Gauge Corporation, backdated several million dollars' worth of employee stock option grants at Gauge so that they appeared to have been issued when Gauge's stock price was at a periodic low point. Rake has earned over $300,000 in profits through this scheme. Which of the following is NOT true with respect to Rake's activities?


A Rake is subject to monetary fines.
B Gauge Corporation can be sentenced to more than one year in prison.
C Rake's actions constituted a violation of the 1934 Securities Act.
D Rake would be liable for securities violations even if he had not profited from the options backdating scheme.

Back 31

The correct answer was B.

Although Rake, the individual who carried out the fraudulent scheme would be subject to criminal sanctions, including prison, a corporation cannot be imprisoned.

Front 32

On May 1, Sterling purchased 4,000 shares of Chute Enterprises, Inc., for $5,600,000 on one of the national stock exchanges. The shares plunged in value within two months due to a downturn in the economy. Sterling sold the shares on the open market for $4,400,000. Sterling brought an action for her losses alleging fraud under the Securities Exchange Act of 1934 based in part on her assertion that she was misled by assertions by Chute's president that Chute Enterprises, Inc., "was recession-proof" and "anticipates continued profits regardless whether there is a downturn in the economy." Sterling's action will


A likely fail since she will be unable to prove reliance on the president's statements.
B likely fail since the president's statements were not material.
C likely fail because the president's statements were not factual.
D likely succeed, but her action must be based upon the price of the securities as of the date suit is filed.

Back 32

The correct answer was C.

The Securities Exchange Act of 1934 prohibits actual fraud in connection with the sale of securities in interstate commerce, as well as fraudulent schemes involving the sale of securities and market manipulation. No actual fraud is present here for a variety of reason, but primarily because the statements by Chute Enterprises' president would not be considered factual since statements regarding future events are not typically expected to induce reasonable reliance.

Front 33

Puritan Cleaning Products, Inc., is subject to the reporting requirements of the Securities Act of 1934. As a result:


A Puritan Cleaning Products, Inc., is exempt from the registration requirements of the 1933 Securities Act.
B must file quarterly financial reports with the SEC.
C is excused from the requirement of filing proxy statements.
D must file a report of a tender offer, but only if the offer is for 10% or more of the company.

Back 33

The correct answer was B.

The 1934 Act requires that issuers regularly file material information with the SEC (the annual 10-K filing and the quarterly 10-Q filing). The filed reports are available to the public through EDGAR. In the event of a material event, the company must timely issue an 8-K filing that reflects these changed conditions. Tender offers for 5% or more of a registered company must be reported.

Front 34

The provisions of Section 10(b) and Rule 10b-5 of Securities Exchange Act of 1934 require that certain matters must be proven to hold a CPA or other expert liable. Which of the following does NOT have to be proven to prevail in an action under the 1934 Act?


A Scienter
B Materiality
C Damages
D Plaintiff was the buyer of the securities

Back 34

The correct answer was D.

To establish a claim for damages under Section 10(b) and Rule 10b-5 one must prove a misstatement or omission of a material fact, knowingly made (or made with reckless disregard for the truth), relied upon by the injured party, and damages. The plaintiff can be the buyer or seller of securities.

Front 35

Section 301 of the Sarbanes-Oxley Act sets forth guidelines for the establishment of public company audit committees. Which of the following provisions is/are contained in Section 301: I. No member of the audit committee shall be a member of the board of directors of the subject company. II. Each audit committee shall have the authority to engage independent counsel or other advisors as necessary to carry out its duties.


A I only is correct.
B II only is correct.
C Neither I nor II is correct.
D Both I and II are correct.

Back 35

The correct answer was B.

Section 301 of the Sarbanes-Oxley Act provides: Each member of the audit committee shall be a member of the board of directors of the issuer, and shall otherwise be independent; the audit committee of an issuer shall be directly responsible for the appointment, compensation, and oversight of the work of any registered public accounting firm employed by that issuer; the audit committee shall establish procedures for the "receipt, retention, and treatment of complaints" received by the issuer regarding accounting, internal controls, and auditing; and, each audit committee shall have the authority to engage independent counsel or other advisors, as it determines necessary to carry out its duties.