Chapter 43. Liability of Accountants

Chapter Objectives
Define an audit and describe the different types of auditor's opinions.
Describe an accountant's liability to his or her client for breach of contract and fraud.
Define accountant malpractice.
Describe an accountant's liability to third parties under the Ultramares doctrine.
Describe an accountant's liability to third parties under the Restatement (Second) of Torts and foreseeability standard.
Describe an accountant's civil liability under federal securities laws.
Describe an accountant's criminal liability under federal securities laws and other laws.
Identify when the accountant-client privilege applies.
Define accountants' work papers.
Identify the liability of other professionals.

Audits and auditor's opinions
An audit is the verification of a company's books and records pursuant to federal securities laws, state laws, and stock exchange rules that must be performed by an independent CPA. Generally, accountants must use generally accepted accounting principles (GAAPs) and generally accepted auditing standards (GAASs).

Accountant's liability to his or her client for breach of contract and fraud
Under common law, accountants may be found liable to clients who hire them under several legal theories, including contract, fraud, and negligence.

Accountant malpractice
Accountant malpractice occurs when the accountant beaches the duty of reasonable care, knowledge, skill, and judgment that he or she owes to a client when providing auditing and other accounting services to the client.

Ultramares doctrine
Under the Ultramares doctrine, an accountant is liable only for negligence to third parties who are in privity of contract (the state of two specified parties being in a contract) or privity-like relationships with the accountant. This doctrine provides the narrowest standard for holding accountants liable to third parties for negligence.

Accountant's liability to third parties
Under Section 552 of the Restatement (Second) of Torts, an accountant is liable only for negligence to third parties who are members of a limited class of intended users of the client's financial statements. This provides a broader standard for holding accountants liable to third parties for negligence than the Ultramares doctrine.

Foreseeability standard
Under the foreseeability standard, an accountant is liable for negligence to third parties who are foreseeable users of the client's financial statements. This provides the broadest standard for holding accountants liable to third parties for negligence.

Accountant's civil liability
Accountants can be liable for violating various federal and state statutes, the most important of which is federal securities laws.

Accountant's criminal liability
Accountants can be criminally liable for violating certain federal and state securities laws and for other law violations.

Accountant/client privilege
Accountant/client privilege says that an accountant cannot be called as a witness against a client in a court action in that state. About 20 states have enacted laws to that effect. Federal courts do not recognize the privilege.

Accountant's work papers
Some states have enacted statutes that say an accountant's work papers cannot be used in a court action in that state. Federal courts do not recognize this statute.

• accountant malpractice—Occurs when the accountant breaches the duty of reasonable care, knowledge, skill, and judgment that he or she owes to a client when providing auditing and other accounting services to the client.
• audit—The verification of a company's books and records pursuant to federal securities laws, state laws, and stock exchange rules that must be performed by an independent CPA.
• certified public accountant (CPA)—An accountant who has met certain educational requirements, has passed the CPA examination, and has had a certain number of years of audit experience.
• engagement—A formal entrance into a contract between a client and an accountant.
• foreseeability standard—A rule that an accountant is liable for negligence to third parties who are foreseeable users of the client's financial statements. Provides the broadest standard for holding accountants liable to third parties for negligence.
• generally accepted accounting principles (GAAPs)—Standards for the preparation and presentation of financial statements.
• generally accepted auditing standards (GAASs)—Standards for the methods and procedures that must be used to conduct audits.
• 1976 Tax Reform Act—An act that imposes criminal liability on accountants and others who prepare federal tax returns if they (1) willfully understate a client's tax liability, (2) negligently understate the tax liability, or (3) wrongfully indorse a client's tax refund check.
• privity of contract—The state of two specified parties being in a contract.
• Racketeer Influenced and Corrupt Organizations Act (RICO)—An act that provides for both criminal and civil penalties for securities fraud.
• section 10(b)—A section of the Securities Exchange Act of 1934 that prohibits any manipulative or deceptive practice in connection with the purchase or sale of any security.
• section 11(a)—A section of the Securities Act of 1933 that imposes civil liability on accountants and others for (1) making misstatements or omissions of material facts in a registration statement or (2) failing to find such misstatements or omissions.
• section 18(a)—A section of the Securities Exchange Act of 1934 that imposes civil liability on any person who makes false or misleading statements in any application, report, or document filed with the SEC.
• section 24—A section of the Securities Act of 1933 that makes it a criminal offense for any person to (1) willfully make any untrue statement of material fact in a registration statement filed with the SEC, (2) omit any material fact necessary to ensure that the statements made in the registration statement are not misleading, or (3) willfully violate any other provision of the Securities Act of 1933 or rule or regulation adopted thereunder.
• section 32(a)—A section of the Securities Exchange Act of 1934 that makes it a criminal offense for any person willfully and knowingly to make or cause to be made any false or misleading statement in any application, report, or other document required to be filed with the SEC pursuant to the Securities Exchange Act of 1934 or any rule or regulation adopted thereunder.
• Section 552 of the Restatement (Second) of Torts—A rule that an accountant is liable only for negligence to third parties who are members of a limited class of intended users of the client's financial statements. Provides a broader standard for holding accountants liable to third parties for negligence than the Ultramares doctrine.
• ultramares doctrine—A rule that an accountant is liable only for negligence to third parties who are in privity of contract or a privity-like relationship with the accountant. Provides the narrowest standard for holding accountants liable to third parties for negligence.
• Uniform Securities Act—An act that has been adopted by many states; it was drafted to coordinate state securities laws with federal securities laws.
• work product immunity—A state statute that says an accountant's work papers cannot be used in a court action in that state; federal courts do not recognize this statute.

Internet Links
Enron: www.insworld.com/web/broker/assurex_global/archive/cmar02.html
AccountingMalpractice.com: www.accountingmalpractice.com/
American Accounting Association: www.accounting.rutgers.edu/raw/aaa/