Chapter 20 – Legal Liability
38. Which of the following statements is (are) correct regarding the common law elements that
must be proven to support a finding of constructive fraud against a CPA?
I. The plaintiff has justifiably relied on the CPA’s misrepresentation.
II. The CPA has acted in a grossly negligent manner.
39. Quincy bought Teal Corp. common stock in an offering registered under the Securities Act
of 1933. Worth & Co., CPAs, gave an unqualified opinion on Teal’s financial statements that
were included in the registration statement filed with the SEC. Quincy sued Worth under the
provisions of the 1933 Act that deal with omission of facts required to be in the registration
statement. Quincy must prove that
Chapter 20 – Legal Liability
40. To be successful in a civil action under Section 11 of the Securities Act of 1933 concerning
liability for a misleading registration statement, the plaintiff must prove
41. While conducting an audit, Larson Associates, CPAs, failed to detect material
misstatements included in its client’s financial statements. Larson’s unqualified opinion was
included with the financial statements in a registration statement and prospectus for a public
offering of securities made by the client. Larson knew that its opinion and the financial
statements would be used for this purpose. Which of the following statements is correct with
regard to a suit against Larson and the client by a purchaser of the securities under Section 11 of
the Securities Act of 1933?
Chapter 20 – Legal Liability
42. Under Section 11 of the Securities Act of 1933, which of the following standards may a
CPA use as a defense?
43. Which statement is correct concerning an auditor’s statutory legal liability?
Chapter 20 – Legal Liability
44. Rule 10b-5 under Section 10(b) of the Securities Exchange Act of 1934 imposes liability on
an accountant for violation of certain duties. Which of the following is an investor not required
to prove to recover from a CPA?
45. West & Company, CPAs, was engaged by Sand Corporation to audit its financial
statements. West issued an unqualified opinion on Sand’s financial statements. Sand has been
accused of making negligent misrepresentations in the financial statements that Reed relied
upon when purchasing Sand’s stock. West was not aware of the misrepresentations and was not
negligent in performing the audit. If Reed sues West for damages based on Section 10(b) and
Rule 10b-5 of the Securities Exchange Act of 1934, West will
Chapter 20 – Legal Liability
46. Which of the following is something that the plaintiff must prove in order for an accountant
to be liable for damages under Section 10(b) and Rule 10b-5 of the Securities Exchange Act of
1934?
47. Under the antifraud provisions of Section 10(b) of the Securities Exchange Act of 1934, a
CPA may be liable if the CPA acted
Chapter 20 – Legal Liability
48. Jay and Co., CPAs, audited the financial statements of Maco Corp. Jay intentionally gave
an unqualified opinion on the financial statements even though material misstatements were
discovered as a result of the audit. The financial statements and Jay’s unqualified opinion were
included in a 10-K (annual report filed with the SEC) for the company. Which of the following
statements is correct regarding Jay’s liability to a purchaser of the offering under Section 10(b)
and Rule 10b-5 of the Securities Exchange Act of 1934?
49. In regards to the Foreign Corrupt Practices Act (FCPA), external auditors
Chapter 20 – Legal Liability
50. This act increased protection available to whistleblowers.
51. The Foreign Corrupt Practices Act requires that
Chapter 20 – Legal Liability
52. When performing an audit, a CPA will most likely be considered negligent when the CPA
fails to
53. Which of the following is the best defense a CPA firm can assert in a suit for common law
fraud based on its unqualified opinion on materially false financial statements?
Chapter 20 – Legal Liability
54. While conducting an audit, Larson Associates, CPAs, failed to detect material
misstatements included in its client’s financial statements. Larson’s unqualified opinion was
included with the financial statements in a registration statement and prospectus for a public
offering of securities made by the client. Larson knew that its opinion and the financial
statements would be used for this purpose. In suit by a purchaser against Larson for
common-law fraud, Larson’s best defense would be that
55. In general, the third-party (primary) beneficiary rule as applied to a CPA’s legal liability in
conducting an audit is relevant to which of the following causes of action against a CPA?
Chapter 20 – Legal Liability
56. Under the liability provisions of Section 11 of the Securities Act of 1933, a CPA may be
liable to any purchaser of a security for certifying materially misstated financial statements that
are included in the security’s registration statement. Under Section 11, a CPA usually will not
be liable to the purchaser
57. Under the liability provisions of Section 11 of the Securities Act of 1933, a CPA may be
liable to any purchaser of a security for certifying materially misstated financial statements that
are included in the security’s registration statement. Under Section 11, which of the following
must be proven by a purchaser of the security?
Chapter 20 – Legal Liability
58. Under the liability provisions of Section 11 of the Securities Act of 1933, an auditor may
help to establish the defense of due diligence if
I. The auditor performed an additional review of the audited statements to ensure that the
statements were accurate as of the effective date of a registration statement.
II. The auditor complied with GAAS.
59. Ocean and Associates, CPAs, audited the financial statements of Drain Corporation. As a
result of Ocean’s negligence in conducting the audit, a material misstatement in the financial
statements went undetected. Ocean was unaware of this fact. The financial statements and
Ocean’s unqualified opinion were included in a registration statement and prospectus for an
initial public offering of stock by Drain. Sharp purchased shares in the offering. Sharp received
a copy of the prospectus prior to the purchase but did not read it. The shares declined in value as
a result of the misstatements in Drain’s financial statements becoming known. Under which of
the following acts is Sharp most likely to prevail in a lawsuit against Ocean?
Chapter 20 – Legal Liability
60. The Sarbanes-Oxley Act of 2002 is considered the most sweeping securities law since the
1933 and 1934 Acts. Which item in the list below was not part of the Sarbanes-Oxley Act of
2002?
61. Auditors can be held liable under two classes of law when sued by clients, investors,
creditors, or the government. Identify and briefly explain both classes of law.
Chapter 20 – Legal Liability
62. Suits are often brought against auditors that allege that the auditors did not detect some type
of fraud or defalcation. List the six defenses that the auditors could mount against client
negligence claims.
The six defenses that the auditors could mount against client negligence claims include:
63. The most restrictive view under common law is that auditors have no liability to third
parties who do not have a privity relationship with the auditor. Briefly define privity and the
effect it has on the auditor, client, investors, and creditors under common law.
Chapter 20 – Legal Liability
64. Section 11 under the Securities Act of 1933 treats claims against auditors more favorably
than common law. What two things does a plaintiff need to prove to have a case against the
auditor of a company in which she purchased new investments? What does the auditor have to
do to have the case dismissed?
65. One of the greatest sources of liability for auditors under the 1934 Act is Section 10(b) and
the related Rule 10b-5 which states that it is unlawful for any person to defraud, make any
untrue statement of a material fact, or engage in any act in connection with the purchase or sale
of a security. Once a plaintiff has established that he or she can sue under Rule 10b-5, there are
four elements that must be proven. List the four elements.
Chapter 20 – Legal Liability
66. What type of liability has the Private Securities Litigation Reform Act of 1995 created for
cases filed under federal statutory law? How did this change from previous legislation? How
has this impacted the cases against auditors and the way cases are now presented?
Chapter 20 – Legal Liability
67. Briefly describe the Sarbanes-Oxley Act of 2002. Be sure to mention (1) who passed the act,
(2) its primary objectives, (3) major aspects of the act, (4) the parties that it affects, and (5) its
relationship to the SEC rules.
Chapter 20 – Legal Liability
68. The Sarbanes-Oxley Act of 2002 grants the PCAOB the ability to undertake two functions
over registered public accounting firms and persons associated with such firms. Briefly explain
the purpose of the PCAOB, making sure to reference their two major functions.