978-0134004006 Chapter 51 Case

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Chapter 51
Accountants’ Duties and Liability
VI. Answers to Critical Legal Thinking Cases
51.1 Accountant’s Liability to a Third Party
No, George Korbakes & Company, LLP (GKCO), the auditor of Brandon Apparel Group, Inc. (Brandon),
is not liable to Johnson Bank for negligent misrepresentation under Section 552 of the Restatement
(Second) of Torts. Under Section 552, an accountant is liable for his or her negligence to any member of a
limited class of intended users for whose benefit the accountant has been employed to prepare the client’s
financial statements or to whom the accountant knows the client will supply copies of the financial
statements. At the time GKCO prepared the most recent audit and financial statements for Brandon, it did
not know that Brandon would later provide those financial statements to Johnson Bank to obtain further
51.2 Auditor’s Liability to Third Party
No, Ernst & Whinney is not liable for either fraud or negligence in this case. To be held for fraud, a party
Ernst & Whinney was not liable to Hutton for fraud. With regards to the negligence claim, the court held
that Ernst & Whinney was not liable for negligence to Hutton either. This was because the court found
and negligence. E.F. Hutton Mortgage Corporation v. Pappas, 690 F.Supp. 1465, 1988 U.S. Dist. Lexis
6444 (United States District Court for the District of Maryland)
51.3 Accountant’s Liability to Third Party
to third parties:
1. The Ultramares Doctrine. Under the Ultramares doctrine, an accountant is only liable for his
negligence to third parties who are in privity of contract or a privity-type relationship with the
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for its negligence.
2. Section 552 of the Restatement. (Second) of Torts. Under Section 552, an accountant may be
held liable for his negligence to any member of a limited class of intended users for whose benefit
them in their sale of their business to Giant. The Rosenblums did not qualify as “intended users”
of the financial statements. Therefore, Touche did not owe a duty to the Rosenblums and is not
Torts.
3. The Foreseeability Standard. The foreseeability standard stipulates that accountants are liable for
their negligence to any foreseeable user of the client’s financial statements. This is the broadest
standard of liability for accounting malpractice. Under this standard, Touche would be liable to
The Supreme Court of New Jersey adopted the foreseeability standard for judging an accountant’s
negligence liability to third parties. The court stated:
When the independent auditor furnishes an opinion with no limitation in the certificate as
to whom the company may disseminate the financial statements, he has a duty to all those
The court found that the Rosenblums were foreseeable recipients of the financial statements and that they
51.4 Ultramares Doctrine
Following is a discussion of Cooper’s liability under the three major theories of accountants’ tort liability
to third parties:
1. The Ultramares Doctrine. Under the Ultramares doctrine, an accountant is only liable for his
negligence to third parties who are in privity of contract or a privity-type relationship with the
accountant. Here, the Lindner Funds were not in privity of contract or a privity-type relationship
whose guidance Coopers prepared the financial statements. Therefore, under Section 552 of the
Restatement (Second) of Torts, Coopers did not owe a duty to the Lindner Funds and is not liable
to them for their alleged negligence.
The Missouri Court of Appeals took this middle ground and chose to apply a balancing test to
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3. The Foreseeability Standard. The foreseeability standard stipulates that accountants are liable for
their negligence to any foreseeable user of the client’s financial statements. This is the broadest
Lindner Fund v. Abney, 770 S.W.2d 437, 1989 Mo. App. Lexis 490 (Court of Appeals of Missouri)
51.5 Section 10(b)
Yes, Laventhol is liable for violating Section 10(b) of the Securities Exchange Act of 1934. Section 10(b)
relied on the audited financial statements and might not have purchased Firestone’s securities if they had
known the truth about that sale. The court found that Laventhol’s labeling of the $1,750,000 as “deferred
gross profit”—as opposed to “unrealized gross profit”—gave the erroneous impression that the profit was
cash in hand that only had to be recorded in the future. Here, the court held that Laventhol acted with
51.6 AccountantClient Privilege
Roberts, the client, wins. Chaple, the accountant, was bound by Georgia’s accountant-client privilege. A
state’s accountant-client privilege prevents an accountant from disclosing information about a client or
becoming a witness against the client in state court proceedings. The court held that the purpose of the
federal government, is investigating Roberts for violation of the Internal Revenue Code, a federal law.
Therefore, if the IRS issued an administrative summons or subpoena to Chaple requesting the confidential
information about Roberts, the Georgia accountant-client privilege could not be asserted to prevent
disclosure of this information to the IRS. Because the IRS could eventually issue such a summons or
VII. Answers to Ethics Cases
51.7 Ethics Case
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the audit program by not obtaining a copy of the stop-loss policy from Lloyd’s and not verifying the
existence of the insurance. If Coopers had done so, the court found, McGee’s defalcations would have
Lexis 5348 (Court of Appeal of Florida)
51.8 Ethics Case
Yes, Howard is criminally liable for violating Section 24 of the Securities Act of 1933. Section 24 makes
it a crime for any person to “willfully” violate any provision of the 1933 Act. The court found that
willful and knowing commission of a crime definitely qualifies as unethical conduct. United States v.
Howard, 328 F.2d 854, 1964 U.S. App. Lexis 6343 (United States Court of Appeals for the Second
Circuit)

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