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CHAPTER 27: PROFESSIONAL LIABILITY AND ACCOUNTABILITY 19
whole or in part.
retrieve, analyze, and report the data that is entered into it. When people enter the data, mistakes are
sometimes made. Because of the widely held notion that computers are infallible, however, whatever a
computer does with data is generally accepted. This can turn what may have been a small error into a major
blunder. How might the losses in such cases be avoided?
Cyberlaw Link
What effect might the availability of financial documents on the Web have on the liability of
auditors for the contents of those documents? Does the existence of the Internet change the
definition of “foreseeable third party”?
be liable to clients for breach of contract, negligence, or fraud. A professional’s failure to perform according to the
terms of a contract may constitute a breach for which a client may recover damages for expenses to secure the
services elsewhere, for penalties imposed for failing to meet deadlines, and for any other reasonable and foreseeable
losses. A professional may be liable for negligence in performing a contract. Professionals are also subject to
standards of conduct established by ethics codes, statutes, and judicial decisions, and by their contracts, and must
principles (GAAP) and generally accepted auditing standards (GAAS). GAAP consist of conventions, rules, and
procedures set by the Federal Accounting Standards Board. GAAS are established by the American Institute of
Certified Public Accountants and concern professional qualities and the judgment that an auditor exercises in
performing an examination and report. An accountant who conforms to GAAP and acts in good faith will not be liable
to a client for incorrect judgment. An accountant may be liable if an impropriety, defalcation, or fraud in a client’s
that indicate misstatements have been made or fraud has been committed.
3. How can a professional limit his or her liability? Professionals can limit their liability to some extent by
disclaiming it, though not all disclaimers are effective in all circumstances. Professionals may be able to limit their
liability for the misconduct of other professionals with whom they work by organizing their business as a professional
whole or in part.
several alternatives. For example, if a client believes that, in regard to his or her case, the attorney is acting
improperly or is not doing something that the client believes should be done, the client can discuss the situation with
the attorney. This is also a starting point when a client loses his or her case and is unhappy that he or she must
nevertheless pay the attorney’s bill, plus other expenses. If a client is upset with the way the attorney handled the
case, the client can file a complaint with the state bar association or the disciplinary board of the state supreme court.
demonstrate that he or she exercised due diligence in preparing the statements (failure to follow GAAP and GAAS
shows a lack of due diligence). An accountant must show that he or she had, “after reasonable investigation,
reasonable grounds to believe and did believe, at the time such part of the registration statement became effective,
that the statements therein were true and that there was no omission of a material fact required to be stated therein or
necessary to make the statements therein not misleading.” An accountant must verify information that corporate
7. How might an accountant be liable under the Securities Exchange Act of 1934? An accountant may be
liable for fraud under Sections 18 or 10(b) of the Securities Exchange Act of 1934 or SEC Rule 10b-5. (An accountant
does not need to prove due diligence to escape liability under these provisions.) Section 18. Section 18 imposes civil
liability on an accountant who makes or causes to be made in any application, report, or document a statement filed
with the SEC that at the time, in light of the circumstances, was false or misleading as to any material fact. This
showing good faith, an accountant may show that the buyer or seller knew that the statement was false and
misleading. To a successful seller or buyer, an accountant may be liable for costs, including attorneys’ fees. Section
10(b). Under Section 10(b), it is unlawful for any person to use, in connection with the purchase or sale of any
security, any manipulative or deceptive device or contrivance in contravention of SEC rules and regulations. Rule
10b-5. Under Rule 10b-5, it is unlawful for any person, by use of any means or instrumentality of interstate commerce
whole or in part.
not necessary) for any oral or written fraudulent statements or omissions made in connection with the purchase or
property. Disclosure of their contents, however, would constitute a breach of the accountant’s fiduciary duty to the
client.
9. What are a client’s rights in regard to working papers? A client has a right of access to working papers
and must give permission before they can be transferred to another accountant. Without the client’s permission or a
order, without the client’s permission. (This privilege is granted because of the need for full disclosure to the attorney
of the facts of a client’s case.) In a few states, accountant-client communications are privileged by state statute. In
most states, however, an accountant must disclose information about his or her client under a court order.
Professional-client communications, except those between an attorney and his or her client, are not privileged under
federal law. Federal law does not recognize state-provided rights to the confidentiality of accountant-client
the students’ state is one of the few in which accountant-client communications are privileged, and if they are not
privileged, the extent to which accountant-client confidentiality is protected; (2) crimes for which accountants may be
particularly liable, and criminal penalties; and (3) the common law liability of accountants—that is, cases in which they
have been charged with negligence, breach of contract, or fraud.
(SEC) in February 1996 and sell the stock on May 2. The SEC required OSM to restate its 1994 statements. This
delayed the public offering until June 13, when, due to unrelated factors, the stock price was lower than it had been
on May 2. OSM filed a suit in an Oregon state court against Coopers, claiming that its advice regarding the 1994
transaction was negligent and caused the delay. The court issued, in Coopers’ favor, a summary judgment, which a
state intermediate appellate court reversed. Coopers appealed. In Oregon Steel Mills, Inc. v. Coopers & Lybrand,
whole or in part.
the appropriate focus because the protection of the public is the purpose of, and the reason for, the rules of
criminal act that reflects adversely on the lawyer's honesty, trustworthiness or fitness as a lawyer, even if the attorney
is never charged or convicted. The court also held that the rules, which prohibit a lawyer from committing a criminal
act that reflects adversely on the lawyer's honesty or trustworthiness, or fitness as a lawyer, do not require a
connection between the act and any legal services that the lawyer renders. Further, the court ruled that a criminal act
can reflect adversely on a lawyer's fitness, in violation of the rules, even if the act does not cause the attorney to
CHAPTER 27: PROFESSIONAL LIABILITY AND ACCOUNTABILITY 25
1. Dave, an accountant, prepares a financial statement for Excel Company, a client, knowing that
Excel will use the statement to obtain a loan from First National Bank. Dave makes negligent
omissions in the statement that result in a loss to the bank. Can the bank successfully sue Dave?
Why or why not? Yes. In these circumstances, when the accountant knows that the bank will use the
statement, the bank is a foreseeable user. A foreseeable user is a third party within the class of parties to
whom an accountant may be liable for negligence.
2. Nora, an accountant, prepares a financial statement as part of a registration statement that
Omega, Inc., files with the Securities and Exchange Commission before making a public offering of
securities. The statement contains a misstatement of material fact that is not attributable to Nora’s
fraud or negligence. Pat relies on the misstatement, buys some of the securities, and suffers a loss.
Can Nora be held liable to Pat? Explain. No. In the circumstances described in the problem, the accountant
will not be held liable to a purchaser of the securities. No. In the circumstances described, the accountant will
not be held liable to a purchaser of the securities. Although an accountant may be liable under securities laws
for including untrue statements or omitting material facts from financial statements, due diligence is a defense
to liability. Due diligence requires an accountant to conduct a reasonable investigation and have reason to
believe that the financial statements were true at the time. The facts say that the misstatement of material fact
in Omega’s financial statement was not attributable to any fraud or negligence on Nora’s part. Therefore,
Nora can show that she used due diligence and will not be held liable to Pat.
whole or in part.
several alternatives. For example, if a client believes that, in regard to his or her case, the attorney is acting
improperly or is not doing something that the client believes should be done, the client can discuss the situation with
the attorney. This is also a starting point when a client loses his or her case and is unhappy that he or she must
nevertheless pay the attorney’s bill, plus other expenses. If a client is upset with the way the attorney handled the
case, the client can file a complaint with the state bar association or the disciplinary board of the state supreme court.
demonstrate that he or she exercised due diligence in preparing the statements (failure to follow GAAP and GAAS
shows a lack of due diligence). An accountant must show that he or she had, “after reasonable investigation,
reasonable grounds to believe and did believe, at the time such part of the registration statement became effective,
that the statements therein were true and that there was no omission of a material fact required to be stated therein or
necessary to make the statements therein not misleading.” An accountant must verify information that corporate
7. How might an accountant be liable under the Securities Exchange Act of 1934? An accountant may be
liable for fraud under Sections 18 or 10(b) of the Securities Exchange Act of 1934 or SEC Rule 10b-5. (An accountant
does not need to prove due diligence to escape liability under these provisions.) Section 18. Section 18 imposes civil
liability on an accountant who makes or causes to be made in any application, report, or document a statement filed
with the SEC that at the time, in light of the circumstances, was false or misleading as to any material fact. This
showing good faith, an accountant may show that the buyer or seller knew that the statement was false and
misleading. To a successful seller or buyer, an accountant may be liable for costs, including attorneys’ fees. Section
10(b). Under Section 10(b), it is unlawful for any person to use, in connection with the purchase or sale of any
security, any manipulative or deceptive device or contrivance in contravention of SEC rules and regulations. Rule
10b-5. Under Rule 10b-5, it is unlawful for any person, by use of any means or instrumentality of interstate commerce
whole or in part.
not necessary) for any oral or written fraudulent statements or omissions made in connection with the purchase or
property. Disclosure of their contents, however, would constitute a breach of the accountant’s fiduciary duty to the
client.
9. What are a client’s rights in regard to working papers? A client has a right of access to working papers
and must give permission before they can be transferred to another accountant. Without the client’s permission or a
order, without the client’s permission. (This privilege is granted because of the need for full disclosure to the attorney
of the facts of a client’s case.) In a few states, accountant-client communications are privileged by state statute. In
most states, however, an accountant must disclose information about his or her client under a court order.
Professional-client communications, except those between an attorney and his or her client, are not privileged under
federal law. Federal law does not recognize state-provided rights to the confidentiality of accountant-client
the students’ state is one of the few in which accountant-client communications are privileged, and if they are not
privileged, the extent to which accountant-client confidentiality is protected; (2) crimes for which accountants may be
particularly liable, and criminal penalties; and (3) the common law liability of accountants—that is, cases in which they
have been charged with negligence, breach of contract, or fraud.
(SEC) in February 1996 and sell the stock on May 2. The SEC required OSM to restate its 1994 statements. This
delayed the public offering until June 13, when, due to unrelated factors, the stock price was lower than it had been
on May 2. OSM filed a suit in an Oregon state court against Coopers, claiming that its advice regarding the 1994
transaction was negligent and caused the delay. The court issued, in Coopers’ favor, a summary judgment, which a
state intermediate appellate court reversed. Coopers appealed. In Oregon Steel Mills, Inc. v. Coopers & Lybrand,
whole or in part.
the appropriate focus because the protection of the public is the purpose of, and the reason for, the rules of
criminal act that reflects adversely on the lawyer's honesty, trustworthiness or fitness as a lawyer, even if the attorney
is never charged or convicted. The court also held that the rules, which prohibit a lawyer from committing a criminal
act that reflects adversely on the lawyer's honesty or trustworthiness, or fitness as a lawyer, do not require a
connection between the act and any legal services that the lawyer renders. Further, the court ruled that a criminal act
can reflect adversely on a lawyer's fitness, in violation of the rules, even if the act does not cause the attorney to
CHAPTER 27: PROFESSIONAL LIABILITY AND ACCOUNTABILITY 25
1. Dave, an accountant, prepares a financial statement for Excel Company, a client, knowing that
Excel will use the statement to obtain a loan from First National Bank. Dave makes negligent
omissions in the statement that result in a loss to the bank. Can the bank successfully sue Dave?
Why or why not? Yes. In these circumstances, when the accountant knows that the bank will use the
statement, the bank is a foreseeable user. A foreseeable user is a third party within the class of parties to
whom an accountant may be liable for negligence.
2. Nora, an accountant, prepares a financial statement as part of a registration statement that
Omega, Inc., files with the Securities and Exchange Commission before making a public offering of
securities. The statement contains a misstatement of material fact that is not attributable to Nora’s
fraud or negligence. Pat relies on the misstatement, buys some of the securities, and suffers a loss.
Can Nora be held liable to Pat? Explain. No. In the circumstances described in the problem, the accountant
will not be held liable to a purchaser of the securities. No. In the circumstances described, the accountant will
not be held liable to a purchaser of the securities. Although an accountant may be liable under securities laws
for including untrue statements or omitting material facts from financial statements, due diligence is a defense
to liability. Due diligence requires an accountant to conduct a reasonable investigation and have reason to
believe that the financial statements were true at the time. The facts say that the misstatement of material fact
in Omega’s financial statement was not attributable to any fraud or negligence on Nora’s part. Therefore,
Nora can show that she used due diligence and will not be held liable to Pat.
