978-1285770178 Solution Manual BL ComLaw 1e SM-Ch27

in whole or in part.

4 UNIT SIX: GOVERNMENT REGULATION

in whole or in part.

CASE 27.3—QUESTIONS (PAGE 532)

WHAT IF THE FACTS WERE DIFFERENT?

If Todman had conducted an audit for DBI but had not issued a certified opinion about

DBI’s financial statements, would the result in this case have been the same? Explain.

The court noted in this case that “if an accountant does not issue a public opinion about a

company, although it may have conducted internal audits or reviews for portions of the

company, the accountant cannot subsequently be held responsible for the company’s public

statements issued later merely because the accountant may know those statements are likely

untrue.”

case, when an accountant issues a certified opinion, it creates a special relationship with

investors. Thus, accountants have a duty to take reasonable steps to correct misstatements that

they discover in previous financial statements on which they know the public is relying. The

applied standard here is that silence in this situation can constitute a false or misleading

statement under Section 10(b) and Rule 10b-5.

complying with GAAP and acting in good faith are defenses only to a prima facie case and do

not excuse liability in every case. Shuebke could argue that her mistake was not due to

negligence, and a court might or might not agree with her, yet conforming to GAAP and acting in

good faith are not failsafe defenses.

question is whether Chase prepared the audit, knowing that Superior would ultimately rely on it.

If so, Chase could be liable under the Restatement rule.

CHAPTER 27: PROFESSIONAL LIABILITY AND ACCOUNTABILITY 5

in whole or in part.

3A. Recovering under Section 10(b) and Rule 10b-5

To be liable for fraud under the 1934 act and Rule 10b-5, an accountant must make untrue

statements or omissions of material facts that render financial statements misleading in

connection with a purchase or sale of securities. Chase clearly did this, failing to conform to

GAAP and preparing a statement that was materially misleading. The 1934 act also requires

that the plaintiff prove intent (scienter) to commit the fraudulent or deceptive act. Superior is able

to do this, having come into possession of an email exchange between Chase and Regal CEO

Buddy Gantry. Therefore, Superior meets all the requirements and can recover damages under

understatement of tax liability. For a willful understatement, the penalty may be $1,000.

Additional penalties of up to $10,000 may apply for aiding and abetting an understatement.

ANSWER TO DEBATE THIS QUESTION IN THE REVIEWING FEATURE

AT THE END OF THE CHAPTER

are no longer in this formerly enviable position because foreign companies don’t want to pay the

huge cost of complying with the Sarbanes-Oxley Act.

Accounting scandals occur not only with the largest U.S. publicly held companies, but

with smaller ones, too. If we exempted all but this country’s largest publicly held corporations

from Sarbanes-Oxley, we would see increased accounting irregularities throughout the

1A. 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

6 UNIT SIX: GOVERNMENT REGULATION

in whole or in part.

accountant knows that the bank will use the statement, the bank is a foreseeable user. A

for negligence.

2A. 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

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.

Patterson’s decision to become creative in his accounting, and hence to abandon generally

accepted accounting principles, will be considered prima facie evidence of negligence on his

part. Under the traditional Ultramares rule, an accountant did not owe any duty to a third person

with whom he or she had no direct contractual relationship. Thus, Tucker could not hold

Patterson liable for negligence because there was no direct contractual relationship between the

of Goldman, Walters, Johnson & Co. will be held liable to Happydays State Bank for negligent

preparation of financial statements. There are various policy reasons for holding accountants

liable to third parties even in the absence of privity. The potential liability would make accoun–

tants more careful in the preparation of financial statements. Moreover, in some situations the

accountants may be the only solvent defendants, and hence, unless liability is imposed on

8 UNIT SIX: GOVERNMENT REGULATION

in whole or in part.

27–6A. Professional malpractice

(Chapter 27—Page 521)

The trial court rejected these claims and the appeals court affirmed. Since the matter concerned

malpractice in litigation, the standard is the same as is applied in cases of legal malpractice. To

prevail on a claim of professional malpractice, a client must show that: (1) he employed an

attorney; (2) the attorney failed to exercise ordinary care, skill, and diligence; and (3) the

attorney’s negligence was the proximate cause of damage to client. Guerrero’s affidavit was

insufficient to show that alleged negligence by McDonald, who represented him in the Tax Court

challenging corporate tax rulings of the IRS, proximately caused, as an element of the

choice of trial tactics or strategy or the good faith exercise of professional judgment.

27–7A. BUSINESS CASE PROBLEM WITH SAMPLE ANSWER—Potential liability to third

parties

KPMG is potentially liable to the hedge funds’ partners under the Restatement (Second) of

accepted accounting principles. As a result, they lost millions of dollars, which exposes KPMG

to possible liability under Section 552.

27-8A. A QUESTION OF ETHICS—Liability for negligence

(a) The court granted Macdonald Page’s motion to dismiss. Frank appealed to the

element in Frank’s case was causation—that is, that “Macdonald Page’s negligent valuation

caused him to receive less than fair market value for his shares.”

For a negligent act “to constitute proximate cause, the act or omission must be a

substantial factor in bringing about the harm and the injury incurred must have been a

reasonably foreseeable consequence” or a direct result. “The mere possibility of such causation

in whole or in part.