CHAPTER 48
PROFESSIONAL LIABILITY
AND ACCOUNTABILITY
ANSWERS TO QUESTIONS
AT THE ENDS OF THE CASES
CASE 48.1—QUESTIONS (PAGE 937)
WHAT IF THE FACTS WERE DIFFERENT?
Suppose that Walsh had not been a CPA but had falsely advertised himself as a CPA. Could sanctions
have been imposed under those circumstances? Explain why or why not. Yes. There is a sufficient
connection between the practice of accountancy and a person’s misrepresenting himself as a CPA. The
Nebraska State Board of Public Accountancy could have imposed sanctions on Walsh for improperly
advertising that he was a CPA. And there may have been other legal consequences. (In fact, Walsh did
improperly advertise himself as a CPA. He had been licensed for several years but had failed to meet the
continuing education requirements. Despite this failure to comply, he had advertised that he was a CPA
without including a disclaimer that he was an “inactive registrant.” The board had imposed sanctions for
this transgression.)
THE ETHICAL DIMENSION
Was the specific purpose for Walsh’s impersonation significant to the result in this case? Why or why
not? No. The misrepresentation could have been for almost any purpose. It was the ethical breach
CASE 48.2—QUESTIONS (PAGE 940)
1A. If the children had suffered no harm as a result of the attorney’s malpractice, would the outcome
of this case have been different? Why or why not? Yes. In fact, very likely there would not be a case,
because Guido sought to recover damages only for the children (realizing that she had no chance of
recovering because the Statute of Limitations had expired). Because of the attorney’s malpractice,
Guido was unable to proceed with the wrongful death suit against the hit-and-run driver who was
responsible for the death of the children’s father. It is possible that she could have won a significant
amount of damages in that lawsuit for the children’s sake. Because of the attorney’s malpractice, the
children were deprived of these potential damages. If, however, it would have been impossible to
obtain damages for the children (an unlikely scenario), then the children would have suffered no harm,
and there would have been no reason for the lawsuit in the first place. Generally, the courts consider a
number of factors when deciding whether an attorney’s duty extends to third parties in a particular
situation or transaction. One of these factors—the extent to which the transaction was intended to
affect the third party—was stressed by the court in this case. The court noted that the children were
the direct and intended beneficiaries of the attorney-client contract, or relationship. Another factor is
the degree of certainty that the third party suffered injury. Still other factors include the foreseeability
of harm, the closeness of the connection between the attorney’s conduct and the injury suffered, the
policy of preventing future harm, and whether recognition of liability under the circumstances would
impose an undue burden on the legal profession. As you can see, in this case most of these factors
weighed in favor of holding the attorney liable to the children.
2A. Why did the court affirm the dismissal of Guido’s individual claim but not the claims that she had
brought on behalf of the children? Guido’s claim was dismissed because she had not filed the
CASE 48.3—QUESTIONS (PAGE 947)
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.”
THE LEGAL ENVIRONMENT DIMENSION
CHAPTER 48: PROFESSIONAL LIABILITY AND ACCOUNTABILITY 421
Did Overton have a valid reason to sue DBI’s auditors? Why or why not? Yes, the investors were
dissatisfied with the result of their investment and looked for the most likely scapegoat, which here was
the accountant. Sometimes, one must simply suffer the consequence of a bad turn o fate. No, because
ANSWERS TO QUESTIONS IN THE REVIEWING FEATURE
AT THE END OF THE CHAPTER
1A. Failing to detect material omissions
What constitutes negligence may vary according to judicial decision and state statutes, but 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.
2A. Applying the majority rule
The majority of courts apply the principles set out in the Restatement (Second) of Torts, which hold an
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 the Securities Exchange Act of 1934.
4A. Understating tax liability
422 UNIT NINE: GOVERNMENT REGULATION
Aiding or assisting in the preparation of a false tax return is a felony punishable by a fine of up to
$100,000 in the case of an individual ($500,000 in the case of a corporation) and imprisonment of up to
three years. A penalty of $250 per return may be assessed for negligent 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
Only the largest publicly held companies should be subject to the Sarbanes-Oxley Act. All U.S.
publicly held companies, other than the very largest, are at a competitive advantage compared to similar
countries in Europe and Asia. Why? Because they have to spend, in total, billions a year satisfying
Sarbanes-Oxley reporting requirements. The U.S. used to be the preferred country to list a foreign
ANSWERS TO QUESTIONS AND CASE PROBLEMS
AT THE END OF THE CHAPTER
48-1A. The Ultramares rule
(Chapter 48—Pages 938–939)
Patterson’s decision to become creative in his accounting, and hence to abandon generally accepted
48-2A. QUESTION WITH SAMPLE ANSWER: The Restatement rule
CHAPTER 48: PROFESSIONAL LIABILITY AND ACCOUNTABILITY 423
Assuming that the court has abandoned the Ultramares rule, it is likely that the accounting firm of
Goldman, Walters, Johnson & Co. will be held liable to Happydays State Bank for negligent preparation
48-3A. Accountants’ liability under Rule 10b-5
(Chapter 48—Pages 1059–1060)
48-4A. Liability for fraud
(Chapter 48—Pages 936–937)
Greenen could be ordered to take a CPA ethics exam and an ethics course, and to pay a fine. (In fact, this
48-5A. CASE PROBLEM WITH SAMPLE ANSWER: Accountant’s liability for audit
The appeals court vacated the order of the Comptroller. The court noted that external auditing of the
48–6A. Professional’s liability
(Chapter 48—Pages 933 & 935–937)
424 UNIT NINE: GOVERNMENT REGULATION
Among the grounds for professional liability discussed in this chapter, DeYoung might file a suit against
Ruggerio for breach of contract, or fiduciary duty; malpractice (professional negligence); and fraud. She
might also file a criminal complaint against him for fraud. He has also violated the attorney’s duty of care
and other professional responsibility and ethical standards. By surreptitiously diverting the children’s
inheritance to his own account, Ruggerio failed to perform as he agreed in his contract with DeYoung.
For this breach, DeYoung might recover the funds (compensatory damages), the expense to secure
another professional to secure the funds (incidental damages), and other reasonable and foreseeable
losses, including interest. Ruggerio failed to exercise reasonable care and professional judgment,
thereby breaching the duty of care that all attorneys owe their clients. For this breach, Ruggerio can be
48–7A. Professional malpractice
(Chapter 48—Page 936)
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
48-8A. A QUESTION OF ETHICS: Liability for negligence
CHAPTER 48: PROFESSIONAL LIABILITY AND ACCOUNTABILITY 425
(a) The court granted Macdonald Page’s motion to dismiss. Frank appealed to the U.S. Court
of Appeals for the First Circuit, which reversed the lower court’s judgment and remanded the case for
further proceedings to resolve the “many factual questions and matters of proof.”
The elements to a negligence claim are (1) the existence of a duty of care, (2) a breach of that
duty, (3) an injury to the plaintiff, and (4) a determination that the proximate cause of the injury was the
breach of the duty. Here, the appellate court recognized that the most critical 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.”
The lower court concluded that Frank could not establish causation because nothing in the
Shareholders’ Agreement or otherwise required him to accept Donna’s offer to buy his stock at the
Macdonald Page price. Instead, under the Shareholders’ Agreement, Frank was obligated to accept
Donna’s offer “only if and when he determined that he was unwilling to offer more money per share to
purchase her stock.” The court opined that Frank “had many options, ranging from challenging the
appraisal in any of a number of ways to offering Donna Holden the same amount per share to offering
her more per share.” Thus, Macdonald Page’s valuation was not and could not have been a cause,
substantial or otherwise, of Frank’s loss.
The appellate court interpreted the Shareholders’ Agreement differently. Hiring Macdonald Page
was “the first step in potentially resolving the stalemate. It was Macdonald Page’s role to provide a
valuation that the parties would use to begin a bidding process. . . . Macdonald Page’s figure was to
serve as a floor—the lowest possible bid. To say that a negligently-arrived-at valuation that set an
artificially low floor would not have a substantial effect on a shareholder in [Frank’s] position ignores the
logic of cause and effect.” Frank was not compelled to accept Donna’s offer, but “he had the absolute
right to accept Ms. Holden’s offer so long as it equaled or exceeded Macdonald Page’s valuation figure.
And that meant he had the right to rely on Macdonald Page to generate a valuation that set a fair price
426 UNIT NINE: GOVERNMENT REGULATION
receives an improperly low bid based on a negligently-reached valuation will suffer a loss based on the
undervaluation of his or her shares.” Macdonald Page knew that its figure would be used to determine
the price that one shareholder would pay to another in this case. In that circumstance, “[t]o argue that
Wetmore’s loss was not foreseeable would be disingenuous.”
(c) The court stated that Frank “was under no compulsion to enter the active bidding
process”—he did not have to sell his shares to Donna or to buy hers. The court recognized, however,
that he could have felt “unable to compete on a level playing field” with the Holdens if he had acquired
the total ownership of the company because “the Holdens would be free to engage in the same business
post-sale, with Holden having the operating experience that Wetmore lacks.”
Frank alleged that “Macdonald Page improperly promulgated a figure that was less than half the
ANSWER TO VIDEO QUESTION NO. 48–9
Accountant’s Liability
(a) Should Ray prepare a financial statement that values a list of assets provided by the ad-
vertising firm without verifying that the firm actually owns these assets? The circumstances in the
video indicate that the client is pressuring Ray to value the assets listed without verifying that the
firm actually owns these assets—because “time is of the essence.” Laura also tells Ray that the
financial statement will be given to a company interested in purchasing Onyx Advertising. Although
courts apply different standards to determine when an accountant can be held liable by third
parties, the majority of courts now hold that accountants can be held liable by third parties whom
they know will be relying on the information. In this situation, Ray knows that the report will be
(b) Discuss whether Ray is “in privity” with the company interested in buying Laura’s adver–
CHAPTER 48: PROFESSIONAL LIABILITY AND ACCOUNTABILITY 427
tising firm. Privity of contract refers to the relationship that exists between the promisor and the
promisee in a contract. Traditionally, an accountant owed no duty to a third party with whom the
accountant was not in privity. Here, Ray is clearly in privity with Laura at Onyx Advertising and not
with the potential acquiror. Although Ray knows that this other company will be getting a copy of
the financial statement, he has no contractual relationship with this company and does not even
know the company’s name.
(c) Under the Ultramares rule, to whom does Ray owe a duty? Under the Ultramares rule,
an accountant owes a duty of care only to those persons for whose “primary benefit” the
statements were intended. Thus, the key issue is whether the financial statement that Ray was
asked to prepare was intended for the “primary benefit” of the company interested in buying
Laura’s advertising firm or for the primary benefit of Onyx. Laura will claim that she contracted
with Ray to prepare the report for her company (Onyx Advertising) and that the statement was
buying the advertising firm was one of those parties for whose primary benefit the statements
were intended (regardless of whether Ray knew the company by name). Note that since the
Ultramares case, a minority of courts have modified the rule somewhat to include third parties that
going to receive and rely on the accountant’s statements.