AUD Legal Liability

Legal Crisis in Accounting

• Auditors are potentially liable to many parties .
• Legal action often results from business failure .
• Audit firms have “deep pockets” .
• Settling may be less expensive than fighting, even when innocent .
• Vicious cycle .

Audit Failure

• Audit Failure is when the auditors failed to follow GAAS and failed to find misstatements or fraud .
• Business failure is when a company goes bankrupt .
• Audit failure is not the same as business failure .
• Often business failure is unfairly blamed on audit failure .

Key Sources of Liability

• Common Law :
• Liability to clients
• Liability to 3rd parties
• Liability to investors

Statutory liability

• Prudent Person Concept
• Auditor expected to exercise due care .
• Standard is what a prudent person would do .
• Generally relies on expert witnesses .
• Good faith and integrity, not infallibility .
• Prudent auditor will not generally be held liable .
• Imprudent auditor will .

Liability for Acts of Others

• Must be aware of partnership laws .
• Form of business is crucial .
• Conviction of Arthur Anderson casts doubt on the future .
• Confidentiality Remember auditors should maintain confidentiality .
• However, auditors do not have privileged communication in most states or at federal level .

Types of Negligence

• Ordinary negligence
• Gross negligence
• Constructive fraud
• Fraud

Auditor’s Defenses Against

• Client Suits
• Lack of duty to perform
• Nonnegligent performance
• Contributory negligence
• Absence of causal connection

Statutes Related to Auditing

• Securities Act of 1933
• Securities Exchange Act of 1934
• Litigation reform Act of 1998
• Sarbanes Oxley

Securities Act of 1933

• Deals with registrations and prospectuses .
• First line of defense, therefore stringent on auditors .
• Auditor is liable for contents of statements until date of registration .
• Burden of proof is on auditor .
• Claimant must only prove :
• Purchased securities
• Statements were false
• Auditor’s only defense is due diligence .