Question

1. a.Explain liability to clients under contract law and give an example of a situation that entails liability to clients under contract law.

b. Explain liability to third parties under common law and give an example of a situation that entails liability to third parties under common law.

c. Explain liability to third parties under federal securities laws and give an example of a situation that entails liability to third parties under federal securities laws.

Answer 1

1(a)

CPAs (Certified Public Accountant) have an obligation to their clients to exercise due professional care. With an engagement letter, they provides the client and other third parties with rights of recovery. If the CPAs are not performing within the agreement set forth in the contract this will be considered a breach of contract. The clients may also claim negligence against the CPAs if the work was performed but contained errors or was not done professionally. This is considered a tort action.An accountant may also be sued by a client under tort law. A tort is a wrong committed which injures another person’s property, body, or reputation. A tort suit by a client is usually based on negligence or fraud.

In order to recover from an auditor under common law, the client must prove Duty of care, Breach of Duty, Losses, Causation.

CPAs may defend against a breach of contract if they can prove that the client’s loss occurred because of factors other than negligence by the auditors. If the auditor proves the loss resulted from causes other than the auditor’s negligence, a client may be accused of contributory negligence. If a state follows the doctrine of contributory negligence, the auditor may eliminate their liability to the client based on contributory negligence by the client.

(b)

Non clients can sue an accountant for fraud. Privity is not necessary. Keep in mind that fraud is based on state, not federal law. Negligence and negligent misrepresentation are also questions of state, not federal law. Negligent misrepresentation evolved from the tort of deceit. Actually, four main approaches or rules have been used by state courts to decide which nonclients are owed a duty by accountants. These four competing rules are: privity, near privity, the known-users or foreseen users or Restatement standard and the foreseeability approach. The four rules are not discrete points but lie on a continuum. Variations exist within each of the four schools of thought.

(c)

Combined group of stockholders sues auditor for not discovering materiality misstated financial statements.