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Understanding Professional Liability: The Legal Environment Impacting Auditors and CPA Firms

This chapter delves into the complexities of professional liability that affect CPA firms, exploring the legal environment surrounding litigation against auditors. Key aspects include contract law, statutory law, and common law liability, as well as the implications of joint and several liability. The text further dissects causes of legal action, defenses available to auditors, and the role of legal concepts such as negligence and fraud. Additionally, practical approaches to mitigating liability exposure, including quality control and defensive auditing, are examined.

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Understanding Professional Liability: The Legal Environment Impacting Auditors and CPA Firms

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  1. Chapter 16 Professional Liability

  2. The Legal Environment Affecting Litigation against Auditors Liability that affects CPA firms is derived from the following laws: Contract law Common law Statutory law

  3. The Legal Environment Affecting Litigation against Auditors (cont’d) • Joint and Several Liability • Audit Time and Fee Pressures • Audits Viewed as an Insurance Policy • Contingent-Fee Compensation for Lawyers • Class Action Suits

  4. Legal Concepts • The Auditor must understand • Concepts of breach of contract and tort • Parties who may bring suit • Legal precedence and statutes that may be used as a standard • Defenses available to auditors

  5. Legal Concepts • Causes of legal action • Breach of contract • Negligence • Gross negligence (constructive fraud) • Fraud • Scienter

  6. Legal Concepts • Parties that may bring suit against auditors • Liability to clients • Breach of contract • Negligence • Misleading financial statements

  7. Legal Concepts • Common-law liability to third parties • Foreseeability and Negligence: Common Law • The Ultramares case: The third-party beneficiary test • Expansion of Ultramares: The identified user test • Foreseen user test • Foreseeable user test • Current status

  8. Legal Concepts Statutory Liability to Third Parties Securities Act of 1933 Securities Act of 1934

  9. Legal Concepts • Criminal Liability to Third Parties • Continental Vending (U.S. v. Simon) • Equity Funding

  10. Legal Concepts • Liability Impact of Internet Dissemination of Audited Financial Information • Summary of Auditor Liability to Third Parties • Auditor defenses • Due diligence • Statements not materially misstated • Audit not the cause of loss • Auditor has no duty to the plaintiff

  11. Approaches to Mitigating Liability Exposure • Continuing Education Requirement • Membership Requirements for Firms • Quality Control Programs • External peer reviews • Internal peer reviews

  12. Defensive Auditing • Engagement letters • Client screening • Evaluating the firm’s limitations • Maintaining accurate and complete working papers • Limited Liability Partnerships (LLP) • Role of insurance • Tort reform

  13. Effect of Court Cases on Auditing Standards and Practice • Engagement letters • Audit Procedures • Subsequent Events • Related-Party Transactions

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