Accountants Legal and Ethical Responsibilities

1. Accountants Legal and Ethical Responsibilities

2. Legal • Federal Securities Law • Contract • Negligence • Racketeering Influenced an Corrupt Organizations Act (RICO) • Private Securities Litigation Reform act of 1995 (Fraud Detection and Disclosure) • Sarbanes-Oxley Act of 2002

3. Securities Act of 1933 • Objective: To provide prospective investors with accurate, complete, and detailed information about new offerings of securities.

4. Securities Act of 1933 Requires that all new issues of securities sold in interstate commerce must be registered with the SEC before sale, unless exempted. Registration includes certified financial statements and prospectus. Prospectus must also be given to each new purchaser.

5. Civil and Criminal Penalties for Violation Liability extends to Issuer, under writer, directors/partners, all signers, and experts (accountants and attorneys) who prepared or certified part of registration statement. CPA liable for false, misleading or omitted information.  Plaintiff need not prove reliance by plaintiff Due diligence (reasonable grounds to believe accuracy) is defense.

6. Civil and Criminal Penalties for Violation a.Criminal – fine and/or imprisonment. Fines up to $10,000 and/or imprisonment up to five years. b.Civil – Monetary damages to investors if there is a failure to register, registration statement or prospectus contained materially false, misleading factual information, or omitted material factual information.

7. Contract • Duty determined by terms of engagement letter. • Liability extends to intended beneficiaries known to accountant. • Lending institutions

8. Negligence • A. Duty of professional care • B. Failure to act in accordance with those duties • C. Proximate cause • D. Loss of damage • Liable to client, known third parties, and possibly foreseen parties (same class as known third parties)

9. Fraud • Requires knowledge, or grossly negligent or reckless conduct. • Extends liability to reasonably foreseeable third parties.

10. Securities Exchange Act of 1934 Regulates ongoing trading of securities after issuance. 1. Prohibits Fraud (Section 10b,Rule 10b-5 • Knowing issuance of financial reports containing false, misleading information or omitting material information in a report. (Plaintiff must prove intent and reliance.)

11. Racketeer Influenced and Corrupt Organizations Act (1970) • Federal Crime to engage in racketeering activity in the acquisition, maintenance or conduct of the affairs of a business enterprise or to conspire to do any racketeering activities. • Incorporates by reference 26 federal crimes and 9 state felonies, including: securities fraud, mail fraud and wire fraud. Requires two or more offenses.

12. RICO • Commission of two or more “predicate acts” within a 10 year period

13. Racketeer Influenced and Corrupt Organizations Act (1970 • Penalties • Criminal - $25,000 per violation • Up to twenty years imprisonment • Civil – Government : Divestiture or dissolution of business • Private: Treble damages, Attorneys fees

14. Private Securities Litigation Reform act of 1995 Requires audits of financial statement include standards designed to provide reasonable assurance of detecting illegal acts that have material effect on financial statements Requires notification to audit committee Notification to corporate board if audit committee does not act. Notification to SEC if board does not notify SEC

15. Duty of Inquiry • If CPA becomes aware of suspicious circumstances, he/she has a duty to inquire • A CPA cannot rely on Management's representations.

16. Sarbanes-Oxley Act of 2002 • Creates a five-member public company accounting oversight board. The Board will have five financially-literate members, appointed for five-year terms. Two of the members must be or have been certified public accountants, and the remaining three must not be and cannot have been CPAs. • Members of the Board are appointed by the Securities and Exchange Commission, "after consultation with" the Chairman of the Federal Reserve Board and the Secretary of the Treasury.

17. Section 103: Auditing, Quality Control, And Independence Standards And Rules. • The Board shall: (1) register public accounting firms; (2) establish, or adopt, by rule, "auditing, quality control, ethics, independence, and other standards relating to the preparation of audit reports for issuers;" (3) conduct inspections of accounting firms; (4) conduct investigations and disciplinary proceedings, and impose appropriate sanctions

18. Standard Setting The Board would be required to "cooperate on an on-going basis" with designated professional groups of accountants and any advisory groups convened in connection with standard-setting,

19. Section 104: Inspections of Registered Public Accounting Firms Annual quality reviews (inspections) must be conducted for firms that audit more than 100 issues, all others must be conducted every 3 years. The SEC and/or the Board may order a special inspection of any firm at any time.

20. Section 201: Services Outside The Scope Of Practice Of Auditors; Prohibited Activities. It shall be "unlawful" for a registered public accounting firm to provide any non-audit service to an issuer contemporaneously with the audit, including: (1)bookkeeping or other services related to the accounting records or financial statements of the audit client; (2)financial information systems design and implementation; (3) appraisal or valuation services, fairness opinions, or contribution-in-kind reports;

21. Section 201: Services Outside The Scope Of Practice Of Auditors; Prohibited Activities. (4) actuarial services; (5) internal audit outsourcing services; (6) management functions or human resources; (7) broker or dealer, investment adviser, or investment banking services;

22. Section 201: Services Outside The Scope Of Practice Of Auditors; Prohibited Activities. 8) legal services and expert services unrelated to the audit; (9) any other service that the Board determines, by regulation, is impermissible. The Board may, on a case-by-case basis, exempt from these prohibitions any person, issuer, public accounting firm, or transaction, subject to review by the Commission.

23. Section 203: Audit Partner Rotation. The lead audit or coordinating partner and the reviewing partner must rotate off of the audit every 5 years.

24. Section 302: Corporate Responsibility For Financial Reports. The CEO and CFO of each issuer shall prepare statement to accompany the audit report to certify the appropriateness of the financial statements and disclosures contained in the periodic report, and that those financial statements and disclosures fairly present, in all material respects, the operations and financial condition of the issuer."

25. Section 401(a): Disclosures In Periodic Reports; Disclosures Required. • Each financial report that is required to be prepared in accordance with GAAP shall • reflect all material correcting adjustments . . . that have been identified by a registered accounting firm . . . ." • "Each annual and quarterly financial report . . . shall disclose all material off-balance sheet transactions" and "other relationships" with "unconsolidated entities" that may have a material current or future effect on the financial condition of the issuer.

26. Section 401(a): Disclosures In Periodic Reports; Disclosures Required. The SEC shall issue rules providing that pro forma financial information must be presented so as not to "contain an untrue statement" or omit to state a material fact necessary in order to make the pro forma financial information not misleading.

27. Title VIII: Corporate and Criminal Fraud Accountability Act of 2002. Felony to "knowingly" destroy or create documents to "impede, obstruct or influence“ any existing or contemplated federal investigation. Auditors are required to maintain "all audit or review work papers" for five years.

28. Title IX: White Collar Crime Penalty Enhancements • Maximum penalty for mail and wire fraud increased from 5 to 10 years. • SEC may prohibit anyone convicted of securities fraud from being an officer or director of any publicly traded company. • Maximum penalties for willful and knowing violations of this section are a fine of not more than $5,000,000 and/or imprisonment of up to 20 years.

29. Professional Responsibilities AICPA Code of Professional Conduct Principles • A. CPA should exercise sensitive professional and moral judgment in all CPA activities. • B. Demonstrate commitment to professionalism • C. Perform responsibilities with integrity to maintain public confidence.

30. Professional Responsibilities • 4. Maintain objectivity and be free of conflicts of interest. • 5. Be independent in fact and in appearance. • 6. Strive to improve competence and quality of services and discharge duties to best of his/her ability.

31. Rules • Rule 101 – Independence • CPA shall be independent in the performance of professional services rendered. (Tax and consulting do not require independence)

32. Independence Rule 101 • Impaired by: • Direct or material indirect financial interest in client • Trustee or executor of trust or estate which has financial interest in client • Joint of closely-held business investment with client or officer, director of principal stockholder. (Fee outstanding for service performed more than one year prior to audit takes on characteristics of a loan from accountant to client.)

33. Competence (Rule 201) • CPA should not undertake any engagement that the CPA cannot reasonably expect to complete with professional competence.

34. Confidentiality (Rule 301) • CPA should not disclose any confidential information obtained in the course of an engagement without consent of the client, unless required to do so by law, AICPA regulations or state CPA societies.

35. Contingent Fees (Rule 302) • Professional services should not be rendered under a contingent fee basis. • Prohibited for the filing of an origial or amended tax return. However, permitted for representing a client in an examination of a client’s tax return.

36. Discreditable Acts (Rule 501 • CPA should not commit an act in personal or professional life that discredits the profession