THE AUDITOR’S LEGAL RESPONSIBILITY CHAPTER 4 Juan M Garcia Merced

1. THE AUDITOR’S LEGAL RESPONSIBILITYCHAPTER 4Juan M Garcia Merced

2. Legal Environment • Responsibility to parties other than clients • Auditing and accounting are more complex • Deep pocket concept of liability • Large civil court judgment • Cpas willing to settle in order to avoid legal cost and adverse publicity • Courts have difficulty understanding and interpreting accounting & auditing matters

3. Legal terminology • Negligence - absence of reasonable care, failure to perform the audit in accordance withGAAS • Gross negligence - lack of even slight care, major failures in GAAS, “pega sellos” • Fraud - misstatement, knowledge, intent • Constructive fraud - recklessness • Proximate cause - absence of causal connection • Contributory negligence - both were negligent • Breach of contract • Engagement letter, privity • Third party beneficiaries • Common vs statutory laws

4. Liability to Clients Client Suits: • Common law • Burden of proof • Material error • Losses • Ordinary negligence • Proximate cause Auditor’s Defenses • Non negligent performance • No proximate cause • Contributory negligence

5. Liability to 3rd Parties • Third party beneficiaries (parties in privity): • Common law, burden of proof • Material error, losses • Ordinary negligence, proximate cause 2. Other third parties (not in privity) • Common law, burden of proof • Material error, losses • Gross negligence or fraud, proximate cause

6. Liability to 3rd Parties Auditor’s Defenses • Non negligent / fraud performance • No proximate cause

7. New theory – Liability to 3rd Parties Other third parties (privity & foreseen) • Common law, burden of proof • Material error, losses • Ordinary negligence • Proximate cause Other third parties (unknown) • Common law, burden of proof • Material error, losses • GROSS NEGLIGENCE OR FRAUD

8. Federal Securities Law

9. Securities Act of 1933 • Only available to original purchasers of securities • Requires a registration statement and a prospectuses • Recovery limited to the price difference • Investor must demonstrates losses and a material error in the financial statements • Auditor has the burden of proof • Civil and criminal liability • Not liable if the auditor acted diligently or he /she can prove absence of causal connection • Liable unless auditor can prove his/her diligence or not proximate cause

10. Securities Act of 1934 • Available to original investors and to the investors in the secondary market • Requires annually audited financial statements • Requires quarterly reviewed financial statements • Antifraud provisions • Investor must demostrates losses, a material error in the financial statements & use of f/s • for decision • Auditor has the burden of proof • Civil and criminal liability • Not liable for diligent, ordinary negligence or absence of causal connection

11. Other Acts Racketeer Influenced & Corrupt Practices Act­Legislation aimed at preventing organized crime Treble (triple) damages Recovery of legal fees Requires at least two acts of racketeering activity within a 10 year period Foreign Corrupt Practices Act Illegal to offer a bribe to an official of a foreign country for obtaining or retaining business SEC registrants must maintain reasonably complete and accurate records an an adequate system of internal control

12. Actions to Minimize • Deal only with clients possessing integnty • Hire, train and supervise personnel • Follow standards • Maintain independence • Understand the client • Perform quality audits • Obtain engagement letters • Carry insurance • Seek legal counsel • Limited liability • Pray every night

13. Questions???????