If CPAs fail to modify the audit report on financial statements that are materially misstated, investors and firm creditors may experience substantial losses.
[4] Concerns about high damage awards and insurance costs have led to proposals to limit liability for public accounting firms.
In order to recover from an auditor under common law negligence theory, the client must prove:[6] 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.
[8] In order for the court to decide if the auditor's duty actually extended to the third party, for ordinary negligence, there are four legal approaches each state could follow.
[9] Ultramares occurred in 1933 where the defendant CPA distributed an unqualified opinion on the balance sheet of a company.
Lawsuits brought against auditors based on statutory provisions differ from those under common law.
In order to complete registration, the company must include audited financial statements and numerous other disclosures.
If the registration statement was to be found materially misstated, both the company and its auditors may be held liable.
The standing precedent on interpretation of due diligence is Escott v. BarChris Construction Corporation, decided in 1968.
The Securities Exchange Act of 1934 requires all companies under SEC jurisdiction to file an annual audit and have quarterly review of financial statements.
In order to avoid liability, auditors must prove they are normally able to establish “good faith” unless they have been guilty of gross negligence or fraud.
This act was established as a means of making sure that CPAs who may have been involved with any illegal mob or racketeering activity were brought to justice.
[22] The Continental Vending case (also known as United States v. Simon)[23] has set the precedent of severe charges for accountants.
The Securities and Exchange Commission (SEC) along with the Public Company Accounting Oversight Board (PCAOB) have implemented consequences for those who are involved in auditing fraud and any other illegal or unethical behavior in the field.
In 1995, the SEC established the Private Securities Litigation Reform Act which in essence mandated auditors to have even stricter guidelines as they pertains to any fraudulent or misleading behavior of their clients.
According to the guidelines of this Act, auditors are relieved of sanctions if they report required information about clients to the SEC in a timely manner.