CPA Legal Liability

Question 1

Breach of Contract

Answer 1

Who can Sue?
- the client
- other parties in privity of contract
- any third party KNOWN TO THE CPA to be relying on the work

What the injured party has to prove:
- CPA committed an act that violates the engagement letter
- this resulted in money damages

CPA Defenses:
- justifiable breach
- client didn’t follow contract
- client provided you with incomplete or misleading information

Statute of Limitations:
- 2 years oral
- 4-6 years written

Damages:
- Compensatory - Money damages to compensate for actual dollar losses
- no punitive damages

Question 2

Ordinary Negligence

Answer 2

Who can sue?
- Clients
- known 3rd parties
- limited class of third parties

What the injured party has to prove:
1. Duty of reasonable care owed
2. CPA breached duty of care
3. Cause/effect relationship
4. Suffered Money Damages

CPA Defenses:
- Followed standards of due crae - GAAS, PCAOB, GAAP, AICPA Standards, Circular 230
- if plaintiff was also careless (comparative negligence) and that contributed to loss, plaintiffs recovery is limited and possibly barred altogether

Statute of Limitations:
- starts on day of breach, not on date of contract

Damages:
- Compensatory - Money damages to compensate for actual dollar losses
- no punitive damages

Examples:
- Carelessly prepared tax return or financial report
- Carelessly forgot to file or filed late
- Carelessly give advice to the client

Question 3

Negligence to Third Parties

Answer 3

Depends on Jurisdiction

Ultra-mares Rule: privity or near privity rule
- liable for negligence only to client and known third party

Restatement Rule:
- non-clients when CPA knows that the information was supplied to the client for their benefit
- CPA knows or should know that the information will influence the third parties in a specific transaction

Foreseeable Users Standard:
- anyone who the CPA could reasonably foresee as a potential user of the financial statements

Question 4

Gross Negligence/Constructive Fraud

Answer 4

• CPA was reckless with regard to the rights of others

Who can sue?
- since fraud is intentional ANYONE injured can sue
- even general public

What the injured party has to prove:
1. Material misrepresentation or omission of fact
2. Unable to prove intent
3. Justifiable reliance on CPA’s work
4. Suffered Money Losses

CPA Defenses:
- misrepresentation was not material
- complied with professional standards

Statute of Limitations:
- 4 years

Damages:
- no punitive damages
- no criminal damages

Question 5

Common Law Fraud

Answer 5

• stealing money by lying
• intentional rather than just careless

Who can sue?
- since fraud is intentional ANYONE injured can sue
- even general public

What the injured party has to prove:
1. Material misrepresentation or omission of fact
2. Intent to deceive or cheat (scienter or bad faith)
3. Justifiable reliance on CPA’s work
4. Suffered Money Losses

CPA Defenses:
- misrepresentation was not material
- no intent to deceive
- complied with professional standards

Statute of Limitations:
- 4 years

Damages:
- punitive damages are possible
- criminal charges are possible

Question 6

1933 Act

Answer 6

** very easy for CPA to be sued

Injured Party needs to prove:
1. they bought the stock
2. material error in audited financial statement
3. they lost money

• no need to prove negligence or fraud on part of the CPA auditor
• CPA guilty until proven innocent
• “due diligence” defenses: followed PCAOB, GAAP
• CPA has burden of proof

Question 7

1934 Act

Answer 7

Injured Party needs to prove:
- fraud on part of CPA
1. material misrepresentation of fact (oral or written)
2. misrepresentation’s connection with purchase or sale
3. scienter - intent to deceive (CPA acted in bad faith)
4. *reliance of the financial statements
5. monetary damages

• CPA innocent until proven guilty