Govt. Regulation of Bus: Accountants' Legal Responsibilities

Question 1

In a suit for damages under Section 11 of the Securities Act of 1933 damages are calculated as:

Answer 1

damages = value of securities on date suit is filed - price paid for securities

Question 2

Misstatements on a registration statement are governed by which act?

Answer 2

The Securities Act of 1933.

Question 3

To win in a case governed by the ‘34 Act, what must a plaintiff do to win?

Answer 3

1. The plaintiff must prove reliance on the F/S in question.
2. There must be evidence of a material misstatement or omission knowingly (or recklessly) made, which the injured party relied upon to his or her detriment.

Question 4

In a case governed by the ‘34 Act, when can an accountant be held liable?

Answer 4

1. When the accountant has engaged in gross negligence, or reckless disregard for the truth.
2. In the case of company fraud, a accountant can not be held liable merely for “aiding and abetting” fraud.

Question 5

Which of the following would constitute a valid defense by a CPA in an action for fraud where the plaintiff was NOT in privity of contract with the CPA?

Answer 5

That the client’s reliance was not reasonable is a valid defense for the CPA.

Question 6

To recover in an action for common law fraud, one must prove five elements:

Answer 6

1. Misstatement or omission;
2. Of a material fact;
3. Knowingly made with an intent to deceive (scienter);
4. Relied upon by the complaining party;
5. Which results in damages.

Question 7

In a suit by A against B, CPA, for common law fraud, A will prevail only if:

Answer 7

A actually relied on B’s services.

Question 8

Is privity of contract a necessary element to prove common law fraud?

Answer 8

Privity of contract may exist, but is not a necessary element.

Question 9

Is proof of mere negligence enough to establish scienter?

Answer 9

No, a willful intent to deceive must be proven.

Question 10

One has fulfilled the general standard of care expected of an accountant if:

Answer 10

1. The services provided by the accountant were provided w/the level of skill ordinarily exercised under the circumstances.
2. An accountant is expected to exercise ordinary care and diligence, measured by the particular circumstances.

Question 11

T/F: A CPA only has liability to the client?

Answer 11

False. CPAs are liable to third parties as well.

Question 12

constructive fraud

Answer 12

1. The CPA did not act with malice of with a specific intent to deceive, but was reckless or grossly negligent.
2. A CPA’s failure to carry out the duty expressed in the engagement will result in liability for breach of contract regardless of negligence.

Question 13

When are CPAs liable to foreseen third parties?

Answer 13

1. When they are aware that their work will be relied upon, such as for an extension of credit.
2. This is usually the standard used.

Question 14

When are CPAs liable to foreseeable third parties?

Answer 14

1. When they are reasonably certain their work will be relied upon.
2. This standard is not applied in most jurisdictions.

Question 15

When is an accountant liable for breach of contract?

Answer 15

1. if negligent in performing the contracted work.

2. It is not necessary for a client to prove gross negligence or fraud.

Question 16

For a third party to recover against a CPA, the third party must:

Answer 16

1. Prove fraud or gross negligence on the part of the CPA,
   1a. OR, if the CPA is merely negligent, the third party may recover if it can be shown that the CPA knew the third party would be relying on the CPAs work product, and actually did rely.

Question 17

accountant-client privilege. Is it broad? Can it be waived?

Answer 17

1. Not as broad as attorney-client privilege.

2. It can be waived only by the client.

Question 18

Section 7525 of the IRS Restructuring and Reform Act of 1998 provides:

Answer 18

1. Provides taxpayers a privilege regarding written or verbal tax advice from a CPA.
2. The creation of the new privilege was not intended to modify, but rather to extend the attorney-client common law confidentiality privilege to other practitioners, such as CPAs.
3. The preparation of tax accrual work papers is not considered tax advice when developed to evaluate a client’s contingent tax liabilities in connection with financial condition disclosures.
4. The privilege does not extend to written tax advice to corporate clients concerning their corporation’s involvement in tax shelters.

Question 19

Can a legal action may be successfully maintained against an accountant by a person not in privity of contract with the accountant?

Answer 19

Mere negligence by an accountant is actionable by an entity not in privity with the accountant only if the accounting work was intended for the plaintiff (or for a group which included the plaintiff) making the plaintiff a “foreseen” third party.

Question 20

To comply with the provisions of the Sarbanes-Oxley Act, members of an audit committee must ensure which of the following:

Answer 20

1. Financial reports reflect all material correcting adjustments; 2. Off–balance sheet transactions be disclosed;
2. Companies disclose to the public on a rapid and current basis information concerning material changes in its financial condition.

Question 21

In a Section 11 ‘33 Act case, can a CPA successfully defend himself/herself? If so, how?

Answer 21

Plaintiffs need not prove negligence on the part of the CPA, but a CPA can avoid liability by proving the exercise of due diligence.

Question 22

‘33 At requirements for a public offering > $5 mil:

Answer 22

1. Either a registration statement must be filed 2. OR, resale of the securities within two years is restricted.

Question 23

Rule 505 of Regulation D

Answer 23

1. Permits a company to sell up to $5 million in securities over a 12 month period
   1a. but prohibits general advertising,
2. Limits a sales to not more than 35 nonaccredited investors and restricts resale for two years.
3. If nonaccredited investors purchase the securities, an audited balance sheet must be provided.

Question 24

In general, the provisions of the Securities Act of 1933 accomplish the goal of stability in the marketplace for securities by:

Answer 24

generally assuring that prospective investors are provided information about an issuer of securities necessary to make an informed investment decision.

Question 25

Violations of Section 17(a) of the Securities Act of 1933, and Sections 10(b) and 13(b)(5) of the Securities Exchange Act of 1934 can result in the following:

Answer 25

1. Civil penalties; 2. Forfeiture of profits, including prejudgment interest; 3. Permanent injunction prohibiting future violations.

Question 26

Rule 144

Answer 26

Safe harbor provision for Regulation D offering.

Question 27

To be in compliance w/Rule 144, a stock owner must:

Answer 27

1. hold the stock for two year before selling. 2. OR, hold the stock for one year, then sells in small brokered transactions after confirming that the company has complied with the periodic reporting requirements of the '34 Act.

Question 28

penalties for insider trading

Answer 28

The SEC may seek to impose civil penalties of up to 3x the profit gained/loss avoided through insider trading.

Question 29

'34 Act's regulation on proxy solicitations

Answer 29

1. Proxies relating to an annual meeting calling for election of directors must include a report containing financial statements covering the previous two fiscal years. 2. Special rules apply when a contest for election or removal of directors is scheduled.

Question 30

proxies for brokers

Answer 30

For securities registered in the names of brokers, a company must attempt to determine the beneficial ownership of the securities and furnish sufficient copies of the proxy statement for distribution to all beneficial owners. Proxies for an annual meeting calling for election of directors must include a report containing financial statements covering the previous two fiscal years.

Question 31

proxies and mailing to shareholders

Answer 31

1. Copies of the proxy statement and proxy form must be filed with the SEC when first mailed to shareholders. 2. Under certain circumstances preliminary copies must be filed ten days before mailing.

Question 32

Does a proxy statement become effective under the '34 Act?

Answer 32

Although a proxy statement does not become "effective" in the same way as a statement registered under the 1933 Act, the SEC may comment on and require changes in the proxy statement before mailing.

Question 33

SLUSA provides for preclusion of certain securities class actions brought under state law:

Answer 33

``` No covered class action based upon the statutory or common law of any State may be maintained in any State or Federal court by any private party alleging: (A) a misrepresentation or omission of a material fact in connection with the purchase or sale of a covered security; (B) OR that the defendant used or employed any manipulative or deceptive device or contrivance in connection with the purchase or sale of a covered security. ```

Question 34

Does SLUSA replace state law?

Answer 34

SLUSA does not itself displace state law with federal law but makes some state-law claims nonactionable through the class action device in federal as well as state court.

Question 35

If after the acquisition A would own 5% or more of B, Inc., the '34 Act requires all of the following (Williams Act):

Answer 35

1. A must file a report with the SEC which includes the source of A's funds. 2. A must file a report with the SEC which includes the purpose of the purchase. 3. A must notify B, Inc., of A's intention.

Question 36

What companies must register under the '34 Act and comply with its provisions?

Answer 36

1. Companies whose securities are traded on a national securities exchange 2. OR, whose assets are in excess of $10 million and which have equity securities held by more than 500 persons.

Question 37

Can a corporation be imprisoned?

Answer 37

No.

Question 38

In a '34 Act action, must the plaintiff prove s/he was the buyer of the securities?

Answer 38

No, the plaintiff can also be the seller.

Question 39

SOX Section 301 provisions:

Answer 39

1. Each member of the audit committee shall be a member of the board of directors of the issuer, and shall otherwise be independent; 2. The audit committee of an issuer shall be directly responsible for the appointment, compensation, and oversight of the work of any registered public accounting firm employed by that issuer; 3. Audit committee shall establish procedures for the "receipt, retention, and treatment of complaints" received by the issuer regarding accounting, internal controls, and auditing; 4. AND, each audit committee shall have the authority to engage independent counsel or other advisors, as it determines necessary to carry out its duties.

Question 40

Form 8-K

Answer 40

After a significant event occurs, a public company generally must file a Current Report on Form 8-K within 4 business days to provide an update to previously filed 10-Qs or 10-Ks.

Question 41

Who is in charge of interpreting and enforcing the AICPA Code of Professional Conduct?

Answer 41

The Professional Ethics Executive Committee of the AICPA

Question 42

A CPA who unwittingly violated the AICPA Code of Professional Conduct (COPC) during a recent attest engagement can be subject to:

Answer 42

1. S/he may be subject to enforcement through the Joint Ethics Enforcement Program (JEEP). B If s/he is not a member of the AICPA, she is still answerable to her state board of accountancy, which likely has adopted standards similar to the COPC. C If s/he is expelled from the AICPA, she may still practice public accounting using her state-issued CPA license.