Auditor's Professional Liability under Common Law | Auditing & Attestation Course | CPA Exam AUD

Summary

This session with Professor For Hat delves into auditors' professional liability under common law, a crucial topic for auditing and CPA exams. Common law, shaped by court precedents, varies by state, impacting how auditors are sued. The lecture outlines three types of third-party users who can sue auditors: identified, foreseen, and foreseeable users. It discusses the evolution of auditors' liability, emphasizing the shift from fraud to negligence and gross negligence as grounds for lawsuits. The Fred Stone & Co. v. Ultramares case is highlighted as a pivotal moment in lowering the proof standard for third parties to sue auditors, increasing their legal exposure.

Takeaways

• 📚 Common law is shaped by court precedents and can vary significantly across different jurisdictions.
• 👨‍⚖️ The evolution of common law is influenced by judges' and juries' decisions, potentially leading to changes in legal standards over time.
• 📊 Differences in common law across states can affect auditors' liability, as the laws may differ depending on where a lawsuit is filed.
• 🌐 The concept of 'precedent' in common law refers to prior court decisions that guide how similar cases are judged in the future.
• 📈 Plaintiffs suing auditors under common law must prove four elements: material misstatement of financial statements, damages, causality, and auditor misconduct.
• 💼 Identified users, foreseen users, and foreseeable users are three groups of third parties who may have the right to sue an auditor, depending on the jurisdiction.
• 🏦 Identified users are those specifically mentioned by the auditor as relying on the financial statements, such as banks named by a client seeking a loan.
• 👥 Foreseen users are a group of people that the auditor anticipates will rely on the financial statements but does not specifically name.
• 🌟 Foreseeable users form the broadest category, including any users who might rely on the financial statements, such as shareholders of a publicly traded company.
• 📉 The Fred Stone case was a pivotal moment in auditors' liability, as it allowed third parties to sue auditors for negligence, not just fraud, expanding the potential for legal action.

Q & A

What is common law?

Common law is a body of law that is derived from the decisions of courts, shaped by legal precedents. It is not statutory law enacted by a legislature, but rather consists of judgments made by courts that have an impact on future similar cases.

Why is it important to understand common law in the context of auditors' professional liability?

Understanding common law is important because it influences the legal framework under which auditors operate, especially concerning their professional liability. Different jurisdictions may have varying laws and precedents that affect how auditors are held accountable for their actions.

How does common law evolve?

Common law evolves over time due to changes in judicial decisions. As new cases are brought before courts and judges or juries make rulings, these decisions can set new precedents that modify or replace existing laws.

What are the three different precedents that courts follow regarding auditors' liability?

The three different precedents that courts follow regarding auditors' liability are Credit Alliance, Restatement (tort), and Ultramares (or Rush factor), which includes the Citizen Bank v. Rosenblum case.

What are the four things a plaintiff must show to succeed under common law when suing an auditor?

The plaintiff must show that the financial statements were materially misstated, there were damages, there is causality between the reliance on the statement and the damages, and there was auditor misconduct.

What is the difference between identified users, foreseen users, and foreseeable users in the context of auditors' liability?

Identified users are those specifically mentioned by the client to the auditor as relying on the financial statements. Foreseen users are a group of people the auditor knows will rely on the statements but are not individually named. Foreseeable users are a general class of users who may or may not rely on the financial statements.

Why is it significant that Ultramares case allowed third parties to sue for gross negligence?

The Ultramares case was significant because it expanded the legal recourse available to third parties beyond fraud, which is difficult to prove. It allowed them to sue for gross negligence, which has a lower standard of proof, thus increasing the potential liability for auditors.

What are the implications of the Fred Stone & Co. v. Ultramares case for auditors?

The Fred Stone & Co. v. Ultramares case established that auditors could be held liable for negligence to third parties who were foreseeable users of the financial statements. This case broadened the scope of auditors' potential liability beyond just those who were directly involved in the engagement.

How does the jurisdiction affect the ability to sue an auditor for negligence?

The jurisdiction determines which precedent is followed, which in turn affects the ability to sue an auditor for negligence. For example, in Credit Alliance jurisdiction, identified users can sue for negligence, while foreseeable users must sue for gross negligence.

What is the significance of the plaintiff's status in suing an auditor under common law?

The plaintiff's status as an identified, foreseen, or foreseeable user determines the type of misconduct they must prove and the jurisdiction in which they can sue. This status influences the ease with which they can establish a case against the auditor.