1. © 2007 West Legal Studies in Business, A Division of Thomson Learning Chapter 31 Professional Liability

2. © 2007 West Legal Studies in Business, A Division of Thomson Learning 2 Under what common law theories may professionals be liable to clients? What are the rules concerning an auditor’s liability to third parties? How might an accountant violate federal securities laws? What crimes might an accountant commit under the Internal Revenue Code? What constrains professionals to keep communication with their clients confidential? Learning Objectives

3. © 2007 West Legal Studies in Business, A Division of Thomson Learning 3 Potential Common Law Liability to Clients Under the common law, professionals may be liable to clients for: –Breach of contract. –Negligence. –Fraud.

4. © 2007 West Legal Studies in Business, A Division of Thomson Learning 4 If professional breaches (express or implied) the terms of a contract, then the client has the right to recover damages from the professional. –Not on time or did not complete work. –Professional performed work below standard of care of professional peers. Liability for Breach of Contract

5. © 2007 West Legal Studies in Business, A Division of Thomson Learning 5 E lement to establish negligence: –Duty of care existed. –Breach of duty. –Plaintiff suffered an injury. –Breach of duty was the cause of injury. Accountants: CASE 31.1 Oregon Steel Mills, Inc. v. Coopers and Lybrand, LLP. (2004). Attorneys: CASE 31.2 Conklin v. Hannoch Weisman (1996). Liability for Negligence

6. © 2007 West Legal Studies in Business, A Division of Thomson Learning 6 Elements to establish fraud: –Misrepresentation of a material fact. –Intent to deceive. –Reliance on misrepresentation. –For damages, the innocent party must have been injured. Liability for Fraud

7. © 2007 West Legal Studies in Business, A Division of Thomson Learning 7 The Ultramares Rule. –Accountants should be liable only to those with whom they are in privity or “near privity” of contract. –CASE 31.3 Reznor v. J. Artist Management, Inc. (2005). The Restatement of Torts Rule. –Accountants should be liable to foreseen, or known, users of their reports or financial statements. Liability to Reasonably Foreseeable Users. –Accountants should be liable to those whose use of their reports or financial statements is reasonably foreseeable. Auditors’ Liability to Third Parties

8. © 2007 West Legal Studies in Business, A Division of Thomson Learning 8 Sarbanes-Oxley Act of 2002 Imposes a number of strict requirements on both domestic and foreign public accounting firms that provide services to companies selling securities to the public. –Public Company Accounting Oversight Board. –Accountability to Public Accounting Firms. –Requirements for Maintaining Working Papers. Must maintain for five years after audit.

9. © 2007 West Legal Studies in Business, A Division of Thomson Learning 9 Potential Statutory Liability of Accountants Liability under the Securities Act of 1933. –Liability under Section 11. –Liability to Purchasers of Securities. –Due Diligence Standard. –Defenses. –Penalties and Sanctions.

10. © 2007 West Legal Studies in Business, A Division of Thomson Learning 10 Liability of Accountants Liability under the Securities Exchange Act of 1934 –Liability under Section 18. –Liability under Section 10(b) and SEC Rule 10b-5. Private Securities Litigation Reform Act of 1995.

11. © 2007 West Legal Studies in Business, A Division of Thomson Learning 11 Potential Criminal Liability Securities Act of 1933. Securities Act of 1934. Internal Revenue Code. State and Federal Criminal Codes.

12. © 2007 West Legal Studies in Business, A Division of Thomson Learning 12 Confidentiality and Privilege Confidentiality. –Professionals are restrained by the ethical tenets of their profession to keep all communications with their clients confidential. Privilege: Right to refuse to testify against client in a court of law. –Attorneys. In all state and federal courts. –Accountants Only in some states’ courts. Not in federal court (IRS!).

13. © 2007 West Legal Studies in Business, A Division of Thomson Learning 13 Limiting Professionals’ Liability Professionals may be able to limit liability by disclaiming it. However, clients do have the right to rely on a professional legal or accounting opinion. Limitation of liability from other professionals in LLP or PC situations.