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1Chapter 5 Legal Liability

Review Questions

5-1 Several factors that have affected the increased number of lawsuits against CPAs are: 1. The growing awareness of the responsibilities of public accountants on the part of users of financial statements. 2. An increased consciousness on the part of the SEC regarding its responsibilit for protecting investors! interests. ". The greater comple#ities of auditing and accounting due to the increasing si$e of businesses% the globali$ation of business% and the intricacies of business operations. &. Societ !s increasing acceptance of lawsuits. '. (arge civil court )udgments against CPA firms% which have encouraged attorne s to provide legal services on a contingent fee basis. *. The willingness of man CPA firms to settle their legal problems out of court. +. The difficult courts have in understanding and interpreting technical accounting and auditing matters. 5-2 The most important positive effects are the increased ,ualit control b CPA firms that is li-el to result from actual and potential lawsuits and the abilit of in)ured parties to receive remuneration for their damages. .egative effects are the energ re,uired to defend groundless cases and the harmful impact on the public!s image of the profession. (egal liabilit ma also increase the cost of audits to societ % b causing CPA firms to increase the evidence accumulated. 5-3 /usiness failure is the ris- that a business will fail financiall and% as a result% will be unable to pa its financial obligations. Audit ris- is the ris- that the auditor will conclude that the financial statements are fairl stated and an un,ualified opinion can therefore be issued when% in fact% the are materiall misstated. 0hen there has been a business failure% but not an audit failure% it is common for statement users to claim there was an audit failure% even if the most recentl issued audited financial statements were fairl stated. 1an auditors evaluate the potential for business failure in an engagement in determining the appropriate audit ris-. 5-4 The prudent person concept states that a person is responsible for conducting a )ob in good faith and with integrit % but is not infallible. Therefore% the auditor is e#pected to conduct an audit using due care% but does not claim to be a guarantor or insurer of financial statements.

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5-5 The difference between fraud and constructive fraud is that in fraud the wrongdoer intends to deceive another part whereas in constructive fraud there is a lac- of intent to deceive or defraud. Constructive fraud is highl negligent performance. 5-6 1an CPA firms willingl settle lawsuits out of court in an attempt to minimi$e legal costs and avoid adverse publicit . This has a negative effect on the profession when a CPA firm agrees to settlements even though it believes that the firm is not liable to the plaintiffs. This encourages others to sue CPA firms where the probabl would not to such an e#tent if the firms had the reputation of contesting the litigation. Therefore% out2of2court settlements encourage more lawsuits and% in essence% increase the auditor!s liabilit because man firms will pa even though the do not believe the are liable. 5-7 An auditor!s best defense for failure to detect a fraud is an audit properl conducted in accordance with auditing standards. SAS 33 4A5 "1*6 states that the auditor should assess the ris- of material misstatements of the financial statements due to fraud. /ased on this assessment% the auditor should design the audit to provide reasonable assurance of detecting material misstatements due to fraud. SAS 33 also states that because of the nature of fraud 4including defalcations6% a properl designed and e#ecuted audit ma not detect a material misstatement due to fraud. 5-8 Contributor negligence used in legal liabilit of auditors is a defense used b the auditor when he or she claims the client or user also had a responsibilit in the legal case. An e#ample is the claim b the auditor that management -new of the potential for fraud because of deficiencies in internal control% but refused to correct them. The auditor thereb claims that the client contributed to the fraud b not correcting material wea-nesses in internal control. 5An engagement letter from the auditor to the client specifies the responsibilities of both parties and states such matters as fee arrangements and deadlines for completion. The auditor ma also use this as an opportunit to inform the client that the responsibilit for the prevention of fraud is that of the client. A well2 written engagement letter can be useful evidence in the case of a lawsuit% given that the letter spells out the terms of the engagement agreed to b both parties. 0ithout an engagement letter% the terms of the engagement are easil disputed. 5-1! (iabilit to clients under common law has remained relativel unchanged for man ears. 7f a CPA firm breaches an implied or e#pressed contract with a client% there is a legal responsibilit to pa damages. Traditionall the distinction between privit of contract with clients and lac- of privit of contract with third parties was essential in common law. The lac- of privit of contract with third parties meant that third parties would have no rights with respect to auditors e#cept in the case of gross negligence. That precedent was established b the 5ltramares case. 7n recent ears some courts have interpreted 5ltramares more broadl to allow recover b third

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5-1! "#ontinue$% parties if those third parties were -nown and recogni$ed to be rel ing upon the wor- of the professional at the time the professional performed the services 4foreseen users6. Still others have re)ected the 5ltramares doctrine entirel and have held the CPA liable to an one who relies on the CPA8s wor-% if that wor- is performed negligentl . The liabilit to third parties under common law continues in a state of uncertaint . 7n some )urisdictions the precedence of 5ltramares is still recogni$ed whereas in others there is no significant distinction between liabilit to third parties and to clients for negligence. 5-11 7n recent ears the auditor!s liabilit to a third part has become affected b whether the part is -nown or un-nown. .ow a -nown third part % under common law% usuall has the same rights as the part that is priv to the contract. An un-nown third part usuall has fewer rights. The approach followed in most states is the Restatement of Torts approach to the foreseen users concept. 5nder the Restatement of Torts approach% foreseen users must be members of a reasonabl limited and identifiable group of users that have relied on the CPA8s wor-% even though those persons were not specificall -nown to the CPA at the time the wor- was done. 5-12 The differences between the auditor!s liabilit under the securities acts of 13"" and 13"& are because the 13"" act imposes a heavier burden on the auditor. Third part rights as presented in the 13"" act are: 1. An third part who purchases securities described in the registration statement ma sue the auditor. 2. Third part users do not have the burden of proof that the relied on the financial statements or that the auditor was negligent or fraudulent in doing the audit. The must onl prove that the financial statements were misleading or not fairl stated. 7n con)unction with these third part rights% the auditor has a greater burden in that he or she must demonstrate that: 1. The statements are not materiall misstated. 2. An ade,uate audit was conducted. ". The user did not incur the loss because of misleading financial statements. The liabilit of auditors under the 13"& act is not as harsh as under the 13"" act. 7n this instance% the burden of proof is on third parties to show that the relied on the statements and that the misleading statements were the cause of the loss. The principal focus of accountants8 liabilit under the 13"& act is on 9ule 1:b2'. 5nder 9ule 1:b2'% accountants generally can onl be held liable if the intentionall or rec-lessl misrepresent information intended for third2part use. 1an lawsuits involving accountants8 liabilit under 9ule 1:b2' have resulted in

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5-12 "#ontinue$% accountants being liable when the -new all of the relevant facts% but merel made poor )udgments. 7n recent ears% however% courts have decided that poor )udgment doesn8t necessaril prove fraud on the part of the accountant. 5-13 The auditor!s legal liability to the client can result from the auditor!s failure to properl fulfill his or her contract for services. The lawsuit can be for breach of contract% which is a claim that the contract was not performed in the manner agreed upon% or it can be a tort action for negligence. An e#ample would be the client!s detection of a misstatement in the financial statements% which would have been discovered if the auditor had performed all audit procedures re,uired in the circumstances 4e.g.% misstatement of inventor resulting from an inaccurate ph sical inventor not properl observed b the auditor6. The auditor!s liability to third parties under common law results from an loss incurred b the claimant due to reliance upon misleading financial statements. An e#ample would be a ban- that has loans outstanding to an audited compan . 7f the audit report did not disclose that the compan had contingent liabilities that subse,uentl became real liabilities and forced the compan into ban-ruptc % the ban- could proceed with legal action against the auditors for the material omission. Civil liability under the Securities Act of 1933 provides the right of third parties to sue the auditor for damages if a registration statement or a prospectus contains an untrue statement of a material fact or omits to state a material fact that results in misleading financial statements. The third part does not have to prove reliance upon the statements or even show his or her loss resulted from the misstatement. An e#ample would be stoc- purchased b an investor in what appears% based upon audited financial statements% to be a sound compan . 7f the financial statements are later found to be inaccurate or misleading% and the investment loses value as a result of a situation e#isting but not disclosed at the date of the financial statements% the investor could file legal proceedings against the auditor for negligence. Civil liability under the Securities Act of 1934 relates to audited financial statements issued to the public in annual reports or 1:2; reports. 9ule 1:b2' of the Act prohibits fraudulent activit b direct sellers of securities. Several federal court decisions have e#tended the application of 9ule 1:b2' to accountants% underwriters and others. An e#ample would be an auditor -nowingl permitting the issuance of fraudulent financial statements of a publicl held client. Criminal liability of the auditor ma result from federal or state laws if the auditor defrauds another person through -nowingl being involved with false financial statements. An e#ample of an act that could result in criminal liabilit would be an auditor!s certif ing financial statements that he or she -nows overstate income for the ear and the financial position of the compan at the audit date.

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5-14 The SEC can impose the following sanctions against a CPA firm: 1. 2. ". &. Suspend the right to conduct audits of SEC clients. Prohibit a firm from accepting an new clients for a period. 9e,uire a review of the firm!s practice b another CPA firm. 9e,uire the firm to participate in continuing education programs. respond and

5-15 Some of the wa s in which the profession can positivel reduce liabilit in auditing are:

1. Continued research in auditing. 2. Standards and rules must be revised to meet the changing needs of auditing. ". The A7CPA can establish re,uirements that the better practitioners alwa s follow in an effort to increase the overall ,ualit of auditing. &. Establish new peer review re,uirements. '. CPA firms should oppose all unfounded lawsuits rather than settling out of court. *. 5sers of financial statements need to be better educated regarding the attest function. +. 7mproper conduct and performance b members must be sanctioned. <. (obb for changes in state and federal laws concerning accountants8 liabilit . &ultiple Choi#e Questions 'ro( C)* +,a(inations 426 4"6 b. b. 416 4&6 c. c. 426 416 d. 426

5-16 a. 5-17 a.

-is#ussion Questions an$ )roble(s =ost and Co. should use the defenses of meeting auditing standards and contributor negligence. The fraud perpetuated b Stuart Suppl Compan was a reasonabl comple# one and difficult to uncover e#cept b the procedures suggested b =ost. 7n most circumstances it would not be necessar to ph sicall count all inventor at different locations on the same da . >urthermore the president of the compan contributed to the failure of finding the fraud b refusing to follow =ost!s suggestion. There is evidence of that through his signed statement. b. There are two defenses =ost and Compan should use in a suit b >irst Cit .ational /an-. >irst there is a lac- of privit of contract. Even though the ban- was a -nown third part % it does not necessaril mean that there is an dut to that part in this situation. That

5-18 a.

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5-18 "#ontinue$% defense is unli-el to be successful in most )urisdictions toda . The second defense which =ost is more li-el to be successful with is that the firm followed auditing standards in the audit of inventor % including the emplo ment of due care. ?rdinaril it is unreasonable to e#pect a CPA firm to find such an unusual problem in the course of an ordinar audit. /ecause the CPA firm did not uncover the fraud does not mean it has responsibilit for it. c. She is li-el to be successful in her defense against the client because of the contributor negligence. The compan has responsibilit for instituting ade,uate internal controls. The president!s statement that it was impractical to count all inventor on the same da because of personnel shortages and customer preferences puts considerable burden on the compan for its own loss. 7t is also unli-el that >irst Cit .ational /an- will be successful in a suit. The court is li-el to conclude that =ost followed due care in the performance of her wor-. The fact that there was not a count of all inventor on the same date is unli-el to be sufficient for a successful suit. The success of =ost!s defenses is also heavil dependent upon the )urisdiction!s attitude about privit of contract. 7n this case there is unli-el to be a claim of e#treme negligence. Therefore it would be re,uired for the court to both ignore the privit of contract precedence and find =ost negligent for the suit to be successful. d. The issues and outcomes should be essentiall the same under the suit brought under the Securities E#change Act of 13"&. 7f the suit were brought under 9ule 1:b2'% it is certainl unli-el that the plaintiff would be successful% inasmuch as there was no intent to deceive. The plaintiff would li-el be unsuccessful in such a suit. 5-1 =es. .ormall a CPA firm will not be liable to third parties with whom it has neither dealt nor for whose benefit its wor- was performed. ?ne notable e#ception to this rule is fraud. 0hen the financial statements were fraudulentl prepared% liabilit runs to all third parties who relied upon the false information contained in them. >raud can be either actual or constructive. @ere% there was no actual fraud on the part of Small or the firm in that there was no deliberate falsehood made with the re,uisite intent to deceive. @owever% it would appear that constructive fraud might be present. Constructive fraud is found where the auditor!s performance is found to be grossl negligent. That is% the auditor reall had either no basis or so flims a basis for his or her opinion that he or she has manifested a rec-less disregard for the truth. Small!s disregard for standard auditing procedures would seem to indicate such gross negligence and% therefore% the firm is liable to third parties who relied on the financial statements and suffered a loss as a result.

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5-2! The answers provided in this section are based on the assumption that the traditional legal relationship e#ists between the CPA firm and the third part user. That is% there is no privit of contract% the -nown versus un-nown third part user is not a significant issue% and high levels of negligence are re,uired before there is liabilit . a. >alse. There was no privit of contract between 1artinson and 0atts and 0illiams% therefore% ordinar negligence will usuall not be sufficient for a recover . b. True. 7f gross negligence is proven% the CPA firm can and probabl will be held liable for losses to third parties. c. True. See a. d. >alse. Aross negligence 4constructive fraud6 is treated as actual fraud in determining who ma recover from the CPA. e. >alse. 1artinson is an un-nown third part and will probabl be able to recover damages onl in the case of gross negligence or fraud. Assuming a liberal interpretation of the legal relationship between auditors and third parties% the answers to a. and e. would probabl both be true. The other answers would remain the same. 5-21 a. @anover will li-el not be found liable to the purchasers of the common stoc- if the suit is brought under 9ule 1:b2' of the Securities E#change Act of 13"& because there was no -nowledge or intent to deceive b the auditor. @owever% if the purchasers are original purchasers and are able to bring suit under the Securities Act of 13""% the plaintiffs will li-el succeed because the must onl prove the e#istence of a material error or omission. @anover was aware that the financial statements were to be used to obtain financing from >irst .ational /an-. @anover is li-el to be held responsible for negligence to the ban- as a -nown third part that relied on the financial statements. The legal issues involved in this case revolve around the auditor!s compliance with auditing standards and contributor negligence. Auditing standards re,uire that accounts receivable be confirmed b the auditor in most circumstances. This procedure was emplo ed in the case% and the legal issue is whether or not the auditor used due care in following up on the confirmation replies received. As a defense in the lawsuit% the auditor would claim to have followed auditing standards b properl confirming accounts receivable. 7n addition% the auditor ma defend him or herself b testif ing that the compan controller was responsible for investigating the reason for the differences reported on the confirmation replies. The auditor ma state that he or she had a right to conclude that

b.

5-22 a.

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5-22 "#ontinue$% the controller had reviewed the e#planations provided b the boo--eeper% and concluded the were correct. The auditor might also use the defense that there was contributor negligence. The controller should not have delegated the wor- to the boo--eeper and should have recogni$ed the potential for intentional wrongdoing b the boo--eeper. b. The CPA!s deficienc in conducting the audit of accounts receivable was his or her failure to investigate and obtain evidence to substantiate the e#planations provided b the boo--eeper. The auditor should have investigated each of the timing differences% through which he or she ma have discovered that no sales allowance had been granted to the customer% but in fact% the customer had mailed pa ment for the merchandise which the boo--eeper had stolen. 5-23
a. =es. Smith was a part to the issuance of false financial statements. The elements necessar to establish an action for common law fraud are present. There was a material misstatement of fact% -nowledge of falsit 4scienter6% intent that the plaintiff ban- rel on the false statement% actual reliance% and damage to the ban- as a result thereof. 7f the action is based upon fraud there is no re,uirement that the ban- establish privit of contract with the CPA. 1oreover% if the action b the ban- is based upon ordinar negligence% which does not re,uire a showing of scienter% the ban- ma recover as a third2 part beneficiar because it is a primar beneficiar . Thus% the banwill be able to recover its loss from Smith under either theor . b. .o. The lessor was a part to the secret agreement. As such% the lessor cannot claim reliance on the financial statements and cannot recover uncollected rents. Even if the lessor was damaged indirectl % his or her own fraudulent actions led to the loss% and the e,uitable principle of Bunclean handsB precludes the lessor from obtaining relief. c. =es. Smith had -nowledge that the financial statements did not follow generall accepted accounting principles and willingl prepared an un,ualified opinion. That is a criminal act because there was an intent to deceive.

5-24 0ard C East!s strongest defense would be that the e#ercised due care in performing the audit and that the adhered to auditing standards. The fact that Dasper C Co. later found fraud should not significantl affect the case in as much as the were specificall engaged to determine the e#istence of fraud% not to do an ordinar audit. 0ard C East are li-el to have to demonstrate that the audit was ade,uatel planned and sufficient appropriate evidence was accumulated and properl evaluated. >or e#ample% the case states that the managers who were defrauding the compan negotiated lower than normal rents in return for the -ic-bac-s. 7t is possible that anal tical procedures or other audit tests might have revealed that some rents

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5-24 "#ontinue$% were abnormall low. The auditor ma have to prove that such procedures were not necessar in the circumstances or would not have uncovered the fraud. Similarl % the decentrali$ation of lease negotiations ma also be cited b the plaintiff as evidence that internal control was inade,uate and that additional testing was necessar that could have uncovered the fraud. 0ard C East ma have to prove that the understanding of internal control the obtained was ade,uate and the audit evidence the accumulated was appropriate% given the decentrali$ed lease negotiations.

5-25 1. 2. ". &. '. *. 5-26 a. c c d d b b /oth. 1aterial misstatements must be shown under both acts. /oth. 1onetar loss must be demonstrated under both acts. .either. Plaintiff dues not have to prove lac- of diligence under the 13"" Act% but the accountant can use due diligence as a defense. Scienter must be demonstrated under the 13"& Act. .either. Privit applies to common law and not the 13"" and 13"& acts. 13"& Act onl . 9eliance is not re,uired under the 13"" Act. Scienter is re,uired under the 13"& Act% but not the 13"" Act.

The case should be dismissed. A suit under Section 1:4b6 and 9ule 1:b2' of the Securities E#change Act of 13"& must establish fraud. >raud is an intentional tort and as such re,uires more than a showing of negligent mannerE the CPAs neither participated in the fraudulent scheme nor did the -now of its e#istence. The element of scienter or guilt -nowledge must be present in order to state a cause of action for fraud under Section 1:4b6 of the Securities E#change Act of 13"&. b. The plaintiffs might have stated a common law action for negligence. @owever% the ma not be able to prevail due to the privit re,uirement. There was no contractual relationship between the defrauded parties and the CPA firm. Although the e#act status of the privit rule is unclear% it is doubtful that the simple negligence in this case would e#tend Aordon C Aroton!s liabilit to the customers who transacted business with the bro-erage firm. @owever% the facts of the case as presented in court would determine this. Another possible theor which has been attempted recentl in the courts is liabilit under Section 1+ of the Securities E#change Act of 13"&% which re,uires registered bro-ers to submit audited financial statements to the SEC. 7n one such case% the plaintiff claimed that the accountant failed to perform a proper audit and thereb created liabilit to the customers of the bro-erage firm who suffered losses as a result of the financial collapse of the bro-erage firm.

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5-27 The ban- is li-el to succeed. 9obertson apparentl -new that 1a)estic was Btechnicall ban-ruptB at Fecember "1% 2::<. 9eporting standards re,uire the auditor to add an e#planator paragraph to the audit report when there is substantial doubt about an entit !s abilit to continue as a going concern. She did not include such a paragraph. To ma-e matters worse% it appears that 9obertson was convinced not to issue the report with the going concern paragraph because of the negative impact on 1a)estic Co.% not because of the solvenc of the compan . That ma be interpreted as a lac- of independence b 9obertson and ma indicate a fraudulent act% potentiall a criminal charge that could result in a prison term. 9obertson!s most li-el defense is that after determining all of the facts% in part through discussion with management% she concluded that the 1a)estic Co. was not technicall ban-rupt and did not re,uire an e#planator paragraph in the audit report. She might also argue that even if such a report was appropriate% her failure to do so was negligence or bad )udgment% not with the intent to deceive the ban-. Such a defense does not seem to be strong given the statement about her -nowledge of 1a)estic!s financial condition. 9obertson might also falsel testif that she did not believe that a going concern problem e#isted. Such statements would be per)ur and are unprofessional and not worth of a professional accountant. Per)ur is also a criminal act and could result in further actions b the courts. Case

5-28 )*R. 1 a. 7n order for Tha#ton to hold 1itchell C 1oss liable for his losses under the Securities E#change Act of 13"&% he must rel upon the antifraud provisions of Section 1:4b6 of the act. 7n order to prevail% Tha#ton must establish that: 1. 2. ". &. There was an omission or misstatement of a material fact in the financial statements used in connection with his purchase of the 0hitlow C Compan shares of stoc-. @e sustained a loss as a result of his purchase of the shares of stoc-. @is loss was caused b reliance on the misleading financial statements. 1itchell C 1oss acted with scienter 4-nowledge of the misstatement6.

/ased on the stated facts% Tha#ton can probabl prove the first three re,uirements cited above. To prove the fourth re,uirement% Tha#ton must show that 1itchell C 1oss had -nowledge of the fraud or rec-lessl disregarded the truth. The facts clearl indicate that 1itchell C 1oss did not have -nowledge of the fraud and did not rec-lessl disregard the truth.

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5-28 )*R. 1 "#ontinue$% b. The customers and shareholders of 0hitlow C Compan would attempt to recover on a negligence theor based on 1itchell C 1oss! failure to compl with auditing standards. Even if 1itchell C 1oss were negligent% 0hitlow C Compan !s customers and shareholders must also establish either that: 1. 2. The were third part beneficiaries of 1itchell C 1oss! contract to audit 0hitlow C Compan % or 1itchell C 1oss owed the customers and shareholders a legal dut to act without negligence.

Although man cases have e#panded a CPA!s legal responsibilities to a third part for negligence% the facts of this case ma fall within the traditional rationale limiting a CPA!s liabilit for negligenceE that is% the unfairness of imputing an indeterminate amount of liabilit to un-nown or unforeseen parties as a result of mere negligence on the auditor!s part. Accordingl % 0hitlow C Compan !s customers and shareholders will prevail onl if 416 the courts rule that the are either third2part beneficiaries or are owed a legal dut and 426 the establish that 1itchell C 1oss was negligent in failing to compl with auditing standards. 5-28 )*R. 2 a. The basis of Dac-son!s claim will be that she sustained a loss based upon misleading financial statements. Specificall % she will rel upon section 114a6 of the Securities Act of 13""% which provides the following: 7n case an part of the registration statement% when such part became effective% contained an untrue statement of a material fact or omitted to state a material fact re,uirement to be stated therein or necessar to ma-e the statements therein not misleading% an person ac,uiring such securit 4unless it is proved that at the time of such ac,uisition he -new of such untruth or omission6 ma % either at law or in e,uit % in an court of competent )urisdiction% sue ever accountant who has with his consent been named as having prepared or certified an part of the registration statement.

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5-28 )*R. 2 "#ontinue$% To the e#tent that the relativel minor misstatements resulted in the certification of materiall false or misleading financial statements% there is potential liabilit . Dac-son!s case is based on the assertion of such an untrue statement or omission coupled with an allegation of damages. Dac-son does not have to prove reliance on the statements nor the compan !s or auditor!s negligence in order to recover the damages. The burden is placed on the defendant to provide defenses that will enable it to avoid liabilit . b. The first defense that could be asserted is that Dac-son -new of the untruth or omission in audited financial statements included in the registration statement. The act provides that the plaintiff ma not recover if it can be proved that at the time of such ac,uisition she -new of such Buntruth or omission.B Since Dac-son was a member of the private placement group and presumabl priv to the t pe of information that would be contained in a registration statement% plus an other information re,uested b the group% she ma have had sufficient -nowledge of the facts claimed to be untrue or omitted. 7f this were the case% then she would not be rel ing on the certified financial statements but upon her own -nowledge. The ne#t defense available would be that the untrue statement or omission was not material. The SEC has defined the term as meaning matters about which an average prudent investor ought to be reasonabl informed before purchasing the registered securit . >or section 11 purposes% this has been construed as meaning a fact that% had it been correctl stated or disclosed% would have deterred or tended to deter the average prudent investor from purchasing the securit in ,uestion. Allen% Funn% and 9ose would also assert that the loss in ,uestion was not due to the false statement or omissionE this is% that the false statement was not the cause of the price drop. 7t would appear that the general decline in the stoc- mar-et would account for at least a part of the loss. Additionall % if the decline in earnings was not factuall connected with the false statement or omission% the defendants have another basis for refuting the causal connection between their wrongdoing and the resultant drop in the stoc-!s price. >inall % the accountants will claim that their departure from auditing standards was too minor to be considered a violation of the standard of due diligence re,uired b the act.

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/nternet )roble( 0olution1 0+C +n2or#e(ent

5-1 The SEC!s Enforcement Fivision Gwww.sec.govHdivisionsHenforce.shtmlI investigates possible violations of securities laws% recommends SEC action when appropriate% either in a federal court or before an administrative law )udge% and negotiates settlements. (itigation 9eleases% which are descriptions of SEC civil and selected criminal suits in the federal court proceedings% are posted on the SEC8s 0eb site. >ind (itigation 9elease .o. 1<&<+ dated Fecember &% 2::" 4@int: (itigation releases are one of four possible Jenforcement actionsK that the SEC can pursue6. 1. 0hat allegedl occurred according to the complaint underl ing (9 .o. 1<&<+L *nswer1 The complaint alleges that /lac-welder% who was a freelance consultant% in or about Dul 2:::% became a mar-eting consultant for Save the 0orld Air% 7nc. 4BST0AB6% a compan that purported to have successfull developed and mar-eted a pollution control device for automobiles called the B$ero emission fuel saver device.B The complaint also alleges that /lac-welder prepared and arranged to have issued at least one false press release announcing a ma)or licensing deal for ST0A that% in fact% did not e#ist. /lac-welder also posted positive messages about ST0A on an 7nternet stocmessage board without disclosing% as re,uired% that he received shares of ST0A as pa ment for the promotion. /lac-welder!s postings were materiall misleading because the created the impression that /lac-welder was e#pressing unbiased views about ST0A and its stoc-% when he was actuall a paid promoter. 2. 0hat section4s6 of federal securities laws was the primar individual accused of violatingL named

*nswer1 /lac-welder was en)oined from violating violations of Section 1+4b6 of the Securities Act of 13"" 4BSecurities ActB6% Section 1:4b6 of the Securities E#change Act of 13"& 4BE#change ActB6% and 9ule 1:b '.
43ote: 7nternet problems address current issues using 7nternet sources. /ecause 7nternet sites are sub)ect to change% 7nternet problems and solutions ma change. Current information on 7nternet problems is available at www.pearsonhighered.comHarens6.

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