Part 10- Corporations, Chapter 46: Legal and Professional Responsibilities of Auditors, Consultants, and Securities Professionals, Doc 1

1. Standard of Care for CDFC CDFC, as a financial consulting and investment banking firm, must meet a professional standard of care when advising Macrohard to issue promissory notes. This standard involves exercising the skill and care of an ordinarily prudent professional in the same circumstances. Specifically, CDFC must:    Ensure that its advice is grounded in a reasonable understanding of Macrohard's financial position and liquidity problems. Provide sound, thorough analysis of the potential benefits and risks of issuing the notes. Act in the best interests of Macrohard and the potential investors by providing clear, accurate, and non-misleading information. 2. CDFC’s Potential Liability under Section 12(a)(2) of the Securities Act of 1933 Section 12(a)(2) of the Securities Act of 1933 allows for liability to be imposed on anyone who offers or sells securities by means of a materially misleading prospectus or oral communication. CDFC’s role in marketing the notes—by contacting prospective investors through phone calls, visits, and emails while emphasizing the high interest rate—raises the possibility of liability under this section if any misrepresentation is made.   Potential Liability: If one of CDFC’s managing partners negligently makes false statements regarding Macrohard’s financial position, CDFC could face liability under Section 12(a)(2). CDFC could be held liable if it made misstatements or omissions in its communications, even if they were not intentionally fraudulent, as the statute includes negligent misstatements. Proper Defendant: CDFC is likely a proper defendant under Section 12(a) (2), as it directly communicated with potential investors in a manner related to the offering of securities. 3. CDFC’s Liability under Rule 10b–5 of the Securities Exchange Act of 1934 Rule 10b-5 of the Securities Exchange Act of 1934 prohibits any fraudulent activities in connection with the purchase or sale of securities, including making false or misleading statements.   Potential Liability: If CDFC’s managing partner negligently makes false statements about Macrohard’s financial position, CDFC could face liability under Rule 10b-5, since this rule applies to fraudulent or misleading conduct in securities transactions, including negligent misrepresentations. Proper Defendant: Yes, CDFC could be a proper defendant under Rule 10b-5 if its partners made false or misleading statements, even negligently. 4. A&Y’s Potential Liability under Section 12(a)(2) A&Y, as the auditor of Macrohard’s financial statements, could potentially be liable under Section 12(a)(2) if the financial statements in the offering circular were misleading.   Potential Liability: If A&Y knew or should have known that the audited financial statements would be used in the offering circular, it could be held liable if the financial statements contained misstatements that led to investors being misled. Consideration of Negligence: A&Y's liability could depend on whether it acted negligently in preparing the financial statements. If A&Y negligently audited the financial statements and they contained material misstatements, A&Y could face liability, even under a negligence standard. 5. A&Y’s Liability under Rule 10b-5 A&Y may also face liability under Rule 10b-5 if it negligently audited the financial statements and those statements were used in the offering circular to mislead investors.   Potential Liability: If A&Y's audit was negligent and the financial statements contained material misstatements, investors could claim that they were defrauded in violation of Rule 10b-5, even if the misstatements were not intentional. Proper Defendant: Yes, A&Y can be considered a proper defendant under Rule 10b-5 if its negligent audit led to false or misleading information being provided to investors. 6. CDFC’s Potential Liability under State Law for Negligent Misrepresentation   Under the Ultramares Doctrine: If CDFC's negligence in providing advice or marketing the notes resulted in harm to third parties (such as purchasers of the notes), the firm may face liability under state law for negligent misrepresentation in a jurisdiction that follows the Ultramares rule. Under this rule, liability is generally limited to those who are in a privity of contract with the wrongdoer or those who are specifically intended to rely on the misrepresentation. If CDFC’s actions were seen as directed toward institutional investors or any parties who relied on CDFC’s statements, CDFC could potentially be liable. Under the Restatement (Second) of Torts: In states following the broader Restatement standard, CDFC could be held liable to any third-party who suffered harm from reliance on CDFC's negligently made representations, even if they were not in privity with CDFC. 7. A&Y’s Potential Liability for Negligent Misrepresentation under State Law   Under the Ultramares Doctrine: A&Y could be liable if it knew or should have known that its audit would be used in the offering circular to sell the notes. However, if A&Y did not know who the purchasers would be, liability may be more limited. Under the Restatement (Second) of Torts: A&Y would likely be liable under this broader rule if it knew its audit would be relied on by potential investors, even if it did not know who they specifically were. 8. CDFC’s Liability under Section 11 of the Securities Act of 1933 in a Public Offering If Macrohard issues preferred stock in a public offering, CDFC, as the underwriter, would face potential liability under Section 11 of the Securities Act of 1933 for misstatements or omissions in the registration statement.   Liability: CDFC would be a statutory defendant under Section 11, especially for parts of the registration statement it helped prepare. The firm could be liable for any material misstatements, particularly regarding the business and risks of the offering, even if it wasn’t directly responsible for the audited financial statements. Due Diligence Defense: CDFC could defend itself by demonstrating that it conducted appropriate due diligence, including investigating Macrohard’s business and financials before the offering. 9. A&Y’s Liability under Section 11 of the Securities Act of 1933 As the auditor of Macrohard’s financial statements included in the registration statement, A&Y could be held liable under Section 11 for any misstatements in those financials.   Liability: A&Y’s liability would be limited to the audited financial statements unless it was involved in other portions of the registration statement. Due Diligence Defense: A&Y can argue a due diligence defense by demonstrating that it followed generally accepted auditing standards (GAAS) and performed an adequate audit. 10. Checklist for Due Diligence under Section 11 A checklist for both CDFC and A&Y would likely include the following:    Review of all offering documents and financial statements. Independent verification of financial and business information. Analysis of the risks involved in the securities offering.   Legal review of the registration statement for completeness and accuracy. Documentation of all steps taken in due diligence to demonstrate compliance. By following due diligence processes and ensuring accurate representations, both CDFC and A&Y can mitigate the risks of liability.