Part 10- Corporations, Chapter 46: Legal and Professional Responsibilities of Auditors, Consultants, and Securities Professionals, Doc 4

Legal and Professional Responsibilities of Auditors, Consultants, and Securities Professionals The passage discusses various legal responsibilities and liabilities of professionals such as auditors, consultants, and securities professionals, especially in relation to their work on financial statements, misstatements, and third-party reliance. 1. Liability in Audit and Consulting: o PwC Case: The plaintiffs in the case against PricewaterhouseCoopers (PwC) argued that the firm negligently allowed third-party reliance on Anicom's Form 10-K, which contained misleading information. PwC was aware that Anicom engaged in improper accounting practices but did not withdraw its audit opinion. However, the court ruled that Tricontinental (the plaintiff) did not establish that PwC's actions were primarily intended to benefit or influence them. For a successful negligent misrepresentation claim under Illinois law, it is not enough to show that a third party relied on the information, but rather, that the professional’s primary intent was to benefit that third party. The court ultimately found that PwC’s actions served Anicom’s interests, not Tricontinental’s. 2. Fraud and Constructive Fraud: o Fraud: Fraud by professionals like auditors can lead to liability for all users who suffer damages from reliance on the fraudulent misstatements, even if there is no privity of contract. Proving fraud requires showing that the professional acted with scienter (knowledge or intent to deceive). Some courts also recognize "constructive fraud," where the professional recklessly or negligently fails to verify a material fact, extending liability to those who justifiably relied on the misstatement. o Constructive Fraud: This applies when a professional has grossly negligently failed to ascertain the truth of a statement, leading to liability for any persons who rely on the false information. 3. Securities Law and Liability: o Section 11 of the Securities Act of 1933: This section holds auditors and underwriters liable for misstatements or omissions of material facts in a registration statement, even if there is no privity of contract between the professional and the plaintiff. The purchaser need not prove they relied on the defective registration statement, but auditors are liable only for the parts of the statement related to their audits (i.e., financial statements). Auditors can defend themselves by showing they exercised "due diligence," which typically involves adhering to Generally Accepted Auditing Standards (GAAS). o Section 12(a)(2): Imposes liability on anyone who misstates or omits a material fact during the sale of securities. This section requires privity of contract between the defendant and the plaintiff but does not typically apply to auditors unless they are actively involved in the sale. o Section 17(a) of the Securities Act: This section allows investors to sue for misstatements or omissions made by auditors or other securities professionals. Proof of reliance on the misstatement is required, and professionals may be liable if they acted with negligence, fraud, or gross recklessness. o Section 18 of the Securities Exchange Act of 1934: Section 18 applies to misstatements or omissions in documents filed with the SEC, such as annual reports (10-K). It allows for lawsuits against auditors if the plaintiff relied on a misstatement in these documents. However, auditors can defend themselves by proving they acted in good faith and without knowledge of the misinformation. 4. Securities Fraud and Liability under Rule 10b-5: o Rule 10b-5 of the Securities Exchange Act prohibits misstatements or omissions of material facts in connection with the purchase or sale of securities. A professional can be sued for violating this rule even without privity of contract. The investor must prove reliance on the misstatements, which may be inferred if the misstatement is material. A crucial element for liability is scienter (intent to deceive or recklessness), which distinguishes fraud from mere negligence. 5. Case Example – Ferris, Baker Watts, Inc. v. Ernst & Young, LLP: o This case involved a broker-dealer (MJK) that collapsed due to the fall in the price of securities it had borrowed and lent. The collapse led to litigation, and questions were raised about the liability of securities professionals involved. The case highlights the risks that professionals face when involved with financial transactions, especially when relying on borrowed or manipulated securities and misstatements related to those assets. Conclusion: The professional liability of auditors, consultants, and securities professionals is extensive, particularly regarding their duty to ensure accuracy and prevent fraud in financial statements and securities transactions. These professionals can be held liable for negligence or fraud, even in the absence of a direct contract with a thirdparty claimant, under both common law and specific provisions of securities legislation such as the Securities Act of 1933 and the Securities Exchange Act of 1934. In practice, proving claims often requires showing that the professional acted with intent to deceive (scienter) or recklessly disregarded the truth, and in some cases, defending their actions as due diligence or good faith efforts.