Academic journal article Journal of Accountancy

U.S. Court of Appeals Says Accountants Can Be Liable under Securities Law

Academic journal article Journal of Accountancy

U.S. Court of Appeals Says Accountants Can Be Liable under Securities Law

Article excerpt

In what best can be termed an inconsistent ruling regarding accountants' liability under securities law, the U.S. Court of Appeals, Ninth Circuit, ruled that an accounting firm could be held liable, under section 11 of the Securities Act of 1933, even when the alleged misrepresentations by the auditors had not become public prior to the bankruptcy of an audited corporation.

This case began when investors in Worlds of Wonder, Inc. (WOW) lost their entire $80 million investment in WOW junk bonds after the corporation filed for bankruptcy on December 21, 1987. The investors sued the officers, directors, underwriters and shareholders, as well as Deloitte & Touche, WOW's auditors.

WOW was formed in 1985 to manufacture and distribute The World of Teddy Ruxpin, and in 1986, the company launched a second product, Lazer Tag. Both products were top-10 selling toys for the 1986 Christmas season. On the basis of this performance, WOW posted net revenue of $327 million for the fiscal year ended March 31, 1987.

In an effort to fund further expansion, WOW sold $80 million of junk bonds on June 4, 1987. On July 27, 1987, the corporation reported losses of $10 million for the first fiscal quarter, and, on November 9 of that year, WOW reported net second-quarter losses of $43 million. On December 21, 1987, the company filed for bankruptcy.

The investors filed a class-action suit alleging securities fraud. The district court granted summary judgment in favor of all the defendants, holding the junk bond prospectus fully disclosed the risks of investing in WOW; even if the 1987 financial statements were false or misleading, all the defendants had established affirmative defences to section 11 liability. …

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