Academic journal article Journal of Accountancy

Auditor's Liability for Securities Violations

Academic journal article Journal of Accountancy

Auditor's Liability for Securities Violations

Article excerpt

The U.S. Court of Appeals for the Ninth Circuit ruled that an audit firm preparing a fraudulent audit report that it knew would be included in its client's annual 10-K filing with the Securities and Exchange Commission may be held liable as a primary violator of the Securities Exchange Act of 1934. This case began in November 1990 when Ernst & Young prepared and issued an allegedly false and misleading audit opinion for its audit of Community Psychiatric Centers (CPC), a publicly traded corporation. The shareholders alleged the firm had failed to disclose that the corporation had a major accounts receivable problem. They further alleged the firm knew the audit opinion would be included in the 10-K. Shareholders sued the firm after the corporation's stock plummeted in September 1991 with the announcement of a major drop in earnings attributed to $37 million in uncollectible debt.

The plaintiffs' class action alleged the firm had produced a fraudulent audit report with the knowledge that the client would disseminate the report to the securities market. As a consequence of these actions, the firm allegedly committed fraudulent acts in connection with the trading of securities and thus violated section 10(b) of the 1934 act. The plaintiffs further claimed the firm was both a primary violator of section 10(b) and a secondary violator as a conspirator and alder and abettor to CPC. …

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