The accounting firm of T, W & S was engaged to perform an audit of Progate Manufacturing Company. During the course of the audit, T, W & S discovered that the company had overvalued its inventory by carrying the inventory on its books at the previous year’s prices, which were significantly higher thancurrent prices. When T, W & S approached Progate’s president, Lehman, about the improper valuation of inventory, Lehman became enraged and told T, W & S that unless the firm accepted the valuation, Progate would sue T, W & S. Although T, W & S knew that Progate’s suit was frivolous and unfounded, it wished to avoid the negative publicity that would arise from any suit brought against it. Therefore, on the assumption that the overvaluation would not harm anybody, T, W & S accepted Progate’s inflated valuation of inventory. Progate subsequently went bankrupt, and T, W & S is now being sued by (1) First National Bank, a bank that relied upon T, W & S’s statement to loan money to Progate; and (2) Thomas, an investor who purchased 20 percent of Progate’s stock after receiving T, W & S’s statement. What are the rights and liabilities of First National Bank, Thomas, and T, W & S? 7. J, B & J, Certified Public Accountants, has audited the Highcredit Corporation for the past five years. Recently,the Securities and Exchange Commission (SEC) has commenced an investigation of Highcredit for possible violations of Federal securities law. The SEC has subpoe-naed all of J, B & J’s working papers pertinent to the audit of Highcredit. Highcredit insists that J, B & J not turn over the documents to the SEC. What action should J, B & J take? Why?
8. On February 1, the Gazette Corporation hired Susan Sharp to conduct an audit of its books and to prepare financial statements for the corporation’s annual meeting on July 1. Sharp made every reasonable attempt to comply with the deadline but could not finish the report on time due to delays in receiving needed information from Gazette. Gazette now refuses to pay Sharp for her audit and is threatening to bring a cause of action against Sharp. What course of action should Sharp pursue? Why?
1. John P. Butler Accountancy Corporation agreed to audit the financial statements of Westside Mortgage, Inc., a mortgage company that arranged financing for real property, for the year ending December 31, 2015. On March 22, 2016, after completing the audit, Butler issued unqualified audited financial statements listing West-side’s corporate net worth as $175,036. The primary asset on the balance sheet was a $100,000 note receivable that had, in reality, been rendered worthless in August 2014 when the trust deed on real property securing the note was wiped out by a prior foreclosure of a superior deed of trust. The note constituted 57 percent of Westside’s net worth and was thus material to an accu- rate representation of Westside’s financial position. In October 2016, International Mortgage Company (IMC) approached Westside for the purpose of buying and selling loans on the secondary market. IMC signed an agreement with Westside in December after reviewing Westside’s audited financial statements. In June 2017, Westside issued a $475,293 promissory note to IMC, on which it ultimately defaulted. IMC brought an action against Westside, its owners, principals, and Butler. IMC alleged negligence and negligent misrepresentation against Butler in auditing and issuing without qualification the defective financial statements on which IMC relied in deciding to do business with Westside. Butler claimed that it owed no duty of care to IMC, a third party that was not specifically known to Butler as an intended recipient of the audited financial statements. Is Butler correct? Explain.
2. Equisure, Inc., was required to file audited financial statements when it applied to have its stock listed on the American Stock Exchange (AmEx). It retained an accounting firm, defendant Stirtz Bernards Boyden Surdel & Larter, P.A. (Stirtz). Stirtz issued a favorable interim audit report that Equisure used to gain listing on the stock exchange. Subsequently, Equisure retained Stirtz to audit the financial statements required for Equisure’s Form 10 filing with the U.S. Securities and Exchange Commission (SEC). Stirtz’s auditor knew that the audit was for the SEC reports. Stirtz issued a “clean” audit opinion, which, with the audited financial statements, was included in Equisure’s SEC filing and made available to the public. NorAm Investment Services, Inc., also known as Equity Securities Trading Company, Inc. (NorAm), a securities broker, began lending margin credit to purchasers of Equisure stock. These purchasers advanced only a portion of the purchase price; NorAm extended credit (a margin loan) for the balance and held the stock as collateral for the loan, charging interest on the balance. When NorAm had loaned approximately $900,000 in margin credit, its president, Nathan Newman, reviewed Stirtz’s audit report and the audited financial statements. Based on his review, NorAm extended more than $1.6 million of additional margin credit for the purchase of Equisure shares. When AmEx stopped trading Equisure stock due to allegations of insider trading and possible stock manipulation, the stock became worthless. NorAm was left without collateral for more than $2.5 million in margin loans. Stirtz resigned as auditor of Equisure and warned that its audit report might be misleading and should no longer be relied upon. NorAm sued Stirtz for negligent misrepresentation and negligence. Explain whether or not NorAm will prevail.
3. Holtz Rubenstein Reminick, CPAs, audited year-end financial statements of Quality Food Brands, Inc., and related companies. Signature Bank, relying upon the audited financial reports prepared by Holtz Rubenstein Reminick, extended a term note to Quality in the principal sum of $10 million. Quality subsequently filed a petition under Chapter 7 of the United States Bankruptcy Code, and Signature Bank only then learned of various false and misleading statements contained in the audited financial reports. Explain whether Signature Bank can recover damages for negligent misrepresentation.
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