5-23 (OBJECTIVES 5-5, 5-6) In order to expand its operations, Gibson Corp. raised $5 million
in a public offering of common stock, and also negotiated a $2 million loan from Citizens
National Bank. In connection with this financing, Gibson engaged Horton & Co., CPAs, to
audit Gibson’s financial statements. Horton knew that the sole purpose of the audit was so
that Gibson would have audited financial statements to provide to Citizens National Bank
and the purchasers of the common stock. Although Horton conducted the audit in conformity with its audit program, Horton failed to detect material acts of embezzlement committed by Gibson Corp.’s president. Horton did not detect the embezzlement because of its
inadvertent failure to exercise due care in designing the audit program for this engagement.
After completing the engagement, Horton issued an unqualified opinion on Barton’s
financial statements. The financial statements were relied upon by the purchasers of the
common stock in deciding to purchase the shares. In addition, Citizens National Bank
approved the loan to Gibson based on the audited financial statements. Within 60 days
after the sale of the common stock and the issuance of the loan, Gibson was involuntarily
petitioned into bankruptcy. Because of the president’s embezzlement, Gibson became
insolvent and defaulted on the loan from the bank. Its common stock became virtually
worthless. Actions have been brought against Horton by
• the purchasers of the common stock, who have asserted that Horton is liable for
damages under Section 10(b) and Rule 10b-5 of the Securities Exchange Act of 1934.
• Citizens National Bank, based upon Horton’s negligence.
• trade creditors who extended credit to Gibson based upon Horton’s negligence.
a. Discuss whether you believe Horton will be found liable to the purchasers of common stock.
b. Indicate whether you believe Citizens National Bank will be successful in its claim against Horton.
c. Indicate whether you believe the trade creditors will be successful in their claim against Horton.*
5-24 (OBJECTIVE 5-6) Under Section 11 of the Securities Act of 1933 and Section 10(b), Rule 10b-5, of the Securities Exchange Act of 1934, a CPA may be sued by a purchaser of registered securities. The following items relate to what a plaintiff who purchased securities must prove in a civil liability suit against a CPA.
The plaintiff security purchaser must allege or prove
1. a monetary loss occurred.
2. material misstatements were included in a filed document.
3. reliance on the financial statements.
4. privity with the CPA.
5. the CPA had scienter (knowledge and intent to deceive).
6. lack of due diligence by the CPA.
For each of the items 1 through 6 listed above, indicate whether the statement must be
proven under
a. Section 11 of the Securities Act of 1933 only.
b. Section 10(b) of the Securities Exchange Act of 1934 only.
c. both Section 11 of the Securities Act of 1933 and Section 10(b) of the Securities
Exchange Act of 1934.
d. neither Section 11 of the Securities Act of 1933 nor Section 10(b) of the Securities
Exchange Act of 1934.*
