Q U E S T I O N S
1. Baldwin Corporation made a public offering of $25 million of convertible debentures and registered the offering with the SEC. The registration statement contained financial statements certified by Adams and Allen, Certified Public Accountants. The financial statements overstated Baldwin’s net income and assets by 20 percent and understated the company’s liability by 15 percent. Because Adams and Allen did not carefully follow Generally Accepted Accounting Standards, it failed to detect these inaccuracies, the discovery of which has caused the bond prices to drop from their original selling price of $1,000 per bond to $720. Can Conrad, who purchased $10,000 of the debentures, collect from Adams and Allen for his damages? Explain.
2. Ingram is a Certified Public Accountant (CPA) employed by Jordan, Keller and Lane, CPAs, to audit Martin Enterprises, Inc., a fast-growing service firm that went public two years ago. The financial statements Ingram audited were included in a proxy statement proposing a merger with several other firms. The proxy statement was filed with the Securities and Exchange Commission and included several inaccuracies. First, approximately $1 million, or more than 20 percent, of the previous year’s “net sales originally reported” had proven nonexistent by the time the proxy statement was filed and had been written off on Martin’s own books. This was not disclosed in the proxy statement, in violation of Accounting Board Opinion Number 9. Second, Martin’s net sales for the current year were stated as $11.3 million when in fact they were less than $10.5 million. Third, Martin’s net profits for the current year were reported as $700,000, when the firm actually had no earnings at all.
a. What civil liability, if any, does Ingram have?
b. What criminal liability, if any, does Ingram have?
3. Girard & Company, Certified Public Accountants, audited the financial statements included in the annual report submitted by PMG Enterprises, Inc., to the Securities and Exchange Commission (SEC). The audit failed to detect numerous false and misleading statements contained in the financial statements.
a. Investors who subsequently purchased PMG stock have brought suit against Girard under Section 18 of the 1934 Act. What defenses, if any, are available to Girard?
b. The SEC has initiated criminal proceedings under the 1934 Act against Girard. What must be proven for Girard to be held criminally liable?
4. Dryden, a certified public accountant, audited the books of Elixir, Inc., and certified incorrect financial statements in a form that was filed with the Securities and Exchange Commission. Shortly thereafter, Elixer, Inc., went bankrupt. Investigation into the bankruptcy disclosed that through an intricate and clever embezzlement scheme Kraft, the president of Elixir, had siphoned off substantial sums of money that now support Kraft in a luxurious lifestyle in South America. Investors who purchased shares of Elixir have brought suit against Dryden under Rule 10b-5. At trial, Dryden produces evidence demonstrating that his failure to discover the embezzlement resulted merely from negligence on his part and that he had no knowledge of the fraudulent conduct. Is Dryden liable under the Securities Exchange Act of 1934? Why or why not?
5. Johnson Enterprises, Inc., contracted with the accounting firm of P, A & E to perform an audit of Johnson. The accounting firm performed its duty in a nonnegligent, competent manner but failed to discover a novel embezzlement scheme perpetrated by Johnson’s treasurer. Shortly thereafter, Johnson’s treasurer disappeared with $75,000 of the company’s money. Johnson now refuses to pay P, A & E its $20,000 audit fee and is seeking to recover $75,000 from P, A & E.
a. What are the rights and liabilities of P, A & E and Johnson? Explain.
b. Would your answer to (a) differ if the scheme were a common embezzlement scheme that Generally Accepted Accounting Standards should have disclosed? Explain
