CASE
5-28 (OBJECTIVES 5-5, 5-6) Part 1. Whitlow & Company is a brokerage firm registered under
the Securities Exchange Act of 1934. The act requires such a brokerage firm to file audited
financial statements with the SEC annually. Mitchell & Moss, Whitlow’s CPAs, performed
the annual audit for the year ended December 31, 2019, and rendered an unqualified
opinion, which was filed with the SEC along with Whitlow’s financial statements. During
2019, Charles, the president of Whitlow & Company, engaged in a huge embezzlement
scheme that eventually bankrupted the firm. As a result, substantial losses were suffered
by customers and shareholders of Whitlow & Company, including Thaxton, who had re-
cently purchased several shares of stock of Whitlow & Company after reviewing the com-
pany’s 2019 audit report. Mitchell & Moss’s audit was deficient; if they had complied with
auditing standards, the embezzlement would have been discovered. However, Mitchell &
Moss had no knowledge of the embezzlement, nor can their conduct be categorized as
reckless.
Answer the following questions, setting forth reasons for any conclusions stated:
a. What liability to Thaxton, if any, does Mitchell & Moss have under the Securities
Exchange Act of 1934?
b. What theory or theories of liability, if any, are available to Whitlow & Company’s customers and shareholders under common law?
Part 2. Jackson is a sophisticated investor. As such, she was initially a member of a small
group that was going to participate in a private placement of $1 million of common stock
of Clarion Corporation. Numerous meetings were held between management and the in-
vestor group. Detailed financial and other information was supplied to the participants.
Upon the eve of completion of the placement, it was aborted when one major investor
withdrew. Clarion then decided to offer $2.5 million of Clarion common stock to the
public pursuant to the registration requirements of the Securities Act of 1933. Jackson
subscribed to $300,000 of the Clarion public stock offering. Nine months later, Clarion’s
earnings dropped significantly, and as a result, the stock dropped 20 percent beneath the
offering price. In addition, the Dow Jones Industrial Average was down 10 percent from
the time of the offering.
Jackson sold her shares at a loss of $60,000 and seeks to hold all parties liable who
participated in the public offering, including Clarion’s CPA firm of Allen, Dunn, and Rose.
Although the audit was performed in conformity with auditing standards, there were
some relatively minor misstatements. The financial statements of Clarion Corporation,
which were part of the registration statement, also contained minor misleading facts. It
is believed by Clarion and Allen, Dunn, and Rose that Jackson’s asserted claim is without
merit.
Answer the following questions, setting forth reasons for any conclusions stated:
a. If Jackson sues under the Securities Act of 1933, what will be the basis of her claim?
b. What are the probable defenses that might be asserted by Allen, Dunn, and Rose in
light of these facts?*
