by Statutory liability is a legal term meaning that someone can be held responsible for a specific action or omission because of a related law that is not open to interpretation. This is a generic term that can apply to any field, not just finance. Within the world of finance, it may apply to real estate transactions, stockholder obligations, or the behavior of a board member.
Statutory law consists of written laws created by legislative bodies. Lawsuits brought against auditors based on statutory provisions differ from those under common law. Common law theories of liability may evolve or change over time, and interpretation and application may differ between jurisdictions, while statutory law is constrained to a greater degree by the text of the underlying statute.
Types of Statutory Liability
The legal responsibilities of a company or individual can extend to a number of different types of statutory liabilities. Here are just a few examples.
Employee benefits liability: Companies can be held accountable should they fail to meet federal laws regarding employee benefits, such as health insurance.
Professional liability: A company that offers professional services (such as accountants, financial advisors, or lawyers) may be held liable should it be deemed they provided inadequate or erroneous advice or services.
Vehicle liability: Companies can be held responsible for property damage and medical bills should a company vehicle cause an accident.
Medical malpractice liability: Providers of healthcare services face malpractice liability should their omission or negligent act cause harm to a patient.
Media liability: Companies that violate media or advertising laws face potential lawsuits filed on behalf of the damaged party. An example of this would be a lawsuit for copyright infringement.
United States
The two most important laws relating to auditors’ liability are the Securities Act of 1933 and the Securities Exchange Act of 1934. CPAs must also be concerned with the application of the Racketeer Influenced and Corrupt Organizations Act (RICO) and with each state’s blue sky laws (which regulate the issuance and trading of securities within a certain state).
The Securities Act of 1933 requires a company to register with the Securities and Exchange Commission (SEC). In order to complete registration, the company must include audited financial statements and numerous other disclosures. If the registration statement was to be found materially misstated, both the company and its auditors may be held liable. Those who initially purchase a security offered for sale are the only ones protected by the 1933 Act. These security purchasers, known as the plaintiffs, only need to prove a loss was constant and that the registration statement was misleading. They do not need to prove that they relied upon the registration or that the auditors were negligent. In order for an auditor to avoid liability, they must provide proof that the audit was performed with due diligence, the plaintiff’s losses were not caused by misstated financial statements, the plaintiffs knew of the misstatement at the time the securities were purchased, or the statute of limitations had expired (one year after the discovery of the misstatement, but no more than three years after the security was offered to the public). The due diligence defense is the defense that most auditors raise, even though it is difficult for auditors to prove their innocence. The standing precedent on interpretation of due diligence is Escott v. BarChris Construction Corporation, decided in 1968.
The Securities Exchange Act of 1934 requires all companies under SEC jurisdiction to file an annual audit and have quarterly review of financial statements. While the 1933 Act creates liability only to those investors involved in the initial distribution of public offerings, the 1934 Act increases that responsibility to subsequent purchasers and sellers of the stock. This act provides absolute protection to original and subsequent purchasers and sellers of securities. These plaintiffs must prove that:
- There was a substantial loss.
- The financial statements were misleading.
- They relied upon the financial statements.
According to Ernst & Ernst v. Hochfelder, plaintiffs must show proof of scienter (the intent to deceive, manipulate, or defraud). In order to avoid liability, auditors must prove they are normally able to establish “good faith” unless they have been guilty of gross negligence or fraud. In addition, the auditors may rely on causation, meaning that the losses experienced by the plaintiffs were caused by factors other than the auditor’s behavior.
Racketeer Influenced and Corrupt Organization Act
In 1970, Congress established the Racketeer Influenced and Corrupt Organizations Act (RICO). This act was established as a means of making sure that CPAs who may have been involved with any illegal mob or racketeering activity were brought to justice. The RICO Act allows for triple damages in civil cases that were brought under the act. This later became an issue of liability in Reves vs. Ernst & Young. This was a significant court case, in that, the court decided that for accountants to be liable for damages of a company under this act, they must have participated in the operation or management of the organization. This also led to the Private Securities Litigation Reform Act which essentially eliminated securities fraud as a civil action under RICO unless prior conviction.
Criminal liability under the Securities Acts
The Continental Vending case (also known as United States v. Simon) has set the precedent of severe charges for accountants. In this case, the U.S. court of appeals convicted three CPAs of gross negligence. Although the CPAs had proof to establish that they complied with U.S. generally accepted accounting principles and the U.S. generally accepted accounting standards, Mano states that the district court judge instructed the jury that mere compliance with professional accounting standards was not a complete defense. This led to the conviction of the three CPAs, who were later pardoned by President Richard Nixon.
As the accounting standards and principles evolve, it is essential for those in regulation, of litigation and in the accounting profession to be aware of the principles and the potential risks affiliated with the system concerning liability. The Securities and Exchange Commission (SEC) along with the Public Company Accounting Oversight Board (PCAOB) have implemented consequences for those who are involved in auditing fraud and any other illegal or unethical behavior in the field. In 1995, the SEC established the Private Securities Litigation Reform Act which in essence mandated auditors to have even stricter guidelines as they pertains to any fraudulent or misleading behavior of their clients. This act simply states that the auditors must promptly report any illegal acts of its clients to the company’s board of directors and if severe enough, to the SEC. According to the guidelines of this Act, auditors are relieved of sanctions if they report required information about clients to the SEC in a timely manner.
All organizations in all industries have exposure to potential liabilities that may arise from investigations or court cases brought by regulatory bodies for alleged breach of statute. Statutory liability policies can cover liabilities that arise out of unintentional violations under a range of New Zealand laws. Some of those statutes include:
- Consumer Guarantees Act
- Building Act
- Fair Trading Act
- Health and Safety in Employment Act 1992 and amendments
