Kay & Lee LLP was retained as the auditor for Holligan Industries to audit the financial statements required by prospective banks as a prerequisite to extending a loan to the client. The auditor knows whichever bank lends money to the client is likely to rely on the audited statements. After the audit report is issued, the bank that ultimately made the loan discovers that the audit client’s inventory and accounts receivable were overstated. The client subsequently went bankrupt and defaulted on the loan. The bank alleged that the auditor failed to communicate about the inadequacy of the client’s internal recordkeeping and inventory control. Moreover, the bank claims that the auditors were grossly negligent in not discovering the overvaluation of inventory and accounts receivable.The auditors asserted that there was no way for them to know that the client included in the inventory account $1 million of merchandise in transit to a customer on December 31, 2015. The shipping terms were unclear so the auditors accepted management’s representations in that regard (FOB Destination). As for the receivables, the auditors claimed the client falsified confirmations by sending them to a post office address, retrieving them, and then confirming the stated balances.
1. Three of six defenses Kay & Lee might use would include which of the following?
The third party did not suffer a loss; any loss was caused by other events; the claim is invalid because the statute of limitations has expired
The auditor did not have a duty to third party; the third party used due care; the auditor’s work was performed in accord with professional standards
The auditor had a duty to parties other than the plaintiff; the third party was not negligent; the claim is invalid under the second restatement of the law of torts
The auditor’s work was performed in accord with GAAS; the third party suffered a loss; any loss to the third party was caused by other events
2. Grant Thornton prevailed in the Epic Resorts case with a defense that included, among other defenses:
There was no evidence of a causal connection between alleged misrepresentation and the funds’ alleged injury.
There was evidence of actual and justifiable reliance.
Liability for fraudulent misrepresentation runs only to those involved in privity, foreseeable reliance, or reasonably foreseeable reliance.
Grant Thornton did not engage in gross negligence.