The liability of accountants and auditors under the Federal Securities Acts and the Racketeer Influenced and Corrupt Organizations Act in the USA
| Date | 01 April 2003 |
| Published date | 01 April 2003 |
| Pages | 159-165 |
| DOI | https://doi.org/10.1108/13590790310808763 |
| Author | Mohammed B. Hemraj |
| Subject Matter | Accounting & finance |
The Liability of Accountants and Auditors under the
Federal Securities Acts and the Racketeer
In¯uenced and Corrupt Organizations Act in the USA
Mohammed B. Hemraj
INTRODUCTION
In the USA more cases are being brought against
professional people than elsewhere. Factors like the
continuation of trial by jury, lawyers charging fees
on a contingency basis, and class actions against pro-
fessional people contribute to the increase in liability
for professional negligence. Furthermore, in the
USA, some statutory provisions like the Securities
and Exchange Act and the Racketeer In¯uenced
and Corrupt Organizations Act (RICO) impose
additional burdens on the auditors in the detection
of accounting errors, irregularities and fraud. The
aim of the paper is to analyse these statutory provi-
sions and consider their impact on the audit profes-
sion in the USA.
LIABILITY UNDER THE FEDERAL
SECURITIES ACTS
The Federal Securities Laws
1
Two factors, the great depression and the stock
market crash of 1929, led the US government to
believe that the doctrine of caveat emptor (let the
buyer beware) was inappropriate where the oering
and trading of securities were concerned. This led
to the imposition of liability under federal securities
laws for audit reports of publicly held corporations
required by law to be ®led with the Securities and
Exchange Commission (SEC). In turn civil liabilities
were imposed on accountants under the provisions of
the Securities Act 1933 (`Securities Act') and the
Securities Exchange Act 1934 (`Exchange Act')
which made signi®cant changes in the principles of
common law liability. The aim was to protect
public investors from unscrupulous promoters for
securities and ®nd a way for stock market investors
to circumvent the privity rule. Prior to the enactment
of the Exchange Act, the investors had cause of action
limited only to prospectuses issued by the companies
and a registration statement ®led at the time a pro-
spectus was proposed. The Exchange Act protected
investors against false reports of the securities traded
on national or over-the-counter exchanges and
®led, by the corporation, with the SEC. The protec-
tion of investors was a prerequisite to allow the
dependence of the companies on private capital and
public dependence on independent accountants'
expertise. The Securities Act deals primarily with
the disclosure in the registration statement and pro-
spectus for a new security issue. The Exchange Act
is primarily concerned with trading in securities.
Meaning of security
The meaning of security was examined in Raves v
Ernst & Young.
2
The trial court awarded the plaintis
$6,100,000 in damages. The certi®ed public accoun-
tant ®rm was basing their defence on notes not
being securities under either state or federal laws,
with which the Court of Appeal concurred. On
further appeal, the Supreme Court held promissory
notes issued by the cooperative were securities as it
had satis®ed the following criteria: (a) there was
common trading of notes, (b) the public perceived
the notes as investments, (c) the cooperative sold
the notes to raise capital and (d) there were no risk-
reducing factors to negate the need for regulation
of notes. The plainti could therefore maintain a
security action against Ernst & Young.
Federal statutory provision
Besides the common law, numerous federal statutory
provisions in the USA impose obligation and liability
upon accountants. Section 10(b) of the Exchange Act
with the SEC rule 10(b)(5) is the most often litigated
section. Section 18 deals with common law fraud.
Section 11 of the Securities Act imposes civil liability
on auditors for misrepresentation or omission of the
material facts in a registration statement. A seller of
a security, who makes a false statement in a prospec-
tus, or in a communication, oral or written, is liable
under the Securities Act.
Section 10(b) of the Exchange Act and rule 1(b)(5)
of the SEC provide a private civil remedy for
Page 159
Journal of Financial Crime Ð Vol. 10 No. 2
Journal of Financial Crime
Vol.10,No. 2,2002,pp. 159 ±165
#HenryStewart Publications
ISSN 1359-0790
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