Decision 2

         I believe there is a mismatch between auditors’ exposure to third party law suits under both common and statutory law and the role audits play in our capital markets.  The readings for Week 1 cover the critical role that audits play in reducing information risk for investors and creditors in our capital markets.  However, current legal liability under both common and statutory law in effect relegate third parties to a secondary position and give the client’s a stronger basis for suing auditors because of the contract between auditors and clients.  That is, clients can always sue for negligence but third parties can only sue for negligence in some jurisdictions and must show gross negligence/constructive fraud or fraud in others.  Third parties in some jurisdictions must show that the auditor knew the third party would rely on the financial statements.  That is, they need to get over thresholds for primary beneficiary or foreseen third party in most states, but only foreseeable third party in others.

If the role of auditors is primarily to reduce information risk to third parties, shouldn’t all third parties that meet the other criteria (reliance on and loss from materially misstated financial statements) always be able to sue for negligence just like the client?  Why or why not?  Given that any increase in auditor’s liabilities might also increase frivolous law suits, suggest a way that the legal environment can be changed to reduce frivolous lawsuits.

Hint – This is a thought provoking question where I would like generate discussion about just how strong an auditor’s responsibility should be to society in general to help insure the reliability of the financial statements they audit.  My point is that nearly all members of society directly or indirectly depend on reliable financial statements and the transparency of capital markets and not just direct investors and creditors.  What should auditor’s responsibilities be for performing quality audits in general regardless of who will eventually use them? 

2)           Auditors can always defend themselves to proving one of the required components needed to show auditor liability doesn’t apply to their case.  Which of these components do you think will be the hardest for the auditor to prove their innocence in court?  Which will be the better defense in a lawsuit?  Why?

Hint – This is a thought provoking question because the text doesn’t discuss how hard different defenses would be to prove in court.  I would like you to place yourself in the role of a juror in an auditor liability lawsuit and think about what evidence the auditor would need to present to convince you of their innocence or lack or responsibility to the plaintiff.