At the interface of law and accounting: An examination of a trend toward a reduction in the scope of auditor liability to third parties in the common law countries

American Business Law Journal

Volumn 37, Issue 2, 2000, Pages 171-236

  Pacini, Carl ^a   Martin, Mary Jill ^a   Hamilton, Lynda ^a  

^a NONE

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EID: 0040951492     PISSN: 00027766     EISSN: None     Source Type: Journal    
DOI: 10.1111/j.1744-1714.2000.tb00271.x     Document Type: Article

References (482)

1. See David Sands, Accountants Around the Globe See Rise in Professional Liability Suits, WASH. TIMES, Oct. 20, 1992, at C3.
2. See Jose Gonzalo, The Role, the Position, and the Liability of the Statutory Auditor Within the European Union, ACCT. HORIZONS, Mar. 1997, at 164, 165; Marleen Willekens et al., Audit Standards and Auditor Liability: A Theoretical Model, 26 ACCT. & BUS. RES. 249, 254 (1996).
3. See Jose Gonzalo, The Role, the Position, and the Liability of the Statutory Auditor Within the European Union, ACCT. HORIZONS, Mar. 1997, at 164, 165; Marleen Willekens et al., Audit Standards and Auditor Liability: A Theoretical Model, 26 ACCT. & BUS. RES. 249, 254 (1996).
4. See Scott Haggett, Fears Raised over Liability Issue: Trend Is to Sue the Accountant When Firms Go Under, FIN. POST, June 25, 1993, at 17.
5. See John Rink, The Shortcomings of Caparo, INT'L. CORP. L.., Mar. 1994, at 18.
6. See B. J. Cooper & M.L. Barkoczy, Third Party Liability: The Auditor's Lament, 9(5) MANAGERIAL AUDITING J. 31 (1994).
7. See Len Bayliss, Arthur Young Lawsuit Highlights Need for Better Standards, ACCT., Feb. 1992, at 7.
8. See Dan Dalton et al., The Big Chill. J. ACCT., Nov. 1994, at 53.
9. The accounting practices of a country are related to that nation's legal system. The degree to which accounting rules are legislated can impact the nature of the accounting system. In code law countries, laws stipulate minimum requirements, and accounting rules tend to be highly prescriptive and procedural. In common law countries, laws establish limits beyond which it is illegal to venture, and within those limits experimentation is encouraged. See Gary Meek & Shahrokh Saudagaran, A Survey of Research on Financial Reporting in a Transnational Context, 9 J. ACCT. LITERATURE 145 (1990). One recent study provides empirical support for the hypothesis that a legal system is a significant predictor of accounting practices. A cluster analysis (using the average linkage method) involving a sample of 174 responses from managing partners of international public accounting firms distributed across 50 countries indicates a dichotomization of accounting practices, procedures, and rules consistent with the common law/code law classification of legal systems. See Stephen Salter & Timothy Doupnik, The Relationship between Legal Systems and Accounting Practices: A Classification Exercise, 5 ADVANCES INT'L. ACCT. 3 (1992).
10. The accounting practices of a country are related to that nation's legal system. The degree to which accounting rules are legislated can impact the nature of the accounting system. In code law countries, laws stipulate minimum requirements, and accounting rules tend to be highly prescriptive and procedural. In common law countries, laws establish limits beyond which it is illegal to venture, and within those limits experimentation is encouraged. See Gary Meek & Shahrokh Saudagaran, A Survey of Research on Financial Reporting in a Transnational Context, 9 J. ACCT. LITERATURE 145 (1990). One recent study provides empirical support for the hypothesis that a legal system is a significant predictor of accounting practices. A cluster analysis (using the average linkage method) involving a sample of 174 responses from managing partners of international public accounting firms distributed across 50 countries indicates a dichotomization of accounting practices, procedures, and rules consistent with the common law/code law classification of legal systems. See Stephen Salter & Timothy Doupnik, The Relationship between Legal Systems and Accounting Practices: A Classification Exercise, 5 ADVANCES INT'L. ACCT. 3 (1992).
11. See Auditors Must Deal with an Increasing Number of Lawsuits Charging Negligence, FIN. POST, Mar. 20, 1990, at 18.
12. See Gundi Jeffrey, Accountants Want Relief from Legal Nightmare, FIN. POST, Apr. 29, 1994, at 12.
13. Michael Beckett, Accountants Debate Move to Limited Liability, DAILY TEL., June 28, 1994, at 28.
14. See Christopher Napier, Intersections of Law and Accountancy: Unlimited Auditor Liability in the United Kingdom, 23 ACCT., ORG. & SOC'Y.105, 106 (1998). The Institute of Chartered Accountants in England and Wales has lobbied the U.K. government consistently over recent years to bring about legislative reform to limit accountants' liability. This effort took on a new sense of urgency after the award of damages of £65 million against Binder Hamlyn, a leading firm of British accountants. See id.
15. See Christopher Napier, Intersections of Law and Accountancy: Unlimited Auditor Liability in the United Kingdom, 23 ACCT., ORG. & SOC'Y.105, 106 (1998). The Institute of Chartered Accountants in England and Wales has lobbied the U.K. government consistently over recent years to bring about legislative reform to limit accountants' liability. This effort took on a new sense of urgency after the award of damages of £65 million against Binder Hamlyn, a leading firm of British accountants. See id.
16. See Bill Pheasant, Accountants Want to Stop the Damage, AUSTL. FIN. REV., Aug. 12, 1993, at 14.
17. See John Lepper, N.Z. Auditors Strain Under Litigation Threat, ACCT., Mar. 1992, at 8.
18. See Dalton et al., supra note 7, at 53; James Granelli, Jumping Ship, L.A. TIMES, Oct. 22, 1995, at D1. In 1994, the Big 6 firms claimed that a tidal wave of liability lawsuits threatened their existence. See Steven Marino & Renee Marino, An Empirical Study of Recent Securities Class Action Settlements Involving Accountants, Attorneys, or Underwriters, 22 SEC. REG. L.J.115, 149-50 (1994). Despite the passage of the Private Securities Litigation Reform Act of 1995, Pub. L. No. 104-67, 109 Stat. 737 (1995)(codified as amended in scattered sections of 15 U.S.C.A. (West Supp. 1996)), the number of shareholder lawsuits naming accountants as defendants has not declined. See Elizabeth MacDonald, More Accounting Firms Are Dumping Risky Clients, WALL ST. J., Apr. 25, 1997, at A2.
19. See Dalton et al., supra note 7, at 53; James Granelli, Jumping Ship, L.A. TIMES, Oct. 22, 1995, at D1. In 1994, the Big 6 firms claimed that a tidal wave of liability lawsuits threatened their existence. See Steven Marino & Renee Marino, An Empirical Study of Recent Securities Class Action Settlements Involving Accountants, Attorneys, or Underwriters, 22 SEC. REG. L.J.115, 149-50 (1994). Despite the passage of the Private Securities Litigation Reform Act of 1995, Pub. L. No. 104-67, 109 Stat. 737 (1995)(codified as amended in scattered sections of 15 U.S.C.A. (West Supp. 1996)), the number of shareholder lawsuits naming accountants as defendants has not declined. See Elizabeth MacDonald, More Accounting Firms Are Dumping Risky Clients, WALL ST. J., Apr. 25, 1997, at A2.
20. See Dalton et al., supra note 7, at 53; James Granelli, Jumping Ship, L.A. TIMES, Oct. 22, 1995, at D1. In 1994, the Big 6 firms claimed that a tidal wave of liability lawsuits threatened their existence. See Steven Marino & Renee Marino, An Empirical Study of Recent Securities Class Action Settlements Involving Accountants, Attorneys, or Underwriters, 22 SEC. REG. L.J.115, 149-50 (1994). Despite the passage of the Private Securities Litigation Reform Act of 1995, Pub. L. No. 104-67, 109 Stat. 737 (1995)(codified as amended in scattered sections of 15 U.S.C.A. (West Supp. 1996)), the number of shareholder lawsuits naming accountants as defendants has not declined. See Elizabeth MacDonald, More Accounting Firms Are Dumping Risky Clients, WALL ST. J., Apr. 25, 1997, at A2.
21. See Dalton et al., supra note 7, at 53; James Granelli, Jumping Ship, L.A. TIMES, Oct. 22, 1995, at D1. In 1994, the Big 6 firms claimed that a tidal wave of liability lawsuits threatened their existence. See Steven Marino & Renee Marino, An Empirical Study of Recent Securities Class Action Settlements Involving Accountants, Attorneys, or Underwriters, 22 SEC. REG. L.J.115, 149-50 (1994). Despite the passage of the Private Securities Litigation Reform Act of 1995, Pub. L. No. 104-67, 109 Stat. 737 (1995)(codified as amended in scattered sections of 15 U.S.C.A. (West Supp. 1996)), the number of shareholder lawsuits naming accountants as defendants has not declined. See Elizabeth MacDonald, More Accounting Firms Are Dumping Risky Clients, WALL ST. J., Apr. 25, 1997, at A2.
22. See Andrew Jack, Rise in Legal Claims Hits Top Accountancy Firms: Auditors Say They Are Turning Away High-Risk Clients, FIN. TIMES, Feb. 21, 1994, at 18; Frederick Jones & K. Raghunandan, Client Risk and Recent Changes in the Market for Audit Services, 17 J. ACCT. & PUB. POL'Y. 169, 171-72 (1998); MacDonald, supra note 15; Alastair Thompson, Big Auditors Priced Out of N.Z. Market, NAT'L. BUS. REV., (Reuters Textline), Sept. 9, 1994.
23. See Andrew Jack, Rise in Legal Claims Hits Top Accountancy Firms: Auditors Say They Are Turning Away High-Risk Clients, FIN. TIMES, Feb. 21, 1994, at 18; Frederick Jones & K. Raghunandan, Client Risk and Recent Changes in the Market for Audit Services, 17 J. ACCT. & PUB. POL'Y. 169, 171-72 (1998); MacDonald, supra note 15; Alastair Thompson, Big Auditors Priced Out of N.Z. Market, NAT'L. BUS. REV., (Reuters Textline), Sept. 9, 1994.
24. See Andrew Jack, Rise in Legal Claims Hits Top Accountancy Firms: Auditors Say They Are Turning Away High-Risk Clients, FIN. TIMES, Feb. 21, 1994, at 18; Frederick Jones & K. Raghunandan, Client Risk and Recent Changes in the Market for Audit Services, 17 J. ACCT. & PUB. POL'Y. 169, 171-72 (1998); MacDonald, supra note 15; Alastair Thompson, Big Auditors Priced Out of N.Z. Market, NAT'L. BUS. REV., (Reuters Textline), Sept. 9, 1994.
25. See Andrew Jack, Rise in Legal Claims Hits Top Accountancy Firms: Auditors Say They Are Turning Away High-Risk Clients, FIN. TIMES, Feb. 21, 1994, at 18; Frederick Jones & K. Raghunandan, Client Risk and Recent Changes in the Market for Audit Services, 17 J. ACCT. & PUB. POL'Y. 169, 171-72 (1998); MacDonald, supra note 15; Alastair Thompson, Big Auditors Priced Out of N.Z. Market, NAT'L. BUS. REV., (Reuters Textline), Sept. 9, 1994.
26. See DAN GOLDWASSER & M.T. ARNOLD, ACCOUNTANTS' LIABILITY 11-1 to 11-3 (1998); Ronald B. Johnson et al., Auditor Preferences for Liability Limitation, ACCT. & FIN., Nov. 1995, at 135.
27. See DAN GOLDWASSER & M.T. ARNOLD, ACCOUNTANTS' LIABILITY 11-1 to 11-3 (1998); Ronald B. Johnson et al., Auditor Preferences for Liability Limitation, ACCT. & FIN., Nov. 1995, at 135.
28. A rise in the number of experienced accountants leaving the ranks of the profession "is of concern both to CPAs and society, because a sound public accounting profession is essential to a healthy free enterprise system. In particular, there is concern that an exodus of experienced personnel from public accounting will harm audit quality." Dalton et al., supra note 7, at 53; Pheasant, supra note 13, at 14.
29. A rise in the number of experienced accountants leaving the ranks of the profession "is of concern both to CPAs and society, because a sound public accounting profession is essential to a healthy free enterprise system. In particular, there is concern that an exodus of experienced personnel from public accounting will harm audit quality." Dalton et al., supra note 7, at 53; Pheasant, supra note 13, at 14.
30. See Auditor Liability Evokes Wider Concerns, CMA MAG., July/Aug.1998, at 31.
31. See H. Fenwick Huss & Fred Jacobs, Risk Containment: Exploring Auditor Decisions in the Engagement Process, 10 AUDITING: J. PRAC. & THEORY 16, 19 (1991); Jones & Raghunandan, supra note 16, at 170.
32. See H. Fenwick Huss & Fred Jacobs, Risk Containment: Exploring Auditor Decisions in the Engagement Process, 10 AUDITING: J. PRAC. & THEORY 16, 19 (1991); Jones & Raghunandan, supra note 16, at 170.
33. See AUDITING STANDARDS BOARD, AMERICAN INSTITUTE OF CERTIFIED PUBLIC ACCOUNTANTS, AUDIT RISK ALERT - 1992; Craig Brumfield et al., Business Risk and the Audit Process, J. ACCT., Apr. 1983, at 60, 60-65.
34. See AUDITING STANDARDS BOARD, AMERICAN INSTITUTE OF CERTIFIED PUBLIC ACCOUNTANTS, AUDIT RISK ALERT - 1992; Craig Brumfield et al., Business Risk and the Audit Process, J. ACCT., Apr. 1983, at 60, 60-65.
35. An accountant may owe a duty to one or more of three categories of people: (1) the client and any other party with whom the accountant is in privity; (2) a known and intended class or group of financial statement users (or beneficiaries of the accountant's work product); and (3) any person the accountant should reasonably foresee as a beneficiary of his or her work product. See Nancy Chaffee, Note, The Role and Responsibility of Accountants in Today's Society, 13 J. CORP. L. 863, 866 (1988).
36. Negligence is one of the most significant tort theories used in auditor litigation. The reasons are: (1) it is not as difficult to prove as fraud; in the latter, the plaintiff must prove intent to deceive or, in some cases, recklessness on the part of the accountant; (2) many securities laws apply only to purchasers and/or sellers of securities; and (3) nonclients cannot sue for breach of contract. In the United States, lawsuits involving state claims, including negligence, accounted for about 69% of auditor lawsuits against Big 6 firms resolved in 1990-1992 and approximately 48% of the dollar amount of settlements and court awards in those years. See Robert Mednick & Jeffrey Peck, Proportionality: A Much-Needed Solution to the Accountants' Legal Liability Crisis, 23 VAL. U. L. REV. 867 (1994).
37. See H.D. Brecht, Auditors' Duty of Care to Third Parties: A Comment on Judicial Reasoning Underlying U.S. Cases, 19 ACCT. & BUS. RES. 175 (1989).
38. See D.R. Gwilliam, The Auditor, Third Parties, and Contributory Negligence, 18 ACCT. & BUS. RES. 25 (1987).
39. See John Siciliano, Negligent Accounting and the Limits of Instrumental Tort Reform, 86 MICH. L. REV. 1929, 1955 (1988).
40. One example of such a situation occurred in Performance Motorcars, Inc. v. Peat Marwick, 643 A.2d 39 (N.J. Super. Ct. App. Div. 1994). Performance Motorcars, Inc., a New York business, sued Peat Marwick in a New Jersey court, alleging that it suffered losses after one of its customers, Coated Sales, Inc., went bankrupt. Id. at 40. Performance conceded that if New York law applied, it would not be able to sue Peat Marwick. Id. Ultimately, an appeals court held that New Jersey law applied giving Performance a legal right to sue under New Jersey law applicable at the time of the suit. In 1995, the New Jersey legislature passed a statute which changed state law to a stricter standard than the one applied in this case for determining the scope of an accountant's duty to nonclients for negligence. N.J. STAT. ANN. § 2A:53A-25 (West 1998).
41. 107 A. 783 (Pa. 1919). In Pennsylvania, strict privity continues to be the prevailing rule of law Raymond Rosen & Co. v. Seidman & Seidman, 579 A.2d 424 (Pa. Super. Ct. 1990); In re Phar-Mor Sec. Litig., 892 F. Supp. 676 (W.D. Pa. 1995); PNC Bank, Kentucky, Inc. v. Housing Mortgage Corp., 899 F. Supp. 1399 (W.D. Pa. 1994).
42. In Virginia, strict privity became law in 1993. Ward v. Ernst & Young, 435 S.E.2d 628 (Va. 1993).
43. 174 N.E. 441 (N.Y. 1931).
44. Id. at 445-46. The decision in Glanzer v. Shepard, 135 N.E. 275 (N.Y. 1922), influenced the outcome reached in Ultramares. In Glanzer, the Court of Appeals held that a public weigher, hired by a seller of beans, was liable to a third party who purchased beans from the bean vendor. The third party was overcharged for the beans because the public weigher negligently overstated the weight of the beans. The public weigher had been hired by the seller to provide a weight certificate directly to the bean purchaser. In distinguishing Glanzer from Ultramares, Judge Cardozo noted that the service rendered by the public weigher was primarily for the benefit or information of a third person while in Ultramares the auditor's service was primarily for the benefit of the Stern Company (the auditor's client) and only collaterally for the use of third persons. Id.
45. Id. at 446.
46. Bonita A. Daley & John M. Gibson, The Delineation of Accountants' Legal Liability to Third Parties: Bily and Beyond, 68 ST. JOHN'S L. REV. 609, 620 (1994); R. James Gormley, The Foreseen, the Foreseeable, and Beyond - Accountants' Liability to Nonclients, 14 SETON HALL L. REV. 528, 531-32 (1984).
47. Bonita A. Daley & John M. Gibson, The Delineation of Accountants' Legal Liability to Third Parties: Bily and Beyond, 68 ST. JOHN'S L. REV. 609, 620 (1994); R. James Gormley, The Foreseen, the Foreseeable, and Beyond - Accountants' Liability to Nonclients, 14 SETON HALL L. REV. 528, 531-32 (1984).
48. 483 N.E.2d 110 (N.Y. 1985). Credit Alliance Corp. provided equipment financing to L.B. Smith, Inc. for many years. Id. at 111. In 1978, Credit Alliance advised Smith that any future extensions of credit would require audited financial statements, including an unqualified opinion from Arthur Andersen, for fiscal years 1976 through 1979. Id. In 1980, L.B. Smith filed for bankruptcy. Id. at 112.
49. Id.
50. Security Pacific Bus. Credit v. Peat Marwick Main, 597 N.E.2d 1080 (N.Y. 1992).
51. Idaho Bank & Trust Co. v. First Bancorp., 772 P.2d 720 (Idaho 1989); Thayer v. Hicks, 793 P.2d 784 (Mont. 1990); Citizens Nat'l Bank v. Kennedy & Coe, 441 N.W.2d 189 (Neb. 1989); Credit Alliance v. Arthur Andersen, 483 N.E.2d 110 (N.Y. 1985).
52. See ARK. CODE ANN. § 16-114-302 (Michie 1998); 225 ILL. COMP. STAT. 450/30.1 (West 1998); KAN. STAT. ANN. § 1-402 (1998); LA. REV. STAT. ANN. § 37:91 (West 1999); MICH. COMP. LAWS § 600.2962 (1998); N.J. STAT. ANN. § 2A; 53A-25 (West 1998); UTAH CODE ANN. § 58-26-12 (1998); WYO. STAT. ANN. § 33-3-201 (Michie 1998).
53. Rusch Factors, Inc. v. Levin, 284 F. Supp. 85 (D.R.I. 1968).
54. RESTATEMENT(SECOND)OF TORTS § 552 (1977). Section 552 provides: § 552. Information Negligently Supplied for the Guidance of Others (1) One who, in the course of his business, profession, or employment, or in any other transaction in which he has a pecuniary interest, supplies false information for the guidance of others in their business transactions, is subject to liability for pecuniary loss caused to them by their justifiable reliance upon the information, if he fails to exercise reasonable care or competence in obtaining or communicating the information. (2) [T]he liability stated in subsection (1) is limited to loss suffered (a) by the person or one of a limited group of persons for whose benefit and guidance he intends to supply the information or knows that the recipient intends to supply it; and (b) through reliance upon it in a transaction that he intends the information to influence or knows that the recipient so intends or in a substantially similar transaction.
55. Id. See also Daley & Gibson, supra note 33, at 632.
56. Id. See also Daley & Gibson, supra note 33, at 632.
57. RESTATEMENT (SECOND) OF TORTS § 552(2), comments i, j; Daley & Gibson, supra note 33, at 627. Audit risk is the risk that the auditor will unknowingly fail to appropriately modify his or her opinion on materially misstated financial statements. WILLIAM C. BOYNTON & WALTER G. KELL, MODERN AUDITING 231 (6th ed. 1996).
58. RESTATEMENT (SECOND) OF TORTS § 552(2), comments i, j; Daley & Gibson, supra note 33, at 627. Audit risk is the risk that the auditor will unknowingly fail to appropriately modify his or her opinion on materially misstated financial statements. WILLIAM C. BOYNTON & WALTER G. KELL, MODERN AUDITING 231 (6th ed. 1996).
59. RESTATEMENT (SECOND) OF TORTS § 552(2), comments i, j; Daley & Gibson, supra note 33, at 627. Audit risk is the risk that the auditor will unknowingly fail to appropriately modify his or her opinion on materially misstated financial statements. WILLIAM C. BOYNTON & WALTER G. KELL, MODERN AUDITING 231 (6th ed. 1996).
60. Richard Panttaja, Accountants' Duty to Third Parties: A Search for a Fair Doctrine of Liability, 23 STETSON L. REV. 927, 941 (1994); Bethlehem Steel Corp. v. Ernst & Whinney, 822 S.W.2d 592, 595 (Tenn. 1991); Raritan River Steel v. Cherry, 367 S.E.2d 609, 617 (N.C. 1988).
61. Richard Panttaja, Accountants' Duty to Third Parties: A Search for a Fair Doctrine of Liability, 23 STETSON L. REV. 927, 941 (1994); Bethlehem Steel Corp. v. Ernst & Whinney, 822 S.W.2d 592, 595 (Tenn. 1991); Raritan River Steel v. Cherry, 367 S.E.2d 609, 617 (N.C. 1988).
62. Amwest Sur. Ins. Co. v. Ernst & Young, 677 So. 2d 409, 411 (Fla. Dist. Ct. App. 1996); RESTATEMENT (SECOND) OF TORTS § 552, comment h (1977).
63. Badische Corp. v. Caylor, 356 S.E.2d 198, 200 (Ga. 1987).
64. Amwest Sur. Ins. Co., 677 So.2d at 411 (Fla. Dist. Ct. App. 1996). By receiving notice of the third parties to whom potential liability may be incurred, the auditor can decide whether to accept the engagement, adjust the audit plan to meet the needs of third parties, and/or negotiate audit fees that are commensurate with the scope of liability. Daley & Gibson, supra note 33, at 633.
65. Amwest Sur. Ins. Co., 677 So.2d at 411 (Fla. Dist. Ct. App. 1996). By receiving notice of the third parties to whom potential liability may be incurred, the auditor can decide whether to accept the engagement, adjust the audit plan to meet the needs of third parties, and/or negotiate audit fees that are commensurate with the scope of liability. Daley & Gibson, supra note 33, at 633.
66. Badische Corp., 356 S.E.2d at 199-200 (Ga. 1987); RESTATEMENT(SECOND) OF TORTS § 552 (2)(a) & (b).
67. Raritan River Steel v. Cherry, 367 S.E.2d 609, 614 (N.C. 1988). According to this case, the Restatement requires only that the auditor know at the time the report is audited or prepared that the client intends to supply information to another person or limited group of persons. Whether the auditor acquires this knowledge from the client or elsewhere is irrelevant. Id. at 618.
68. Thomas Gossman, The Fallacy of Expanding Accountants' Liability, 1988 COLUM. BUS. L. REV. 213, 218.
69. Ryan v. Kanne, 170 N.W.2d 395, 403 (Iowa 1969). Intent to influence a class of beneficiaries is a threshold issue. A plaintiff may rely on an accountant's misrepresentation but no liability attaches without intent to influence. Bily v. Arthur Young & Co., 834 P.2d 745 (Cal. 1992).
70. The states which have adopted the Restatement standard or a variation include: Alabama, Alaska, Arizona, California, Colorado, Florida, Georgia, Hawaii, Iowa, Massachusetts, Minnesota, Missouri, New Hampshire, North Carolina, Ohio, South Carolina, Tennessee, Texas, Washington, and West Virginia.
71. 461 A.2d 138 (N.J. 1983). The holding in this case ceased to be law in March 1995 upon the enactment of an accountant privity statute. N.J. STAT. ANN. § 2A: 53A-25 (West 1998).
72. Rosenblum, 461 A.2d at 153.
73. Id.
74. Denzl Causey, Accountants' Liability in an Indeterminate Amount for an Indeterminate Class: An Analysis of Touche Ross & Co. v. Commercial Union Ins. Co., 57 Miss. L.J. 379, 380 (1987).
75. Willis Hagen III, Accountants' Common Law Liability to Third Parties, 1988 COLUM. BUS. L. REV. 181, 189. The holding in Rosenblum became ineffective in March 1995 upon passage of an accountant privity statute. N.J. STAT. ANN. § 2A: 53A-25 (West 1998).
76. The eight states are Arkansas (ARK. CODE ANN. § 16-114-302 (Michie 1998)), Illinois (225 ILL. COMP. STAT. 450/30.1 (West 1998)), Kansas (KAN. STAT. ANN. § 1-402 (West 1998)), Louisiana (LA. REV. STAT. ANN. § 37:91 (West 1999)), Michigan (MICH. COMP. LAWS § 600.2962 (1998)), New Jersey (N.J. STAT. ANN. § 2A: 53A-25 (West 1998)), Utah (UTAH CODE ANN. § 58-26-12 (1998)), and Wyoming (WYO. STAT. ANN. § 33-3-201 (Michie 1998)).
77. The Arkansas statute is used here as an example. The statute reads as follows: No person . . . shall be liable to persons not in privity of contract . . . for civil damages resulting from acts, omissions, decisions, or other conduct in connection with professional services, except for: (2) Other acts, omissions, decisions, or conduct, if the person, partnership or corporation was aware that a primary intent of the client was for the professional services to benefit or influence the person bringing the action . . . . For purposes of this subdivision, if the person, partnership, or corporation: (a) identifies in writing to the client those persons who are intended to rely on the services, and (b) sends a copy of the writing or similar statement to those persons identified in the writing or statement, then the person . . . may be held liable only to the persons intended to rely in addition to those persons in privity of contract . . . . ARK. CODE ANN. § 16-114-302 (Michie 1998).
78. 908 S.W.2d 660 (Ark. 1995).
79. Id. at 662-63.
80. 667 N.E.2d 543 (Ill. Ct. App. 1996).
81. The general rule of liability is that an accountant owes a duty to a nonclient if the accountant was aware that a primary intent of the client was for the professional services to benefit or influence the particular third party. Christine Guerci, Liability of Independent Accountant to Investors or Shareholders, 48 A.L.R. 5th 389 (1998). The Chestnut court rejected a reading of the statute that makes written notice to a third party or nonclient a condition of liability for negligent misrepresentation. Id.
82. The general rule of liability is that an accountant owes a duty to a nonclient if the accountant was aware that a primary intent of the client was for the professional services to benefit or influence the particular third party. Christine Guerci, Liability of Independent Accountant to Investors or Shareholders, 48 A.L.R. 5th 389 (1998). The Chestnut court rejected a reading of the statute that makes written notice to a third party or nonclient a condition of liability for negligent misrepresentation. Id.
83. Chestnut, 667 N.E.Sd at 546.
84. Id.
85. Id. at 547.
86. Id.
87. Id.
88. KAN. STAT. ANN. § 1-402 (West 1998).
89. Id. § 1-402(b)(2).
90. Id. § 1-402(b)(1).
91. Id.
92. Id. §1-402(b)(2).
93. Id § 1-402(b).
94. ARK. CODE ANN. § 16-114-302 (2) (Michie 1998); 225 ILL. COMP. STAT. 450.30.1(2) (West 1998); UTAH CODE ANN. § 58-26-12(2) (1998).
95. The accountant liability statutes in Arkansas, Illinois, and Utah are silent on whether the accountant's awareness or knowledge of the client's intent can occur after reliance on the financial statements by the nonclient. None of these three statutes defines precisely when the accountant "was aware" of the primary intent of the client.
96. KAN STAT. ANN. § 1-402 (b)(1) (1998).
97. Id. § 1-402 (b)(2).
98. UTAH CODE ANN. § 58-26-12 (1998).
99. Nordica USA, Inc. v. Deloitte & Touche, 839 F. Supp. 1982 (D. Vt. 1993).
100. 908 S.W.2d 660 (Ark. 1995).
101. N.J. STAT. ANN. § 2A: 53A-25 (West 1998).
102. The pertinent language of the New Jersey statute reads as follows: No accountant shall be liable for damages for negligence arising out of and in the course of rendering professional services unless. . . the accountant: (2)(a) Knew at the time of the engagement by the client or agreed with the client after the time of the engagement, that the . . . service rendered to the client would be made available to the claimant, who was specifically identified to the accountant in connection with a specified transaction. . .; (b) Knew that the claimant intended to rely upon the . . . service in connection with that specified transaction; and (c) directly expressed to the claimant, by words or conduct, the accountant's understanding of the claimant's intended reliance. N.J. STAT. ANN. § 2A:53A-25 (West 1998).
103. 483 N.E.2d 110 (N.Y. 1985).
104. The New Jersey statute applies to banks with the addition of the following provision: "In the case of a bank claimant, the accountant must acknowledge the bank's intended reliance on the . . . accounting service and the client's knowledge of that reliance in a written communication." N.J. STAT. ANN. § 2A:53A-25 (West 1998).
105. Id.
106. ARK. CODE ANN. § 16-114-302 (Michie 1998); 225 ILL. COMP. STAT. 450/30.1 (West 1998); UTAH CODE ANN. § 58-26-12 (1998).
107. N.J. STAT. ANN. § 2A: 53A-25(2)(c) (West 1998).
108. WYO. STAT. ANN. § 33-3-201 (Michie 1998).
109. Id. § 33-3-201 (c)(ii).
110. KAN. STAT. ANN. § 1-402 (1998).
111. WYO. STAT. ANN. § 33-3-201(d) (Michie 1998).
112. Id.
113. Under Michigan's accountant liability law, a certified public accountant may be liable for a negligent act, omission, decision, or other conduct if the "certified public accountant was informed in writing by the client at the time of the engagement that a primary intent of the client was for the . . . accounting services to benefit or influence the person bringing the action for civil damages. . . . The certified public accountant may be held liable only to each identified person, generic group or class description." MICH. COMP. LAWS § 600.2962 (1998).
114. Id.
115. Id.
116. Id.
117. LA. REV. STAT. ANN. § 37:91 (West 1999). See supra note 84 for the text of the New Jersey statute, which is almost identical to the Louisiana statute except for the provision which addresses reliance on the accountant's work product by banks.
118. E. R. Fencl, Rebuilding the Citadel: State Legislative Responses to Accountant Non-Privity Suits, 67 WASH. U. L.Q. 863, 887 (1989).
119. It may be argued that under Michigan law circumstances could arise (e.g., a client provides an accountant a writing that names a large class of users as those to be benefitted by the CPA's services) which could defeat the near-privity character of the statute However, a CPA may decline a client engagement because the client must inform the CPA at the time of the engagement who is to be influenced by the accounting services. MICH. COMP. LAWS § 600.2962 (1998).
120. PNC Bank, Kentucky, Inc. v. Housing Mortgage Corp., 899 F. Supp. 1399 (W.D. Pa. 1994).
121. In re Phar-Mor Sec. Litig., 892 F. Supp. 676 (W.D. Pa. 1995).
122. 435 S.E. 2d 628 (Va. 1993).
123. Id. at 630.
124. Id. at 631.
125. Id. at 631-32.
126. Id. at 634.
127. 772 P.2d 720 (Idaho 1989). 110 Id. at 722.
128. 895 P.2d 1195 (Idaho 1995).
129. Id. at 1197.
130. Citizens Nat'l Bank v. Kennedy & Coe, 441 N.W.2d 180 (Neb. 1989).
131. Id. at 182.
132. Id.
133. Id. The cases cited by the Nebraska Supreme Court in support of its holding are Landrigan v. Nelson, 420 N.W.2d 313 (Neb. 1988); Ames Bank v. Hahn, 287 N.W.2d 687 (Neb. 1980); Lilyhorn v. Dier, 335 N.W.2d 554 (Neb. 1983).
134. 507 N.W.2d 275 (Neb. 1993).
135. 551 So. 2d 390 (Ala. 1989).
136. 639 So. 2d 504 (Ala. 1994).
137. William Hardie, Liability of Professionals for Negligent Certification, ALA. LAW., July 1994, at 229.
138. Boykin, 639 So.2d at 505.
139. RESTATEMENT (SECOND) OF TORTS § 552, comment h (1977).
140. 793 P.2d 784 (Mont. 1990).
141. Id. at 785-88.
142. Id. at 791. The reason appears to be that the jury instructions at the trial level covered only the first two elements of the Credit Alliance test and the court did not want to reverse and remand.
143. 367 S.E.2d 609 (N.C. 1988).
144. Id. at 615.
145. Id.
146. Id. at 616.
147. Specifically, the Supreme Court rejected a balancing test first set forth in Biakanja v. Irving, 320 P.2d 16 (Cal. 1958), where a notary public was held liable to an intended beneficiary under a negligently prepared will. The factors used in the balancing test are: (1) the extent to which the transaction was intended to affect the plaintiff; (2) the foreseeability of harm to the plaintiff; (3) the degree of certainty that the plaintiff suffered injury; (4) the closeness of the connection between the defendant's conduct and the injury suffered; (5) the moral blame attached to the defendant's conduct; and (6) the policy of preventing future harm. The balancing test was rejected because it "approximates a 'reasonable foreseeability' test" and "is difficult to apply." Raritan River Steel, 367 S.E.2d at 617.
148. Id.
149. Marcus Brothers Textiles, Inc. v. Price Waterhouse, 498 S.E.2d 196 (N.C. Ct. App. 1998).
150. 386 S.E.2d 310 (W. Va. 1989).
151. Id.
152. A review consists primarily of inquiries of client personnel and analytical procedures applied to financial data. It is substantially less in scope than a financial statement audit. BOYNTON & KELL, supra note 42, at 11.
153. First Nat'l Bank, 386 S.E.2d at 311.
154. Id. at 311-15.
155. Id. at 313.
156. Id.; see supra notes 126-32 and accompanying text.
157. 483 S.E.2d 248 (W.Va. 1996).
158. 558 So. 2d 9 (Fla. 1990).
159. 457 So. 2d 467 (Fla. 1984).
160. Marquest Med Prod. Inc. v. Daniel, McKee & Co., 791 P.2d 14 (Colo. App. 1990); Mehaffy Rider, Windholz & Wilson v. Central Bank, 892 P.2d 230 (Colo. 1995).
161. 822 S.W.2d 592 (Tenn. 1991).
162. Id. at 593-95.
163. Id. at 594.
164. Id.
165. 912 S.W.2d 128 (Tenn. 1995).
166. 834 P.2d 745 (Cal. 1992).
167. 223 Cal. Rptr. 218 (Cal. Ct. App. 1986).
168. Bily, 834 P.2d at 752-59, 768-73.
169. Id at 769. The court even suggested a special jury instruction for negligent misrepresentation cases. The instruction emphasizes the court's intent to narrowly define the class of third parties who can recover from accountants. Thomas G. Mackey, Accountants' Liability after Bily v. Arthur Young & Co.: A More Equitable Proposal for Third Party Recovery, 45 HASTINGS L.J. 147, 160 (1993). The special jury instruction reads as follows: The representation must have been made with the intent to induce plaintiff, or a particular class of persons to which plaintiff belongs, to act in reliance upon the representation in a specific transaction, or specific type of transaction, that defendant intended to influence. Defendant is deemed to have intended to influence [the] transaction with plaintiff whenever defendant knows with substantial certainty that plaintiff, or the particular class of persons to which plaintiff belongs, will rely on the representation . . . . Bily, 834 P.2d at 772-73.
170. Panttaja, supra note 43, at 930.
171. Bily, 834 P.2d at 761.
172. Siciliano, supra note 26, at 1956-57.
173. 851 S.W.2d 563 (Mo. App. 1993).
174. 493 S.W. 2d 378 (Mo. App. 1973).
175. Id. at 380-83.
176. MidAmerican Bank, 851 S.W.2d at 565-67.
177. 442 S.E.2d 804 (Ga. Ct. App. 1994).
178. Id. at 805-06.
179. Demetracopoulos v. Wilson, 640 A.2d 279 (N.H. 1994).
180. 463 S.E.2d 618 (S.C. Ct. App. 1995).
181. Id. at 625-28.
182. Id. at 626-27 The M-L Lee court relied upon the public policy analysis contained in Raritan River Steel v. Cherry, 367 S.E.2d 609 (N.C. 1988).
183. M-L Lee Acquisition Fund, 463 S.E.2d at 626-27.
184. Id.
185. Id.
186. See e.g., Winburn v. Insurance Co. of N. Am., 339 S.E.2d 142, 146-47 (S.C. Ct. App. 1985) (analyzing negligent misrepresentation in a case involving an insurance ajustert); First Fed. Sav. Bank v. Knauss, 370 S.E.2d 906, 908 (S.C. Ct. App. 1988); Daniel W. Hayes, The Law of Torts, 48 S.C. L. REV. 193 (1996).
187. M-L Lee Acquisition Fund v. Deloitte & Touche, 489 S.E.2d 470 (S.C. 1997).
188. 945 P.2d 317 (Ariz. Ct. App. 1996).
189. 677 P.2d 1292, 1295 (Ariz. 1984) (an action in which a construction contractor sued an architect for negligent misrepresentation due to errors contained in a set of plans and specifications).
190. 945 P.2d at 365.
191. Id. at 366.
192. Kohala Agric. v. Deloitte & Touche, 949 P.2d 141 (Haw. App. 1997).
193. Id. at 162-64.
194. Id. at 160.
195. Id. at 161.
196. Id. at 162-63.
197. Id. at 163.
198. Nycal Corp. v. KPMG Peat Marwick, 688 N.E.2d 1368 (Mass. 1998).
199. Id. at 1372.
200. Id. at 1372-73.
201. Id.
202. Id. at 1376-77. The leading case in Massachusetts on the duty owed by a professional to third parties on which the court relied is Craig v. Everett M. Brooks Co., 222 N.E.2d 752 (Mass. 1967) (considering negligent surveying performed by a civil engineer/surveyor for a general contractor).
203. Nycal Corp., supra note 183, at 1378.
204. John G. Fleming, The Negligent Auditor and Shareholders, L.Q. REV., July 1990, at 349.
205. 1 All E.R. 426 (Eng. C.A. 1951).
206. W.A. Seavey, Candler v. Crane, Christmas & Co.: Negligent Misrepresentation by Accountants, L.Q. REV., Oct. 1951, at 466, 468. In his dissenting judgment, Lord Denning suggested three conditions for the creation of a duty of care in tort for professionals. First, the advice must be given by one whose profession it is to give advice upon which others rely in the ordinary course of business. Second, it must be known to the adviser that the advice would be communicated to the plaintiff in order to induce him to adopt a particular course of action. Third, the advice must be relied upon for the purpose of the particular transaction for which it was known to the advisers that the advice was required. Candler, 1 All E.R. at 441-46. However, Lord Denning did not consider these conditions as necessarily exhaustive criteria for the existence of a duty. Caparo Indus. PLC v. Dickman 1990 App. Cas. 605 (Eng. H.L.).
207. 1964 App. Cas. 465 (Eng. H.L.).
208. Napier, supra note 12, at 111. Hedley Byrne is the first significant inroad in the United Kingdom into the general denial of the ability of nonclients to sue accountants for negligent misstatements. Bruce Chapman, Limited Auditors' Liability: Economic Analysis and the Theory of Tort Law, 20 CAN. BUS. L. J. 180, 189 (1992).
209. Napier, supra note 12, at 111. Hedley Byrne is the first significant inroad in the United Kingdom into the general denial of the ability of nonclients to sue accountants for negligent misstatements. Bruce Chapman, Limited Auditors' Liability: Economic Analysis and the Theory of Tort Law, 20 CAN. BUS. L. J. 180, 189 (1992).
210. Hedley Byrne & Co., 1964 App. Cas. at 467.
211. Id. at 467-69.
212. Id. at 469.
213. Chapman, supra note 193, at 180.
214. Gillian Morris, The Liability of Professional Advisers: Caparo and After, 1991 J. BUS. L. 36 (1991).
215. M.F. James, Negligent Misstatement: The Special Relationship, 133 SOLIC. J. 1016 (1989).
216. Ivan F. Ivankovich, Accountants and Third-Party Liability - Back to the Future, 23 OTTAWA L. REV. 505, 509 (1991). The law Lords did, however, endorse the dissenting judgment of Lord Denning in Candler v. Crane, Christmas & Co., 1 All E.R. 426, 439 (Eng. C.A.), wherein he stated that accountants owe a duty "to any third person to whom they themselves show the accounts, or to whom they know their employer is going to show the accounts . . . [but that duty is not] extended still further so as to include strangers of whom they have heard nothing . . . ." Id. at 172.
217. Ivan F. Ivankovich, Accountants and Third-Party Liability - Back to the Future, 23 OTTAWA L. REV. 505, 509 (1991). The law Lords did, however, endorse the dissenting judgment of Lord Denning in Candler v. Crane, Christmas & Co., 1 All E.R. 426, 439 (Eng. C.A.), wherein he stated that accountants owe a duty "to any third person to whom they themselves show the accounts, or to whom they know their employer is going to show the accounts . . . [but that duty is not] extended still further so as to include strangers of whom they have heard nothing . . . ." Id. at 172.
218. Ivankovich supra note 200, at 510-12; James, supra note 199, at 1017-19.
219. Ivankovich supra note 200, at 510-12; James, supra note 199, at 1017-19.
220. Ivankovich, supra note 200, at 511; M. F. James, Negligence and the Auditor's Duty of Care after Caparo, PROF. NEGL., June 1990, at 17, 20.
221. Ivankovich, supra note 200, at 511; M. F. James, Negligence and the Auditor's Duty of Care after Caparo, PROF. NEGL., June 1990, at 17, 20.
222. 1978 App. Cas. 728 (Eng. H.L.).
223. Id. at 751-52.
224. Id.
225. Ivankovich, supra note 200, at 511; Morris, supra note 198, at 38.
226. Ivankovich, supra note 200, at 511; Morris, supra note 198, at 38.
227. Ivankovich, supra note 200, at 512.
228. 3 All E.R. 289 (Eng. C.A. 1981).
229. Id. at 293-97.
230. I.S. Stephenson, A Time of Rejoicing for Company Auditors, SOLIC. J., Oct. 1990, at 819.
231. The court reached a conclusion that an auditor's duty to nonclients could be based on foreseeability alone. Martin Davies, The Liability of Auditors to Third Parties in Negligence, 14 U.N.S.W. L.J. 171, 174 (1991).
232. 1982 Sess. Cas. 113.
233. Id. at 115-21.
234. Id. at 122-26.
235. 1990 App. Cas. 605 (Eng. H.L.); Philip Marshall, Auditors' Duties: A Narrow Approach, L.M.C.L.Q., Nov. 1990, at 478; Ivankovich, supra note 200, at 507.
236. 1990 App. Cas. 605 (Eng. H.L.); Philip Marshall, Auditors' Duties: A Narrow Approach, L.M.C.L.Q., Nov. 1990, at 478; Ivankovich, supra note 200, at 507.
237. 1990 App. Cas. 605 (Eng. H.L.); Philip Marshall, Auditors' Duties: A Narrow Approach, L.M.C.L.Q., Nov. 1990, at 478; Ivankovich, supra note 200, at 507.
238. Caparo Indus., 1990 App. Cas. at 614-15.
239. Id.
240. Id. at 615-16.
241. An example of a special circumstance would be an audit report commissioned on behalf of a plaintiff for a particular purpose. Kevin Nicholson, Third Party Reliance on Negligent Advice, 40 INT'L. COMP. L.Q. 551 (1991).
242. John Murphy, Expectation Losses, Negligent Omissions, and the Tortious Duty of Care CAMBRIDGE L.J., Mar.1996, at 52. The three-prong test of Caparo received endorsement by the House of Lords in Marc Rich & Co. A-G v. Bishop Rock Marine Co. Ltd., 3 W.L.R. 227 (1995).
243. Ivankovich, supra note 200, at 514; James, supra note 202, at 17.
244. Ivankovich, supra note 200, at 514; James, supra note 202, at 17.
245. Ivankovich supra note 200, at 516-18; Marshall, supra note 215, at 479-80. The three conditions that must be met to satisfy the proximity element make the Caparo test quite similar to the U.S. Restatement standard. The one aspect of the Caparo test not formally outlined in the Restatement standard is imposing liability from a policy standpoint on a "just and reasonable basis." Ironically, U.S. courts often engage in open policy discussions when addressing the scope of an accountant's duty to third parties for negligence.
246. Ivankovich supra note 200, at 516-18; Marshall, supra note 215, at 479-80. The three conditions that must be met to satisfy the proximity element make the Caparo test quite similar to the U.S. Restatement standard. The one aspect of the Caparo test not formally outlined in the Restatement standard is imposing liability from a policy standpoint on a "just and reasonable basis." Ironically, U.S. courts often engage in open policy discussions when addressing the scope of an accountant's duty to third parties for negligence.
247. Morris, supra note 198, at 41.
248. Ivankovich, supra note 200, at 516.
249. In considering the auditor's liability for negligence, it is useful to focus on any liability arising out of an audit performed in accordance with the requirements of the Companies Act (the U.K. equivalent of the U.S. securities laws). An important distinction relates to the individuals or groups to whom the auditor may be liable. Under the Companies Act, the auditor of a British company reports to the members of the company, but contracts with the company as a corporate entity. Napier, supra note 12, at 106-07.
250. The Caparo case implies that an auditor can, however, voluntarily assume liability vis-a-vis a third party, but there needs to be some specific act on the part of the auditor by which liability is assumed, or specific knowledge on the part of the auditor that accounts will be relied on by a nonclient. Napier, supra note 12, at 107; Lloyd Cheyham & Co. Ltd. v. Littlejohn & Co.,1987 BCLC 303 (Eng. C.A.). For example, the recent Binder Hamlyn case involved a careless acknowledgment of responsibility for a set of audited accounts made to a takeover bidder by the firm's senior partner. Napier, supra note 12, at 107.
251. The Caparo case implies that an auditor can, however, voluntarily assume liability vis-a-vis a third party, but there needs to be some specific act on the part of the auditor by which liability is assumed, or specific knowledge on the part of the auditor that accounts will be relied on by a nonclient. Napier, supra note 12, at 107; Lloyd Cheyham & Co. Ltd. v. Littlejohn & Co.,1987 BCLC 303 (Eng. C.A.). For example, the recent Binder Hamlyn case involved a careless acknowledgment of responsibility for a set of audited accounts made to a takeover bidder by the firm's senior partner. Napier, supra note 12, at 107.
252. The Caparo case implies that an auditor can, however, voluntarily assume liability vis-a-vis a third party, but there needs to be some specific act on the part of the auditor by which liability is assumed, or specific knowledge on the part of the auditor that accounts will be relied on by a nonclient. Napier, supra note 12, at 107; Lloyd Cheyham & Co. Ltd. v. Littlejohn & Co.,1987 BCLC 303 (Eng. C.A.). For example, the recent Binder Hamlyn case involved a careless acknowledgment of responsibility for a set of audited accounts made to a takeover bidder by the firm's senior partner. Napier, supra note 12, at 107.
253. The quoted language is from Justice Cardozo's famous opinion in Ultramares v. Touche, 174 N.E. 441 (N.Y. 1931).
254. Suzanie Chua, The Auditor's Liability in Negligence, 1995 J. BUS. L. 15, 16 (1995); Ivankovich, supra note 200, at 518-19.
255. Suzanie Chua, The Auditor's Liability in Negligence, 1995 J. BUS. L. 15, 16 (1995); Ivankovich, supra note 200, at 518-19.
256. See Raritan River Steel v. Cherry, 367 S.E.2d 609 (N.C. 1988); Bily v. Arthur Young & Co., 834 P.2d 745 (Cal. 1992).
257. Napier, supra note 12, at 107, 110-12; Chua, supra note 228, at 16-19.
258. Napier, supra note 12, at 107, 110-12; Chua, supra note 228, at 16-19.
259. 1 All E.R. 134 (Eng. C.A.1990).
260. Id. at 143.
261. Id. at 143-48. According to one commentator, Caparo adopts an "end and aim rule" for negligent misstatement cases: liability should be imposed only where damage is incurred in transactions related to the purpose for which the statement or information is provided. B. FELDTHUSEN, ECONOMIC NEGLIGENCE: THE RECOVERY OF PURE ECONOMIC LOSS 199-280 (2d ed. 1989). One major policy consideration in favor of limiting liability is the chilling effect on the free flow of commercial information upon which a capitalist economy depends. The Caparo decision does not mention this consideration.
262. Id. at 143-48. According to one commentator, Caparo adopts an "end and aim rule" for negligent misstatement cases: liability should be imposed only where damage is incurred in transactions related to the purpose for which the statement or information is provided. B. FELDTHUSEN, ECONOMIC NEGLIGENCE: THE RECOVERY OF PURE ECONOMIC LOSS 199-280 (2d ed. 1989). One major policy consideration in favor of limiting liability is the chilling effect on the free flow of commercial information upon which a capitalist economy depends. The Caparo decision does not mention this consideration.
263. 1 All E.R. 148 (Eng. C.A. 1991).
264. Id. at 153-57.
265. Id. at 154.
266. Id. at 160.
267. The facts in Caparo and Morgan Crucible are, however, distinguishable. Morris, supra note 198, at 45-47; Chua, supra note 228, at 17-18.
268. The facts in Caparo and Morgan Crucible are, however, distinguishable. Morris, supra note 198, at 45-47; Chua, supra note 228, at 17-18.
269. James, supra note 202, at 21.
270. [1977] 1 S.C.R. 466.
271. Id.
272. Id. at 466-67.
273. Id. at 476-77.
274. The first of the three tests is based on "foresight": what the reasonable man would expect in the circumstances, the familiar test of responsibility for negligence where physical harm to a person or his property is involved. The remaining tests rely upon "knowledge": actual appreciation of the facts and awareness that a specific consequence will occur. G.H.L. Fridman, Negligent Misrepresentation: A Postcript, 22 MCGILL L.J. 649, 652 (1976).
275. The majority opinion indicates that the accountants knew that the financial statements were being prepared for the very purpose of influencing, in addition to the bank and SEDCO, a limited number of potential investors. The names of the potential investors were not material to the accountants. The nature of the intended transactions is the important factor that delineates liability. Daniel Ish, Liability Arising Out of Negligent Misrepresentation, 42 SASK. L.R. 147, 151 (1977).
276. Arguably, this proposition goes beyond the reasoning in Hedley Byrne. The Supreme Court decided that even though the accountants could not have known of the existence and circumstances of Haig when they did their work, they nevertheless owed him a duty of care. At the heart of the issue, as the matter was concluded in Haig, is not the mere extension of third party liability in particular circumstances, but rather the definition of the precise class of persons to whom such a duty of care may be owed. It is one thing, in a relatively simple situation, to identify a small and discreet group of individuals who are or can be identified as relying directly on the judgments of professionals with whom they have no direct contractual or fiduciary relationship. It is another question altogether, in more complex cases, to contemplate the dimensions of the liability for negligence which may arise where it is known that the opinions and certificates of an accountant or other professional are to be widely disseminated and relied upon by a broad class of persons. R.D. Brown, Haig v. Bamford, 15 OSGOODE HALL L.J. 474, 481-82 (1977).
277. Ish, supra note 245, at 152-53.
278. A. M. LINDEN, CANADIAN TORT LAW (4th ed. 1988).
279. Bruce Cheffins, Auditor's Liability in the House of Lords: A Signal Canadian Courts Should Follow, 18 CAN. BUS. L. J. 118, 131-33 (1991).
280. [1990] 73 D.L.R. (4th) 207. The circumstances surrounding the Surrey Credit Union case demonstrate that high litigation costs might arise from auditors having a broad legal duty of care. The case must have generated substantial legal expenses because it consumed over 50 days of trial time. Cheffins, supra note 249, at 132.
281. [1990] 73 D.L.R. (4th) 207. The circumstances surrounding the Surrey Credit Union case demonstrate that high litigation costs might arise from auditors having a broad legal duty of care. The case must have generated substantial legal expenses because it consumed over 50 days of trial time. Cheffins, supra note 249, at 132.
282. The evidence at trial indicated that a Surrey Credit Union director, after examining the audited financial statements of Northland Bank, the auditor's client and bond-issuing firm, made an oral report to the Surrey board about Northland's financial status. The board itself and the credit union's officers did not examine the financial statements before deciding to purchase Northland's bonds. The plaintiff's damages were estimated at over $7 million. Cheffins, supra note 249, at 133.
283. Ivankovich, supra note 200, at 525;
284. Surrey Credit Union, 73 D.L.R. (4th) at 212.
285. [1994] 22 B.C.L.R. (2d) 86.
286. Peter Wardle & Doris James, Professional Negligence : Has Hercules Given Judges More Discretion? INT'L. COMM. LlTIG., Feb. 1998, at 32, 34.
287. Id.
288. [1997] 2 S.C.R. 165.
289. Id. at 165-66.
290. Id.
291. Anns v. Merton London Borough Council, 1978 App. Cas. 728 (Eng. H.L.); Kamloops v. City of Nielson [1984] 2 S.C.R. 2; see supra notes 203-07 and accompanying text.
292. Hercules Managements Ltd., 2 S.C.R. at 167-70.
293. Id. at 175-80; Michael Deturbide, Liability of Auditors, CAN. BAR REV., Mar./June, 1998, at 262.
294. Id. at 175-80; Michael Deturbide, Liability of Auditors, CAN. BAR REV., Mar./June, 1998, at 262.
295. The two-stage approach has been applied by the Supreme Court of Canada in the context of various types of negligence actions, including cases involving claims for different forms of economic loss. It was implicitly endorsed in the context of an action in negligent misrepresentation in Edgeworth Constr. Ltd. v. N.D. Lea & Assoc. Ltd., [1993] 3 S.C.R. 206.
296. The court explicitly noted that to create a "pocket" of negligent misrepresentation cases in which the existence of a duty of care is determined differently from other negligence cases would be incorrect. This indicates that economic losses stemming from negligently misstated financial statements will be considered by courts using the same general framework as other cases involving economic losses. Accountants should not be treated any differently than other professionals such as lawyers, architects, etc. Nicholas Rafferty, Recent Professional Negligence Decisions from the Supreme Court of Canada, 14 PROF. NEGL. 72, 73 (1998).
297. Id.
298. Hercules Managements Ltd., 2 S.C.R. at 179-81.
299. Id. In negligent misrepresentation actions against accountants, the plaintiff's claim stems from detrimental reliance on the accountant's statements. As the court aptly noted, however, mere reliance on an accountant's representation will not, in all circumstances, be reasonable. Id.
300. Some Canadian legal commentators urge that foreseeability of harm cannot be the sole determinant of liability. They argue as follows. The predication of liability upon pure foreseeability of economic harm is incompatible with a competitive economic system. A free market system treats many types of losses as legitimate and even beneficial; the economically inefficient deserve to incur certain losses. Once foreseeability of harm is established, to answer the duty question in any given situation involves an inquiry into two broad areas. First, does it make economic sense to shift this type of loss? Second, what do community expectations have to say about whether the plaintiff is reasonably entitled to rely upon the defendant to protect him or her from harm in the particular situation? Such questions are unavoidable and are matters of policy. Earl Cherniak & Kirk Stevens, Two Steps Forward or One Step Back? Anns at the Crossroads in Canada, 20 CAN. BUS. L. J. 164, 176 (1992). This argument points out the overriding importance of the second prong of the Anns/Kamloops test.
301. Hercules Managements Ltd., 2 S.C.R. at 179-81.
302. Id. at 182-83.
303. Id. at 182-84.
304. The undesirable consequences cited by the court are outlined in Cheffins, supra note 249, at 125-27,
305. The undesirable consequences cited by the court are outlined in Cheffins, supra note 249, at 125-27, and Cherniak & Stevens, supra note 267, at 170-71.
306. Hercules Managements Ltd., 2 S.C.R. at 182-84.
307. Deturbide, supra note 261, at 262-63.
308. Rafferty, supra note 263, at 72-73.
309. Hercules Managements Ltd., 2 S.C.R. at 182-85. The majority opinion, written by Justice LaForest, points out that Haig is an example of a situation where the auditors were found to owe a duty of care because concerns over indeterminate liability did not arise. The very end and aim of the financial statements prepared by the accountants in Haig was to secure additional financing for Scholler from a Saskatchewan government agency and an equity investor. The financial statements were required primarily tor these third parties and only collaterally for use by the company. Id.
310. Id. at 186-88. Thus, even if the specific identity or class of potential plaintiffs is known to a defendant, use of the defendant accountant's work product for a purpose or transaction other than that for which it was prepared or intended could still lead to indeterminate liability. Id.
311. (1997) 71 A.L.J.R. 448.
312. Andrew Greinke & Gregory Shailer, Auditing the Auditors B the Esanda Case, AUSTL. ACCT., Aug. 1997, at 16.
313. (1968) 122 C.L.R. 556 (Austl.).
314. Id. at 571.
315. Id. at 572-73.
316. Esanda Fin. Corp. Ltd., 71 A.L.J.R. at 455-57. The duty of care identified and described by Chief Justice Barwick in Evatt was later upheld in Shaddock & Assoc. Proprietary Ltd. v. Parramatta City Council, (1981) 150 C.L.R. 225. This case was also concerned with the duty owed in relation to information or advice provided in response to a request.
317. Kevin Nicholson, Third Party Reliance on Negligent Advice, 40 INT'L. COMP. L.Q. 551, 567-68 (1991).
318. (1983) 3 N.S.W.L.R. 221.
319. Davies, supra note 211, at 171, 184.
320. BT Australia Ltd., 3 N.S.W.L.R. at 233.
321. Nicholson, supra note 283, at 573.
322. 1982 Sess. Cas. 113. In JEB Fasteners, the Queen's Bench Division ruled that an auditor's duty to nonclients could be based on foreseeability alone. Davies, supra note 211, at 171, 174; see supra notes 208-11 and accompanying text.
323. Nicholson, supra note 283, at 573-74.
324. BT Australia Ltd., 3 N.S.W.L.R. at 229-31.
325. Nicholson, supra note 283, at 574.
326. (1992) 29 N.S.W.L.R. 141.
327. Id. at 173-75.
328. The composite phrase "knew or ought to have known" is often used but not with much precision. The phrase is used as if it were roughly synonymous with the phrase "reasonably foreseeable." When used with precision the words signify a kind of half-way house between knowledge and reasonable foreseeability. Davies, supra note 211, at 186.
329. Minnesota and Texas both have adopted liberal interpretations of the Restatement standard. In Bonhiver v. Graff, 248 N.W.2d 291 (Minn. 1976), the court stated that "there is no logical justification for denying relief. . . based upon the 'limited' or 'unlimited' nature . . . of a class, or whether the reliance of the particular injured parties was not 'specifically foreseeable.'" Id. at 302. In Blue Bell v. Peat, Marwick, Mitchell & Co., 715 S.W.2d 408 (Tex. Civ. App. 1986), the court stated that they "adopt[ed] a less restrictive interpretation" of the Restatement standard. The court concluded that "if an accountant preparing audited financial statements knows or should know that such statements will be relied upon . . . the accountant may be liable . . . ." Id. at 412.
330. (1992) 2 V.R. 671.
331. Id. at 672-78.
332. Id. at 682-83.
333. Id. at 679. The court's reasoning relied to some extent on the holding in San Sebastian Party Ltd. v. The Minister (1986) 162 C.L.R. 340. In that case, the plaintiffs were developers who sued a municipal council and a planning authority for negligent misstatements contained in documents dealing with a planning scheme to redevelop a suburban area in Sydney. The San Sebastian court held that a duty of care to avoid a negligent misstatement to a third party or class to which the third party belongs arises when the defendant intends the third party or class members to rely on the misstatement or reasonable reliance by the third party or class member is indicated by other circumstances. Angus Corbett, The Rationale for the Recovery of Economic Loss in Negligence and the Problem of Auditors' Liability, 19 MELB. U. L. REV. 814, 865 (1994); Davies, supra note 211, at 183-85.
334. Id. at 679. The court's reasoning relied to some extent on the holding in San Sebastian Party Ltd. v. The Minister (1986) 162 C.L.R. 340. In that case, the plaintiffs were developers who sued a municipal council and a planning authority for negligent misstatements contained in documents dealing with a planning scheme to redevelop a suburban area in Sydney. The San Sebastian court held that a duty of care to avoid a negligent misstatement to a third party or class to which the third party belongs arises when the defendant intends the third party or class members to rely on the misstatement or reasonable reliance by the third party or class member is indicated by other circumstances. Angus Corbett, The Rationale for the Recovery of Economic Loss in Negligence and the Problem of Auditors' Liability, 19 MELB. U. L. REV. 814, 865 (1994); Davies, supra note 211, at 183-85.
335. Id. at 679. The court's reasoning relied to some extent on the holding in San Sebastian Party Ltd. v. The Minister (1986) 162 C.L.R. 340. In that case, the plaintiffs were developers who sued a municipal council and a planning authority for negligent misstatements contained in documents dealing with a planning scheme to redevelop a suburban area in Sydney. The San Sebastian court held that a duty of care to avoid a negligent misstatement to a third party or class to which the third party belongs arises when the defendant intends the third party or class members to rely on the misstatement or reasonable reliance by the third party or class member is indicated by other circumstances. Angus Corbett, The Rationale for the Recovery of Economic Loss in Negligence and the Problem of Auditors' Liability, 19 MELB. U. L. REV. 814, 865 (1994); Davies, supra note 211, at 183-85.
336. R. Lowe Lippman, 2 V.C.R. at 682. Following San Sebastian, the court indicated that an intention on the part of the auditor to induce the plaintiff, or a class to which the plaintiff belongs, to rely on the report need not always exist for a duty to arise. There must be, however, other circumstances present sufficient to impose a duty of care. Id. at 679. One such circumstance may be where the auditor is aware that a particular party will use the auditor's report for a specific purpose in an identified transaction. Corbett, supra note 299, at 865. The suggested circumstance is quite similar to the conditions set forth in the accountant privity statutes passed by eight American states. See supra notes 58 & 59.
337. (1997) 71 A.L.J.R. 448.
338. Jane Swanton & Barbara McDonald, Common Law - The Reach of the Tort of Negligence, AUSTL. L. J., Nov. 1997, at 822, 823. A considerable burden was lifted from auditors with the Esanda decision. It signals a more conservative approach by Australian courts. Greinke & Shailer, supra note 278, at 16.
339. Jane Swanton & Barbara McDonald, Common Law - The Reach of the Tort of Negligence, AUSTL. L. J., Nov. 1997, at 822, 823. A considerable burden was lifted from auditors with the Esanda decision. It signals a more conservative approach by Australian courts. Greinke & Shailer, supra note 278, at 16.
340. 71 A.L.J.R. at 465-68. For example, see STONE, PRECEDENT AND THE LAW 254-55 (1985) and TRINDADE & CANE, THE LAW OF TORTS IN AUSTRALIA 279 (ist ed. 1985).
341. 71 A.L.J.R. at 465-68. For example, see STONE, PRECEDENT AND THE LAW 254-55 (1985) and TRINDADE & CANE, THE LAW OF TORTS IN AUSTRALIA 279 (ist ed. 1985).
342. 71 A.L.J.R. at 465-68. For example, see STONE, PRECEDENT AND THE LAW 254-55 (1985) and TRINDADE & CANE, THE LAW OF TORTS IN AUSTRALIA 279 (ist ed. 1985).
343. Swanton & McDonald, supra note 302, at 822.
344. Esanda Finance, 71 A.L.J.R. at 455-56.
345. Id.
346. Id.
347. Id. at 468-70.
348. Id. at 471-75.
349. One Australian legal commentator has argued that it will be seldom, if ever, that an auditor will audit the accounts intending to induce third parties to rely on them. The auditor will not usually have any interest in inducing third parties to rely on the audited information, or any reason for wanting third parties to so rely. Davies, supra note 211, at 184. By focusing on the intention of the defendant auditor the Esanda court may have stated its support for a test so restrictive that it will hardly ever be satisfied.
350. If the accountant knows the purpose for which information is supplied to a nonclient and the information is in fact used for that purpose (e.g., a specific transaction) then the third party's reliance is considered reasonable. Esanda Finance, 71 A.L.J.R. at 465-70. Reasonable reliance is the cornerstone of liability for negligent misstatement. San Sebastian, 162 C.L.R. at 357.
351. Esanda Finance, 71 ALJR at 469-71. Because the decision was concerned with whether the plaintiff's pleadings disclosed a good cause of action, it was not necessary for the court to specify what factors would give rise to a duty of care absent a clear intent on the part of the auditor to induce reliance by a nonclient. Swanton & McDonald, supra note 302, at 822-23. Certain factors may be identified, however, by the court's emphasis on their absence from the pleadings: 1) the maker of a statement may possess skill and competence in the area which is the subject of the communication; 2) the maker of a statement has an interest in the recipient of the statement acting in a certain way; or 3) the provider of information may warrant the correctness of the information supplied to a third party.
352. Esanda Finance, 71 A.L.J.R. at 469-74.
353. Greinke & Shailer, supra note 278, at 16.
354. [1978] 1 N.Z.L.R. 553.
355. Iain Johnston, Negligent Mis-Statement - Auditor's Liability to Third Parties for Careless Report on Company's Annual Accounts, 8 N.Z.U.L. REV. 176 (1978).
356. Davies, supra note 211, at 174.
357. Scott Group Ltd., 1 N.Z.L.R. at 575.
358. 1978 App. Cas. 728 (Eng. H.L.); see supra notes 203-07 and accompanying text.
359. Justice Woodhouse found no policy reasons for negating the existence of a duty of care under the second prong of the Anns test. The fear of indeterminate liability was, in his view, exaggerated. Liability would be adequately restricted by the foresight criterion and the need to prove causation. Johnston, supra note 316, at 179-81. Moreover, the court rejected the policy argument of indeterminate liability as merely a plea in mitigation to excuse negligent activity because the consequences of liability are too great to justify responsibility. Peter Cawthorn, Comment B Scott Group v. McFarlane, 3 AUCKLAND U.L. REV.. 465 (1979).
360. Justice Woodhouse found no policy reasons for negating the existence of a duty of care under the second prong of the Anns test. The fear of indeterminate liability was, in his view, exaggerated. Liability would be adequately restricted by the foresight criterion and the need to prove causation. Johnston, supra note 316, at 179-81. Moreover, the court rejected the policy argument of indeterminate liability as merely a plea in mitigation to excuse negligent activity because the consequences of liability are too great to justify responsibility. Peter Cawthorn, Comment B Scott Group v. McFarlane, 3 AUCKLAND U.L. REV.. 465 (1979).
361. Caparo Indus. PLC v. Dickman, 1990 App. Cas. 605, 648-49 (Eng. H.L.); Murphy v. Brentwood Dist. Council, 1991 App. Cas. 398 (Eng. H.L.); Hercules Managements Ltd. v. Ernst & Young [1997] 2 S.C.R. 165, 183-86; Sutherland Shire Council v. Heyman (1985) 157 C.L.R. 424; Esanda Fin. Corp. Ltd v. Peat Marwick Hungerfords (1997) 71 A.L.J.R. 448, 468-70.
362. [1999] 2 N.Z.L.R. 276.
363. [1978] 1 N.Z.L.R. 553.
364. Boyd, 2 N.Z.L.R. at 280.
365. Id.
366. Id.
367. Id.
368. Id. at 287.
369. Id. at 288.
370. Id.
371. Id. (quoting Candler v. Crane, Christmas & Co., 1 All E.R. 426, 442-3 (Eng. C.A.)).
372. Boyd Knight, 2 N.Z.L.R. at 290.
373. Id.
374. Id. at 288.
375. Id. at 290.
376. Brenda Porter, An Empirical Study of the Audit Expectation-Performance Gap, 24 ACCT. & BUS. RES. 49 (1993).
377. Graham Ward, Auditors' Liability in the UK: The Case for Reform, 10 CRITICAL PERSP. ACCT. 387, 389 (1999); Carl Pacini et al., Assurance Services and the Electronic Frontier: The International Legal Environment of the CPA/CA Webtrust, 12 ADVANCES INT'L. ACCT. 227, 235 (1999).
378. Graham Ward, Auditors' Liability in the UK: The Case for Reform, 10 CRITICAL PERSP. ACCT. 387, 389 (1999); Carl Pacini et al., Assurance Services and the Electronic Frontier: The International Legal Environment of the CPA/CA Webtrust, 12 ADVANCES INT'L. ACCT. 227, 235 (1999).
379. Christopher Humphrey et al., The Audit Expectations Gap in Britain: An Empirical Investigation, 23 ACCT. & BUS. RES. 395 (1993).
380. The expectation gap relates mostly to three troublesome areas: (1) detecting and reporting on fraud; (2) detecting and reporting on illegal client acts; and (3) reporting when there is uncertainty about the ability of an entity to continue as a going concern. Porter, supra note 336, at 53-59. Different underlying explanations have been offered for the continuing presence of significant expectations problems over a long period of time. For example, a common response of the auditing profession has been to stress the misguided nature of external expectations, arguing that the investing public expects too much and remains largely ignorant as to the precise nature, purpose, and capacities of the audit function. Humphrey et. al., supra note 338, at 395. In contrast, it has been argued that the legitimacy of the duties and standards adopted by any self-regulating profession can never be isolated from the expectations of the various interest groups who pay for and rely upon its services. David Godsell, Auditors' Legal Liability and the Expectation Gap, 61 AUSTL. ACCT. 22, 25 (1991).
381. The expectation gap relates mostly to three troublesome areas: (1) detecting and reporting on fraud; (2) detecting and reporting on illegal client acts; and (3) reporting when there is uncertainty about the ability of an entity to continue as a going concern. Porter, supra note 336, at 53-59. Different underlying explanations have been offered for the continuing presence of significant expectations problems over a long period of time. For example, a common response of the auditing profession has been to stress the misguided nature of external expectations, arguing that the investing public expects too much and remains largely ignorant as to the precise nature, purpose, and capacities of the audit function. Humphrey et. al., supra note 338, at 395. In contrast, it has been argued that the legitimacy of the duties and standards adopted by any self-regulating profession can never be isolated from the expectations of the various interest groups who pay for and rely upon its services. David Godsell, Auditors' Legal Liability and the Expectation Gap, 61 AUSTL. ACCT. 22, 25 (1991).
382. The expectation gap relates mostly to three troublesome areas: (1) detecting and reporting on fraud; (2) detecting and reporting on illegal client acts; and (3) reporting when there is uncertainty about the ability of an entity to continue as a going concern. Porter, supra note 336, at 53-59. Different underlying explanations have been offered for the continuing presence of significant expectations problems over a long period of time. For example, a common response of the auditing profession has been to stress the misguided nature of external expectations, arguing that the investing public expects too much and remains largely ignorant as to the precise nature, purpose, and capacities of the audit function. Humphrey et. al., supra note 338, at 395. In contrast, it has been argued that the legitimacy of the duties and standards adopted by any self-regulating profession can never be isolated from the expectations of the various interest groups who pay for and rely upon its services. David Godsell, Auditors' Legal Liability and the Expectation Gap, 61 AUSTL. ACCT. 22, 25 (1991).
383. Christian Bellavance, Liability and the "Expectation Gap," 13 CA MAG. 11 (1998).
384. A recent survey of investors provides evidence that the expectation gap continues to exist. Marc Epstein & Marshall Geiger, Investor Views of Audit Assurance: Recent Evidence of the Expectation Gap, J. ACCT., Jan. 1994, at 60. Almost half of the respondents expected complete or absolute assurance that auditors would detect material errors in financial statements. Over 70% expected absolute assurance that material misstatements due to fraud would be detected. Id.
385. A recent survey of investors provides evidence that the expectation gap continues to exist. Marc Epstein & Marshall Geiger, Investor Views of Audit Assurance: Recent Evidence of the Expectation Gap, J. ACCT., Jan. 1994, at 60. Almost half of the respondents expected complete or absolute assurance that auditors would detect material errors in financial statements. Over 70% expected absolute assurance that material misstatements due to fraud would be detected. Id.
386. Humphrey et al., supra note 338, at 410.
387. CANADIAN INSTITUTE OF CHARTERED ACCOUNTANTS (CICA), REPORT OF THE COMMISSION TO STUDY THE PUBLIC'S EXPECTATIONS OF AUDITS (1988).
388. Gary Monroe & David Woodliff, An Empirical Investigation of the Audit Expectation Gap: Australian Evidence, 34 ACCT. & FIN. 47, 48 (1994).
389. Porter, supra note 336, at 64.
390. Bellavance, supra note 340.
391. NATIONAL COMMISSION ON FRAUDULENT FINANCIAL REPORTING, REPORT OF THE NATIONAL COMMISSION ON FRAUDULENT FINANCIAL REPORTING (1987).
392. AICPA, A SPECIAL REPORT BY THE EXPECTATION GAP ROUNDTABLE (1992).
393. AICPA, A SPECIAL REPORT BY THE PUBLIC OVERSIGHT BOARD OF THE SEC PRACTICE SECTION (1993).
394. CICA, supra note 343.
395. COMMITTEE ON THE FINANCIAL ASPECTS OF CORPORATE GOVERNANCE, REPORT OF THE COMMITTEE ON THE FINANCIAL ASPECTS OF CORPORATE GOVERNANCE (1992).
396. AUSTRALIAN SOCIETY OF CERTIFIED PRACTISING ACCOUNTANTS & THE INSTITUTE OF CHARTERED ACCOUNTANTS IN AUSTRALIA (1996).
397. Brenda Porter, Review B A Research Study on Financial Reporting and Auditing -Bridging the Expectation Gap, ACCT. HORIZONS, Mar. 1996, at 130, 131-34.
398. John Hill et al., Auditing's Emerging Legal Peril under the National Surety Doctrine: A Program for Research, ACCT. HORIZONS, Mar. 1993, at 12, 13; Carl Pacini & Patrick Maroney, Using Changes in Non-Litigating Client Firm Stock Values to Measure the Varying Importance of the Insurance Hypothesis Resulting from Shifts in Auditor Liability Laws, 22 S. BUS. & ECON. J. 243 (1999); Ward, supra note 337, at 389; Godsell, supra note 339, at 24-5.
399. John Hill et al., Auditing's Emerging Legal Peril under the National Surety Doctrine: A Program for Research, ACCT. HORIZONS, Mar. 1993, at 12, 13; Carl Pacini & Patrick Maroney, Using Changes in Non-Litigating Client Firm Stock Values to Measure the Varying Importance of the Insurance Hypothesis Resulting from Shifts in Auditor Liability Laws, 22 S. BUS. & ECON. J. 243 (1999); Ward, supra note 337, at 389; Godsell, supra note 339, at 24-5.
400. John Hill et al., Auditing's Emerging Legal Peril under the National Surety Doctrine: A Program for Research, ACCT. HORIZONS, Mar. 1993, at 12, 13; Carl Pacini & Patrick Maroney, Using Changes in Non-Litigating Client Firm Stock Values to Measure the Varying Importance of the Insurance Hypothesis Resulting from Shifts in Auditor Liability Laws, 22 S. BUS. & ECON. J. 243 (1999); Ward, supra note 337, at 389; Godsell, supra note 339, at 24-5.
401. John Hill et al., Auditing's Emerging Legal Peril under the National Surety Doctrine: A Program for Research, ACCT. HORIZONS, Mar. 1993, at 12, 13; Carl Pacini & Patrick Maroney, Using Changes in Non-Litigating Client Firm Stock Values to Measure the Varying Importance of the Insurance Hypothesis Resulting from Shifts in Auditor Liability Laws, 22 S. BUS. & ECON. J. 243 (1999); Ward, supra note 337, at 389; Godsell, supra note 339, at 24-5.
402. K. Menon & David Williams, The Insurance Hypothesis and Market Prices, 66 ACCT. REV. 327 (1994); William Baber et al., Client Security Price Reactions to the Laventhol and Horwath Bankruptcy, 33 J. ACCT. RES. 385, 386-87 (1995).
403. K. Menon & David Williams, The Insurance Hypothesis and Market Prices, 66 ACCT. REV. 327 (1994); William Baber et al., Client Security Price Reactions to the Laventhol and Horwath Bankruptcy, 33 J. ACCT. RES. 385, 386-87 (1995).
404. Douglas DeJong & John H. Smith, The Determination of Audit Responsibilities: An Application of Agency Theory, 4 AUDITING: J. PRAC. & THEORY 20, 24 (1984).
405. Id.
406. James John Jurinski, The Common Law Liability of Auditors: Judicial Allocation of Business Risk, 23 WILLIAMETTE L. REV. 367, 400 (1987).
407. 465 U.S. 805, 817-18 (1984).
408. Gwilliam, supra note 25.
409. Brecht, supra note 24.
410. 461 A.2d 138 (N.J. 1983).
411. 223 Cal. Rptr. 218 (Cal. Ct. App. 1986).
412. 3 All E.R. 289 (Eng. C.A.1981) .
413. 1982 Sess. Cas. 113.
414. [1990] 73 D.L.R. (4th) 207.
415. (1992) 29 N.S.W.L.R. 141.
416. [1978] 1 N.Z.L.R. 553.
417. Tort law was increasingly viewed as an instrument of social engineering, with expanded liability serving as a powerful means to encourage greater safety, particularly in the area of products liability. As a result, the foreseeability of harm, rather than the nature of the contract, began to define legal duty in many areas of the law, including accounting services. John Siciliano, Trends in Independent Auditor Liability: The Emergence of a Sane Consensus? 16 J. ACCT. & PUB. POL'Y. 339, 344 (1997); Ivankovich, supra note 200, at 511-13.
418. Tort law was increasingly viewed as an instrument of social engineering, with expanded liability serving as a powerful means to encourage greater safety, particularly in the area of products liability. As a result, the foreseeability of harm, rather than the nature of the contract, began to define legal duty in many areas of the law, including accounting services. John Siciliano, Trends in Independent Auditor Liability: The Emergence of a Sane Consensus? 16 J. ACCT. & PUB. POL'Y. 339, 344 (1997); Ivankovich, supra note 200, at 511-13.
419. Siciliano, supra note 369; Corbett, supra note 299, at 818-23.
420. Siciliano, supra note 369; Corbett, supra note 299, at 818-23.
421. Rosenblum v. Adler, 461 A.2d 138 (N.J. 1983); Scott Group Ltd. v. Macfarlane [1978] 1 NZLR 553; Hercules Managements Ltd. v. Ernst & Young [1997] 2 S.C.R. 165.
422. Siciliano, supra note 26, at 1939; A.M. Tettenborn, When Must Accountants Account? 48 CAMBRIDGE L.J. 177, 179 (1989); Ivankovich, supra note 200, at 519.
423. Siciliano, supra note 26, at 1939; A.M. Tettenborn, When Must Accountants Account? 48 CAMBRIDGE L.J. 177, 179 (1989); Ivankovich, supra note 200, at 519.
424. Siciliano, supra note 26, at 1939; A.M. Tettenborn, When Must Accountants Account? 48 CAMBRIDGE L.J. 177, 179 (1989); Ivankovich, supra note 200, at 519.
425. Biankanja, 223 Cal. Rptr. at 220-21; Ivankovich, supra note 200, at 519.
426. Biankanja, 223 Cal. Rptr. at 220-21; Ivankovich, supra note 200, at 519.
427. Rusch Factors, 284 F. Supp. at 91; J.G. Fleming, supra note 189, at 351. Arguably, this is accomplished by placing the risk of loss on auditors who in turn spread the loss to clients and the ultimate consuming public or purchase insurance to cover such losses. Biankanja, 223 Cal. Rptr. at 232-33; Ivankovich, supra note 200, at 520. See generally G. CALABRESI, THE COST OF ACCIDENTS: A LEGAL AND ECONOMIC ANALYSIS (1970).
428. Rusch Factors, 284 F. Supp. at 91; J.G. Fleming, supra note 189, at 351. Arguably, this is accomplished by placing the risk of loss on auditors who in turn spread the loss to clients and the ultimate consuming public or purchase insurance to cover such losses. Biankanja, 223 Cal. Rptr. at 232-33; Ivankovich, supra note 200, at 520. See generally G. CALABRESI, THE COST OF ACCIDENTS: A LEGAL AND ECONOMIC ANALYSIS (1970).
429. Rusch Factors, 284 F. Supp. at 91; J.G. Fleming, supra note 189, at 351. Arguably, this is accomplished by placing the risk of loss on auditors who in turn spread the loss to clients and the ultimate consuming public or purchase insurance to cover such losses. Biankanja, 223 Cal. Rptr. at 232-33; Ivankovich, supra note 200, at 520. See generally G. CALABRESI, THE COST OF ACCIDENTS: A LEGAL AND ECONOMIC ANALYSIS (1970).
430. Rusch Factors, 284 F. Supp. at 91; J.G. Fleming, supra note 189, at 351. Arguably, this is accomplished by placing the risk of loss on auditors who in turn spread the loss to clients and the ultimate consuming public or purchase insurance to cover such losses. Biankanja, 223 Cal. Rptr. at 232-33; Ivankovich, supra note 200, at 520. See generally G. CALABRESI, THE COST OF ACCIDENTS: A LEGAL AND ECONOMIC ANALYSIS (1970).
431. Rusch Factors, 284 F. Supp. at 91; J.G. Fleming, supra note 189, at 351. Arguably, this is accomplished by placing the risk of loss on auditors who in turn spread the loss to clients and the ultimate consuming public or purchase insurance to cover such losses. Biankanja, 223 Cal. Rptr. at 232-33; Ivankovich, supra note 200, at 520. See generally G. CALABRESI, THE COST OF ACCIDENTS: A LEGAL AND ECONOMIC ANALYSIS (1970).
432. Siciliano, supra note 369, at 345; Ivankovich, supra note 200, at 520-21.
433. Siciliano, supra note 369, at 345; Ivankovich, supra note 200, at 520-21.
434. Siciliano, supra note 369; Siciliano, supra note 26, at 1959-60; Esanda Fin., 71 A.L.J.R. at 468; Hercules Managements Ltd., 2 S.C.R. at 179; Bily, 834 P.2d at 761; Jones & Raghunandan, supra note 16; Jack, supra note 16. Audited financial statements are necessary to gain access to the capital markets of the United States, United Kingdom, Canada, Australia, and New Zealand. A decreased availability of audit services produces a barrier to the growth of firms going public and to the ultimate expansion of an economy. Siciliano, supra note 369, at 346.
435. Siciliano, supra note 369; Siciliano, supra note 26, at 1959-60; Esanda Fin., 71 A.L.J.R. at 468; Hercules Managements Ltd., 2 S.C.R. at 179; Bily, 834 P.2d at 761; Jones & Raghunandan, supra note 16; Jack, supra note 16. Audited financial statements are necessary to gain access to the capital markets of the United States, United Kingdom, Canada, Australia, and New Zealand. A decreased availability of audit services produces a barrier to the growth of firms going public and to the ultimate expansion of an economy. Siciliano, supra note 369, at 346.
436. Siciliano, supra note 369; Siciliano, supra note 26, at 1959-60; Esanda Fin., 71 A.L.J.R. at 468; Hercules Managements Ltd., 2 S.C.R. at 179; Bily, 834 P.2d at 761; Jones & Raghunandan, supra note 16; Jack, supra note 16. Audited financial statements are necessary to gain access to the capital markets of the United States, United Kingdom, Canada, Australia, and New Zealand. A decreased availability of audit services produces a barrier to the growth of firms going public and to the ultimate expansion of an economy. Siciliano, supra note 369, at 346.
437. Siciliano, supra note 369; Siciliano, supra note 26, at 1959-60; Esanda Fin., 71 A.L.J.R. at 468; Hercules Managements Ltd., 2 S.C.R. at 179; Bily, 834 P.2d at 761; Jones & Raghunandan, supra note 16; Jack, supra note 16. Audited financial statements are necessary to gain access to the capital markets of the United States, United Kingdom, Canada, Australia, and New Zealand. A decreased availability of audit services produces a barrier to the growth of firms going public and to the ultimate expansion of an economy. Siciliano, supra note 369, at 346.
438. Siciliano, supra note 369; Siciliano, supra note 26, at 1959-60; Esanda Fin., 71 A.L.J.R. at 468; Hercules Managements Ltd., 2 S.C.R. at 179; Bily, 834 P.2d at 761; Jones & Raghunandan, supra note 16; Jack, supra note 16. Audited financial statements are necessary to gain access to the capital markets of the United States, United Kingdom, Canada, Australia, and New Zealand. A decreased availability of audit services produces a barrier to the growth of firms going public and to the ultimate expansion of an economy. Siciliano, supra note 369, at 346.
439. Siciliano, supra note 369; Siciliano, supra note 26, at 1959-60; Esanda Fin., 71 A.L.J.R. at 468; Hercules Managements Ltd., 2 S.C.R. at 179; Bily, 834 P.2d at 761; Jones & Raghunandan, supra note 16; Jack, supra note 16. Audited financial statements are necessary to gain access to the capital markets of the United States, United Kingdom, Canada, Australia, and New Zealand. A decreased availability of audit services produces a barrier to the growth of firms going public and to the ultimate expansion of an economy. Siciliano, supra note 369, at 346.
440. Zoe-Vonna Palmrose, An Analysis of Auditor Litigation and Audit Service Quality, 58 ACCT. REV. 55, 70 (1988).
441. Siciliano, supra note 369; Cherniak & Stevens, supra note 267, at 169; Chapman, supra note 193, at 190-92.
442. Siciliano, supra note 369; Cherniak & Stevens, supra note 267, at 169; Chapman, supra note 193, at 190-92.
443. Siciliano, supra note 369; Cherniak & Stevens, supra note 267, at 169; Chapman, supra note 193, at 190-92.
444. Esanda Fin., 71 A.L.J.R. at 470; Cherniak & Stevens, supra note 267, at 169-70; William Bishop, Negligent Misrepresentation through Economists' Eyes, 96 L.Q. REV. 360, 361-66 (1980); Siciliano, supra note 369, at 346. In Hedley Byrne, Lord Pearce captured this unique characteristic of information when he wrote: The reason for some divergence between the law of negligence in word and that of negligence in act is clear. Negligence in word creates problems different from those of negligence in act. Words are more volatile than deeds. They are used without being expended and take effect in combination with innumerable facts and other words. 1964 App. Cas. 465, 534 (Eng. H.L.).
445. Esanda Fin., 71 A.L.J.R. at 470; Cherniak & Stevens, supra note 267, at 169-70; William Bishop, Negligent Misrepresentation through Economists' Eyes, 96 L.Q. REV. 360, 361-66 (1980); Siciliano, supra note 369, at 346. In Hedley Byrne, Lord Pearce captured this unique characteristic of information when he wrote: The reason for some divergence between the law of negligence in word and that of negligence in act is clear. Negligence in word creates problems different from those of negligence in act. Words are more volatile than deeds. They are used without being expended and take effect in combination with innumerable facts and other words. 1964 App. Cas. 465, 534 (Eng. H.L.).
446. Esanda Fin., 71 A.L.J.R. at 470; Cherniak & Stevens, supra note 267, at 169-70; William Bishop, Negligent Misrepresentation through Economists' Eyes, 96 L.Q. REV. 360, 361-66 (1980); Siciliano, supra note 369, at 346. In Hedley Byrne, Lord Pearce captured this unique characteristic of information when he wrote: The reason for some divergence between the law of negligence in word and that of negligence in act is clear. Negligence in word creates problems different from those of negligence in act. Words are more volatile than deeds. They are used without being expended and take effect in combination with innumerable facts and other words. 1964 App. Cas. 465, 534 (Eng. H.L.).
447. Esanda Fin., 71 A.L.J.R. at 470; Cherniak & Stevens, supra note 267, at 169-70; William Bishop, Negligent Misrepresentation through Economists' Eyes, 96 L.Q. REV. 360, 361-66 (1980); Siciliano, supra note 369, at 346. In Hedley Byrne, Lord Pearce captured this unique characteristic of information when he wrote: The reason for some divergence between the law of negligence in word and that of negligence in act is clear. Negligence in word creates problems different from those of negligence in act. Words are more volatile than deeds. They are used without being expended and take effect in combination with innumerable facts and other words. 1964 App. Cas. 465, 534 (Eng. H.L.).
448. Esanda Fin., 71 A.L.J.R. at 470; Cherniak & Stevens, supra note 267, at 169-70; William Bishop, Negligent Misrepresentation through Economists' Eyes, 96 L.Q. REV. 360, 361-66 (1980); Siciliano, supra note 369, at 346. In Hedley Byrne, Lord Pearce captured this unique characteristic of information when he wrote: The reason for some divergence between the law of negligence in word and that of negligence in act is clear. Negligence in word creates problems different from those of negligence in act. Words are more volatile than deeds. They are used without being expended and take effect in combination with innumerable facts and other words. 1964 App. Cas. 465, 534 (Eng. H.L.).
449. Ultramares Corp. v. Touche, 174 N.E. 441, 444 (N.Y. 1931).
450. Raritan River Steel v. Cherry, 367 S.E.2d 609, 616 (N.C. 1988). As a matter of commercial reality, audits are performed in a client-controlled environment. The client typically prepares its own financial statements; it has direct control over and assumes primary responsibility for their contents. Client control also predominates in the dissemination of the audit report. Once the report reaches the client, the extent of its distribution and the communications that accompany it are within the exclusive province of the client management. Thus, regardless of efforts of the auditor, the client retains effective primary control of the financial reporting process. Bily, 834 P.2d at 762.
451. Raritan River Steel v. Cherry, 367 S.E.2d 609, 616 (N.C. 1988). As a matter of commercial reality, audits are performed in a client-controlled environment. The client typically prepares its own financial statements; it has direct control over and assumes primary responsibility for their contents. Client control also predominates in the dissemination of the audit report. Once the report reaches the client, the extent of its distribution and the communications that accompany it are within the exclusive province of the client management. Thus, regardless of efforts of the auditor, the client retains effective primary control of the financial reporting process. Bily, 834 P.2d at 762.
452. Hercules Managements Ltd., 2 S.C.R. at 182; Esanda Fin., 71 A.L.J.R. at 462-63; Bily, 834 P.2d at 761; Siciliano, supra note 369, at 348.
453. Hercules Managements Ltd., 2 S.C.R. at 182; Esanda Fin., 71 A.L.J.R. at 462-63; Bily, 834 P.2d at 761; Siciliano, supra note 369, at 348.
454. Hercules Managements Ltd., 2 S.C.R. at 182; Esanda Fin., 71 A.L.J.R. at 462-63; Bily, 834 P.2d at 761; Siciliano, supra note 369, at 348.
455. Hercules Managements Ltd., 2 S.C.R. at 182; Esanda Fin., 71 A.L.J.R. at 462-63; Bily, 834 P.2d at 761; Siciliano, supra note 369, at 348.
456. Noel O'Sullivan, Auditors' Liability: Its Role in the Corporate Governance Debate, 23 ACCT. & BUS. RES. 412, 416-17 (1993). In Hercules Managements Ltd., the Supreme Court of Canada highlighted the impracticality of the auditor-as-insurer argument: Creditors and investors on the other hand are likely to be in a better position than auditors to know the likely extent of their losses . . . . Unlike most plaintiffs in negligence cases, these investors and creditors can take steps to protect themselves against loss. Some creditors and investors will have the staff or means to investigate and verify that part of the audited person's financial affairs that is relevant to the loan or investment . . . . Investors can spread their risk by diversifying their investments. 2 S.C.R. at 182-87.
457. Noel O'Sullivan, Auditors' Liability: Its Role in the Corporate Governance Debate, 23 ACCT. & BUS. RES. 412, 416-17 (1993). In Hercules Managements Ltd., the Supreme Court of Canada highlighted the impracticality of the auditor-as-insurer argument: Creditors and investors on the other hand are likely to be in a better position than auditors to know the likely extent of their losses . . . . Unlike most plaintiffs in negligence cases, these investors and creditors can take steps to protect themselves against loss. Some creditors and investors will have the staff or means to investigate and verify that part of the audited person's financial affairs that is relevant to the loan or investment . . . . Investors can spread their risk by diversifying their investments. 2 S.C.R. at 182-87.
458. In the United States, large accounting firms are now able to buy only a portion of the coverage they could buy prior to 1985 and only for much higher premiums. Virtually all mid-size firms tend to be highly underinsured. Liability insurance for small firms is expensive with almost 50% not carrying any insurance at all. DAN GOLDWASSER & M.T. ARNOLD, ACCOUNTANT'S LIABILITY (1998). In the United Kingdom, below $75 million the Big Five retain the risks themselves as self-insurance using their own captive insurance companies. The effective ceiling on coverage is $340 million. Peter Mozier & Lisa Hansford-Smith, UK Auditor Liability: An Insurable Risk, 2 INT'L. J. AUDITING 197, 204 (1998). In Canada and Australia, the scale of the problem is such that auditors are finding it increasingly difficult to obtain insurance and that where it is available it is extremely expensive. Ward, supra note 337.
459. In the United States, large accounting firms are now able to buy only a portion of the coverage they could buy prior to 1985 and only for much higher premiums. Virtually all mid-size firms tend to be highly underinsured. Liability insurance for small firms is expensive with almost 50% not carrying any insurance at all. DAN GOLDWASSER & M.T. ARNOLD, ACCOUNTANT'S LIABILITY (1998). In the United Kingdom, below $75 million the Big Five retain the risks themselves as self-insurance using their own captive insurance companies. The effective ceiling on coverage is $340 million. Peter Mozier & Lisa Hansford-Smith, UK Auditor Liability: An Insurable Risk, 2 INT'L. J. AUDITING 197, 204 (1998). In Canada and Australia, the scale of the problem is such that auditors are finding it increasingly difficult to obtain insurance and that where it is available it is extremely expensive. Ward, supra note 337.
460. The unavailability of insurance protection affects the U.K. auditing profession s self-regulation strategy. In order to conform with The Companies Act 1989, auditors must demonstrate an ability to satisfy professional liability claims. Insurers' underwriting techniques impose financial penalties on low-quality auditors. Insurance schemes provide for the withdrawal of practicing certificates from those auditors unable to obtain insurance protection. The unavailability of insurance is likely to remove insurers monitoring of auditor quality which could reduce corporate disclosure quality. O'Sullivan, supra note 383, at 417.
461. 2 S.C.R. at 174-6.
462. Esanda Fin., 71 A.L.J.R. at 462-63; Bily, 834 P.2d at 763.
463. Duncan Green, Litigation Risk for Auditors and the Risk Society, 10 CRITICAL PERSP. ACCT. 339 (1999).
464. Section 20 of the Uniform Accountancy Act is a near-privity standard that reflects the holding of the New York Court of Appeals in Credit Alliance. The operative language of the model law is: Sec. 20 - Privity of Contract (b) This section governs any action based on negligence brought against any accountant or firm . . . by any person or entity claiming to have been injured as a result of financial statements or other information . . . reported or opined on...by the defendant accountant . . . . (c) No action covered by this section may be brought unless: (1) The plaintiff (1) is issuer . . . of the financial statements or other information...reported or opined on . . . and (2) engaged the defendant licensee . . . ; or (2) The defendant . . . (1) was aware at the time the engagement was undertaken that the financial statements or other information were to be made available for use in connection with a specified transaction by the plaintiff who was specifically identified to the . . . accountant, (2) was aware that the plaintiff intended to rely upon such . . . information in connection with the specified transaction, and (3) had direct contact and communication with the plaintiff. . . and expressed . . . understanding of the reliance . . . .
465. See supra notes 56-99 and accompanying text.
466. Telephone Interview with Virgil Webb, Assistant General Counsel of the AICPA (Apr. 9, 1999).
467. Id.
468. LA. REV. STAT. ANN. § 37:91 (West 1999).
469. Public Law No. 104-67, 109 Stat. 737 (1995) (codified as amended in scattered sections of 15 U.S.C.A. (West Supp. 1996).
470. Jim Cousins et al., Auditor Liability: The Other Side of the Debate, 10 CRITICAL PERSP. ACCT. 283, 285 (1999).
471. Id. at 294.
472. The Department of Trade and Industry (DTI) is the government department responsible for Company Law, Insolvency, and Financial Services Regulation. The U.K. Law Commission generally issues a consultation paper on a given legal issue and solicits comments from the legal, academic, and business communities. DEPARTMENT OF TRADE AND INDUSTRY FEASIBILITY OF JOINT AND SEVERAL LIABILITY (1996).
473. Cousins et al., supra note 395, at 296. The practice of restricting liability for non-audit work has become common. In recent years, major accounting firms have worked in concert to set identical limits on their liability. Auditors Limit Liability, DAILY TEL., Jan. 24, 1997, at 24.
474. Cousins et al., supra note 395, at 296. The practice of restricting liability for non-audit work has become common. In recent years, major accounting firms have worked in concert to set identical limits on their liability. Auditors Limit Liability, DAILY TEL., Jan. 24, 1997, at 24.
475. Green, supra note 388, at 345.
476. Malcolm Miller, Auditor Liability and the Development of a Strategic Evaluation of Going Concern, 10 CRITICAL PERSP. ACCT. 355, 358-9 (1999).
477. An insurance arrangement may specify different maximum amounts of liability for different kinds of work within an occupational association. Id. at 360.
478. Miller, supra note 400, at 361-63.
479. Siciliano, supra note 369, at 350.
480. James Henderson, Jr. & Theodore Eisenberg, The Quiet Revolution in Products Liability: An Empirical Study of Legal Change, 37 U.C.L.A. L. REV. 479, 480-82 (1990).
481. Anthony Mason, The Recovery and Calculation of Economic Loss, in TORTS IN THE NINETIES (N.J. Mullany ed. 1997).
482. Siciliano, supra note 369, at 350.