Class: Legal Environment of Business 1- Deena is an accountant for the Bean and
ID: 363322 • Letter: C
Question
Class: Legal Environment of Business
1- Deena is an accountant for the Bean and Counter CPA firm. She was asked to evaluate Denqrt Co. and prepare certified financial statements. She reviewed the financial records and prepared the financial reports, which were incorporated into an SEC registration statement and prospectus. Denqrt was able to issue $35 million in new stock during this offering. In early 2011, it was discovered that Denqrt management had manipulated the books by overstating sales revenue and hiding the manipulation from Bean and Counter. The result was that Deqrt income was substantially overstated for the years 2009 and 2010. The news reports caused the company stock to decline in value on the stock exchange. The investors suffered $25 million in losses after having relied on the information in purchasing Denqrt stock. The investors are now prepared to sue for stock fraud based on a false securities registration statement. Investors seek damages from a. Deena, b.her CPA firm, c. Denqrt Co., d. the six members of the Deqrt board of directors, and e. Denqrt's eight corporate officers. Please discuss their potential liability under federal security law.
Explanation / Answer
Federal securities law basically consists of two statutes - the Securities Act of 1933 and the Securities Exchange Act of 1934. While the earlier deals with the issuance of the stock, the latter is concerned with the trading of the issued securities. When any security has been sold subject to a registration statement, Section 11 of the Act levies express liability on those who have included any false statement of a material fact in the registration statement and who have suppressed any material fact from it. This section imposes liability on the issue (in this case, Deqrt), all persons who signed the registration statement, every person who was a director or partner (in this case, Deqrt board of directors), the accountant who prepared any part of the registration statement (in this case, Deena), and any underwriters.
These persons generally are jointly liable for the amount paid for the security, less either its value at the time of suit or the price for which it was sold, to any person who acquires the security without knowledge of the untruth or suppression. A defendant is not liable for any or the entire amount otherwise recoverable under Section 11 that the defendant proves was caused by something other than the defective disclosure.
With that being said, Deena may assert the defense of due diligence. The due diligence defense generally requires the defendant to show that she had reasonable grounds to believe and did believe that there were no untrue statements or material omissions. With the exception of the issuer, the other defendants may also claim due diligence.