Common Law Accountant Liability to Third Parties

You just finished learning about how clients may bring claims against accountants for professional malpractice. Another important issue in accountant liability is whether third parties have any claim against an accountant on the basis of their reliance on negligently prepared financial statements.

Third-party liability, as decided by the states, falls into three general groupings: (1) privity or near-privity, (2) foreseen users and classes of users, and (3) reasonably foreseeable users. Review the sections in your text regarding liability to third parties in Chapter 11 for a better understanding of the differences among these three groupings.

Read the case below and answer the questions. All of the questions ask you to consider the different theories and tests for liability to third parties.

Suppose some investors purchased stock warrants for the hypothetical company myPhone, the manufacturer of a mass-market phone designed to compete with the iPhone. Because of an inability to produce a competitive product line, myPhone filed for bankruptcy shortly after the warrants were issued. The investors received nothing for their investment.

An accountant from a large accounting firm had audited myPhone's financial statements for the three years preceding the issuance of the warrants and had issued unqualified opinions on their fairness and compliance with generally accepted accounting principles. Now the investors are suing the accounting firm for fraud, negligence, and negligent misrepresentation.

After a trial in which the investors' expert witness alleged 100 deficiencies in the accountant's audit and its noncompliance with Generally Accepted Auditing Standards, the jury found the accounting firm liable for professional negligence. The accountant appealed based on the jury instructions regarding its liability to third parties.

The appeals court ruled on the decision, including decisions on the following topics:

1. There was no allegation of either a particular purpose for the reports' preparation or the prerequisite conduct on the part of the accountants nor any allegation the accountant had any direct dealings with the investors and agreed to prepare the report for investors' use or had specifically agreed to provide investors with a copy of the report.

2. We cannot conclude that the investors were known third-party users of the accountant's work product and that the accountant could specifically foresee this class of users.

3. The accountant should have foreseen the investors as possible users of the accountant's work product. The investors did in fact use and rely on that work product for a proper business purpose, i.e., investing.

Another type of liability to third parties is based on the Restatement test. When is an accountant liable to a third-party user under the Restatement test?

Now look at topic number 2 in the case study. Should the accountant be held liable under the Restatement test? Why or why not?