West Coast Inns (WCI). a major Pacific Northwest hotel chain planned to raise capital for a major expansion (adding 4 new hotels) by borrowing from banks and making several stock offerings. WCI relied on a local bank and engaged Potts & Panns CPAs, to audit its December 31, 2020, financial statements. WCI's CEO told Paula Potts, the CPA firm's managing partner that the financial statements would be given to certain named banks and included in the prospectuses for the stock offerings.

Potts & Pans CPAS "underbid" the audit, and the pressure was on to get it finished "on budget." Figuring that WCI was financially sound anyway, Peter Pann, the audit partner decided to "streamline" confirming accounts receivables. He just closed his eyes and picked 5 of the 14,000 records to confirm. He called all five creditors and was satisfied with their answers. This "unique" approach was very "efficient" but not "effective," and, as a result, failed to discover a material overstatement of accounts receivable. Peter Pann was aware of a pending sexual harassment lawsuit filed by former WCI female employees alleging that a hotel manager required inappropriate "auditions" in a hotel room as part of their interview process. That lawsuit was not disclosed in WCIs financial statements, despite the auditors being advised by WCI's legal counsel that WCIs likely potential liability under the lawsuit could result a bankruptcy. Peter Pann decided to omit any reference to the lawsuit and Potts & Panns issued an unqualified opinion on WCIs financial statements.

NW Bank, one of the named banks, relied on the financial statements and Potts & Panns' auditor's opinion in giving WCI a $1,500,000 loan for working capital on January 2, 2020. WCI raised an additional $23,000,000 through the following stock offerings, which were sold completely:

January 2020WCI made a $15,000,000 unregistered offering of Class B nonvoting common stock under Rule 504 of Regulation D of the Securities Act of 1933. This offering was sold to 20 large accredited investors by general solicitation.

February 2020WCI made a $5,000,000 unregistered offering of Class A voting common stock under Rule 506(b) of Regulation D of the Securities Act of 1933. This offering was sold to 200 accredited investors and 3000 nonaccredited investors through a private placement.

March 2020WCI made a $3,000,000 unregistered offering of preferred stock under Rule 506(c) of Regulation D of the Securities Act of 1933. This offering was sold to forty nonaccredited investors by private placement.

Shortly after the loan and security sales were made, covid-19 disrupted travel forcing WCI to close most of its hotels completely. WCI began experiencing cash flow problems as room and meal revenue dropped to zero but was able to stay in business because of the money raised by the stock offerings. WCI was found liable in the employee lawsuit (held over Zoom) omitted from the financial statements. This resulted in a judgment WCI would have trouble paying. WCI also defaulted on the NW Bank loan and was involuntarily petitioned into bankruptcy. This caused NW Bank to sustain a complete loss on the loan and WCIs stockholders to lose their investments.

REQUIRED: Evaluate each of 3 legal claims. Are they valid; will they succeed? (Explain why or why not)

1. The SEC claimed that all three of WCIs stock offerings were made improperly and were not exempt from registration.

2. WCI shareholders sued Potts & Panns for Negligence and Fraud under the 1934 Securities Exchange Act.

3. NW Bank sued Potts & Panns for Negligence and fraud under the 1934 Securities Exchange Act.