Malpractice Claims: An Emerging Concern for Auditors

by William I. Eskin, CPA
Pursuit, Year End 2006

CPAs must be aware that SAS No. 99 is one of the biggest hurdles the profession has been faced with in a long time. Auditors are now called upon to uncover fraudulent financial reporting with a new zeal. SAS 99 concentrates on two key areas: misappropriation of assets and fraudulent financial reporting. Law suits involving CPA audits have surfaced as an intriguing subject-one worthy of every practitioner's consideration.

In most CPA malpractice lawsuits, an expert witness will be called upon to provide evidence that the audit was not prepared in accordance with Generally Accepted Auditing Standards (GAAS). Noncompliance with GAAS typically involves material GAAP errors contained in the financial statements. As a result, third parties relying upon the financial statements suffer damages from the flawed reports.

There are five basic issues that the plaintiff, or user of the audited financial information, must prove to obtain a judgment against a CPA:
• Reliance - Plaintiffs must prove that they relied upon the CPA's audited financial statements when making financial decisions. This usually translates to extending credit to the CPA's client.
• Damages - Plaintiffs must prove that due to their reliance on the CPA's audited financial statements, they incurred monetary damages.
• Malpractice - Plaintiffs must prove that the CPA did not follow GAAS in planning, performing, or supervising the audit.
• Errors - Plaintiffs must prove that failure of the CPA to adhere to GAAS resulted in material GAAP errors in the relied upon financial statements.
• State Issues - Each state has its own particular laws concerning professional malpractice such as statute of limitations and privity.

Proving these issues can be quite difficult and often depends upon the testimony of a CPA with proficiency in GAAP and GAAS, as well as the particular industry involved in the case.

The burden of proving CPA malpractice rests on the plaintiff, and the CPA remains innocent until the charge is proven by the plaintiff. To accomplish this, the plaintiff must prove one of the following:
• Negligence - The CPA violated the duty of due care to its client and/or the third party, and knew that the financial statement would be relied upon to make financial decisions
• Gross Negligence - Wrongful misconduct bordering on recklessness
• Fraud - The CPA knowingly and intentionally misstated the financial statements

Sharpening your forensic techniques and increasing your familiarity with the auditor's responsibilities under SAS No. 99 will help you provide an effective buffer against CPA malpractice claims.

If you have questions concerning the issues discussed in this
article, please confer with your legal counsel.