Preparing for and Defending Accounting Liability Litigation (Portfolio 5500)

Bloomberg Tax Portfolio 5500, Preparing for and Defending Accounting Liability Litigation, focuses on accountant liability and provides information and insight to help accountants understand the intricacies of litigation that they could potentially face.

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Bloomberg Tax Portfolio 5500, Preparing for and Defending Accounting Liability Litigation, focuses on accountant liability and provides information and insight to help accountants understand the intricacies of litigation that they could potentially face. The portfolio is particularly timely in light of the continued attention on corporate responsibility and the role accounting firms played in the high-profile demises of numerous publicly-held corporate giants.
This Portfolio begins by helping accountants to think through the precise nature of the accountant-client relationship and to ensure that the accountant-client relationship is not only accurately defined in an engagement letter, but also redefined in writing as the nature of the relationship evolves.
The authors explain the myriad of claims that can be filed against accountants, including professional negligence, misrepresentation, breach of contract, RICO, unfair trade practices, civil conspiracy, breach of fiduciary duty, and securities fraud. The Portfolio addresses document retention policies and procedures to help accountants satisfy their obligation to preserve records and manage information, in both electronic and paper form, when litigation is pending and/or likely.
The Portfolio then guides accountants through each step of a lawsuit, from the filing of a complaint and other pleadings, to discovery, witness preparation, retention of experts, trial preparation, and settlement. In this discussion, the Portfolio analyzes defensive strategies that are available to accountants at each stage of the litigation.
Please note that the Portfolio is intended for general informational purposes only. It is not intended to be and should not be considered legal advice or a substitute for obtaining legal advice from independent, legal counsel. Publication of this information is not intended to create, and receipt does not constitute, an attorney-client relationship.
This Portfolio may be cited as Bloomberg Tax Portfolio 5500, Braver, Krock, Davidson & Glad, Preparing for and Defending Accounting Liability Litigation (Accounting Policy and Practice Series). Within the Accounting Portfolio Series, however, references to the Portfolios will include only the Portfolio numbers and titles.


Samuel W. Braver, Esq.

Samuel W. Braver, J.D., Duquesne University; B.A., University of Pittsburgh. A shareholder with Buchanan Ingersoll & Rooney PC, Mr. Braver represents clients in commercial litigation. Mr. Braver was elected to the Judiciary Committee of the Allegheny Bar Association, was a member of the Academy of Trial Lawyers of Allegheny County, and has served as a faculty member for the National Institute of Trial Advocacy training programs.

Gregory J. Krock, Esq.

Gregory J. Krock, J.D., University of Pittsburgh; B.S., Business Administration, University of North Carolina at Chapel Hill. Mr. Krock is a shareholder with Buchanan Ingersoll & Rooney PC and is a member of its Commercial Litigation Group. Mr. Krock's practice involves a wide range of commercial matters, including trade secret and covenant not to compete litigation, securities fraud and shareholder suits, and professional/accounting liability actions.

Kristi A. Davidson, Esq.

Kristi A. Davidson, J.D., The College of William & Mary; B.S., Truman State University. Ms. Davidson is an associate with the firm's Commercial Litigation Group, focusing her practice in securities litigation, misappropriation of trade secrets, real estate tax exemptions, and claims against accounting firms. A member of the Allegheny County Bar Association, Ms. Davidson has chaired committees involving real estate tax appeals and quality of practice issues.

David M. Glad, Esq.

David M. Glad, J.D., Cornell University; B.S., Accounting, Duquesne University. Mr. Glad is a Manager at Gran Thornton, specializing in federal, state, and local tax and business matters. He is a former associate at Buchanan Ingersoll & Rooney PC, a certified public accountant, and a member of the Allegheny County Bar Association and the American and Pennsylvania Institutes of Certified Public Accountants.

Table of Contents

Detailed Analysis

I. Introduction

II. Types of Services Performed by Accountants

Introductory Material

A. Attestation Engagements and the Compilation, Review, and Audit of Financial Statements

1. Attestation Engagements

2. Compilation, Review, and Audit of Financial Statements

B. Tax Services

C. Advisory and/or Consulting Services

D. Litigation Services

E. Bankruptcy Services

III. Defining the Accountant-Client Relationship

Introductory Material

A. Engagement Letter

B. Subsequent Communications With the Client

C. Marketing Literature

IV. Overview of the Litigation Process

Introductory Material

A. Pleadings

B. Discovery

C. Summary Judgment

D. Trial

E. Special Rules Applicable to Professional Liability Actions

1. Colorado

2. Georgia

3. Minnesota

4. New Jersey

5. Pennsylvania

V. Claims Brought Against Accountants by Clients

A. Theories of Recovery

B. Professional Negligence

1. Duty

2. Breach of Duty

3. Proximate Causal Connection

4. Damages

a. Compensatory and Punitive Damages

b. Potential Liability Caps

C. Misrepresentation

D. Breach of Contract

1. Existence of a Valid Contract

a. Failure to Perform With Requisite Care or Sufficient Quality

b. Failure to Comply With Professional Standards

2. Causation and Damages

3. Damages


1. Statutory Framework

2. Bringing a RICO Claim

a. Section 1962(a): Use of Investment Income

b. Section 1962(b): Acquisition of Entity Engaged in Interstate Commerce

c. Section 1962(c): Employees/Associates Engaged in Racketeering

d. Section 1962(d): Conspiracy

F. Unfair Trade Practices Act

G. Civil Conspiracy

H. Breach of Fiduciary Duty

1. Existence of Fiduciary Duty

a. Client Control

b. Action on Behalf of the Client

c. Fiduciary Relationship

2. Breach of a Fiduciary Duty

3. Damages Proximately Caused by Breach

I. Securities Fraud and Liability Under Section 10(b) and Rule 10b-5

1. Misrepresentation or Omission of Material Fact

a. Forward-Looking Statements: Safe Harbor and "Bespeaks Caution" Doctrine

b. Presumption of an Efficient Market

2. Scienter

a. Intent Versus Recklessness

b. Pleading Scienter

c. Motive and Opportunity to Commit Fraud

d. Recklessness

e. Subsequently Learning or Recklessness in Not Learning and Failing to Correct

3. In Connection With a Purchase or Sale of Securities

a. "In Connection With"

b. "A Purchase or Sale of Securities"

4. Reliance

a. Actual Reliance

b. Presumed Reliance and Fraud-on-the-Market Theory

5. Proximate Cause of Injury

a. Transaction Causation

b. Loss Causation

6. Damages in a Federal 10b-5 Suit

J. Section 11 of the Securities Exchange Act of 1934

K. Section 12(2) of the Securities Exchange Act of 1934

L. Section 14(a) of the Securities Exchange Act of 1934

M. Common Law Fraud

VI. Claims Brought by Persons and Organizations Other Than Clients

A. Claims Brought Under Sarbanes-Oxley Act

1. Public Company Accounting Oversight Board

2. Auditor Independence

3. Conflicts of Interest

4. Communication With Audit Committee

5. Enhanced Disclosure Requirements

6. SEC Censure for Unfit Character

7. Document Retention Requirements

8. Auditing Standards

9. PCAOB Reporting Requirements

10. Enforcement by the PCAOB

11. Criminal Enforcement

B. Claims Brought Under Common Law

1. Theories of Recovery

2. Professional Malpractice and Negligent Misrepresentation

a. Privity

b. Near Privity

c. Foreseeability

d. Restatement

e. Statutory Authority to Commence an Action

3. Breach of Contract

4. Fraud

VII. Actions Filed by Plaintiffs in Representative Capacity

A. Class Action Lawsuits

1. Prerequisites to Class Actions

2. Plaintiff Class Actions

3. Opposing Class Actions

a. Numerosity

b. Commonality

c. Typicality and Adequacy of Representation

d. Rule 23(b)(3) Requirements

(1) Predominance

(2) Superiority

B. Derivative Suits

1. Prerequisites for Derivative Suits

2. Defenses to Derivative Suits

VIII. Defensive Strategies Available to Accountants

Introductory Material

A. Substantive Affirmative Defenses

1. Statute of Limitations

a. Negligence

b. Breach of Contract

c. Breach of Fiduciary Duty

d. Section 804: Statute of Limitations Extended for 10b-5 Fraud

2. Defenses Specifically Applicable in Negligence

a. Contributory Negligence

b. Comparative Negligence

c. Imputation of Management Fraud

3. Statute of Frauds

4. Scope of Engagement and Parol Evidence

5. Defenses Specifically Applicable to Fraud Cases

a. Plaintiff's Lack of Due Diligence

b. In Pari Delicto

6. Witness Immunity

B. Motions to Dismiss

C. Finding a Favorable Forum: Choosing the Right Court and the Best Factfinder

1. Subject Matter and Removal to Federal Court

2. Personal Jurisdiction

3. Change of Venue

4. Trial by Judge or Jury

5. Arbitration

D. Joinder of Third Parties and Joint Defense Agreements

E. Counterclaims

F. Professional Liability Insurance

IX. Document Retention Policies and the Duty to Preserve Documents

Introductory Material

A. When Does the Duty to Preserve Documents Arise?

B. What Must Be Preserved?

C. Sanctions for Failing to Preserve Relevant Documents

1. Purpose of Sanctions

2. Types of Sanctions

a. Default Judgment/Dismissal

b. Adverse Inference

c. Monetary Sanctions

d. Criminal Sanctions

D. Independent Causes of Action Based Upon Destruction of Documents

1. Intentional Spoliation of Evidence by a Third Party

2. Negligent Spoliation of Evidence by a Third Party

E. Case in Point-Arthur Andersen

F. Whistleblower Procedures and Protection

1. Reporting Procedures

2. Whistleblower Protection

a. Subject of Protection

b. Procedure

c. Remedies and Sanctions

X. Separation of Issues and Claims

Introductory Material

A. Furthering Convenience and Expediting Resolution

B. Avoiding Prejudice

C. Separation of Issues as a Discovery Tool

XI. Discovery

A. Timing and Role

B. Informal Discovery

1. Internal Discovery

2. Public Discovery

C. Formal Discovery Tools

1. Initial Disclosures Under Federal Rule of Civil Procedure 26(a)

2. Document Requests

3. Depositions

4. Interrogatories

5. Requests for Admissions

D. Use of Discovery at Trial

E. Electronic Discovery

F. Discovery Commonly Served in Accounting Cases

1. Document Requests

a. Work Papers

b. Internal Procedural Manuals

c. Personnel Files

2. Interrogatories

3. Requests for Admissions

G. Allocating Costs of Discovery

H. Avoiding Unnecessary Disclosures

1. Accountant-Client Privilege

a. Federal Common Law Privilege

b. Federal Statutory Privilege

c. State Accountant-Client Privilege

2. Other Common Objections

3. Protective Orders and Confidentiality Agreements

I. Discovery Issues With Respect to Former Employees

1. Contacting the Opposing Party's Former Employee

2. When Communications Between a Former Employee and the Accounting Firm's Counsel Are Protected From Disclosure

a. Attorney-Client Privilege

b. Attorney Work Product

3. Indemnity and Joint Representation Agreements

a. Indemnity

b. Joint Defense Agreement

XII. The Art of Preparing Witnesses

Introductory Material

A. Attorney Preparation Must Precede Witness Preparation

B. Accountant Witness Should Come Prepared

C. Preparing for Deposition Testimony

D. Preparing for Trial Testimony

XIII. Preparing for Trial

Introductory Material

A. Summary Judgment

B. Motions in Limine

C. Pretrial Statements

XIV. Using Experts

Introductory Material

A. Deciding to Retain an Expert

B. Selecting an Appropriate Expert Witness

C. Withstanding a Daubert or Frye Challenge

D. Overcoming Expert Witness Impeachment

E. Preparing Expert Witness Testimony

XV. Settlement Issues

Introductory Material

A. Settlement as a Defensive Tool

B. Settlement as a Means of Resolving Dispute at Hand

1. Settlement Amounts May Be Astronomical, But Litigation Costs Are High

2. Settlement Does Not Begin With Negotiations

3. Settlement May Limit Adverse Publicity

4. Accounting Firm Must Determine Its Goals and Communicate Those Goals Clearly to Counsel

5. Settlement Issues Involving Co-Defendants Must Be Considered

6. In Appropriate Circumstances, Consider Employing Separate Settlement Counsel

7. Settlement Terms

XVI. Conclusion

Working Papers

Working Papers


Worksheet 1 Hierarchy of U.S. Generally Accepted Accounting Principles for Nongovernmental Entities

Worksheet 2 Hierarchy of U.S. Generally Accepted Accounting Principles for Governmental Entities

Worksheet 3 Example of Joint and Several Liability and Proportionate Fault Under the Private Securities Litigation Reform Act of 1995




U.S. Code

Federal Register


Federal Rules of Civil Procedure

SEC Releases

PCAOB Auditing Standards

PCAOB: Other Releases

PCAOB: Disciplinary Proceedings

FASB Statements of Financial Accounting Standards

American Institute of Certified Public Accountants

AICPA Audit and Accounting Guides

AICPA Code of Professional Conduct

AICPA Interpretations of Statements on Auditing Standards

Professional Ethics Executive Committee

AICPA Statements of Position

AICPA Statements on Auditing Standards

AICPA Statements on Standards for Accounting and Review Services

AICPA Statements on Standards for Attestation Engagements

AICPA Statements on Standards for Consulting and Review Services

AICPA Technical Practice Aids

State Statutes

Case Law


Journal Articles

Newspaper Articles


Various Other Sources