Question

Overton v. Todman & Co., CPAs

Background and Facts: From 1999 through 2002, Todman & Company, CPAs, P.C., audited the financial statements of Direct Brokerage, Inc. (DBI), a broker-dealer in New York registered with the Securities and Exchange Commission (SEC). Each year, Todman issued an unqualified opinion that DBI’s financial statements were accurate. DBI filed its statements and Todman’s opinions with the SEC. Despite the certifications of accuracy, Todman made significant errors that concealed DBI’s largest liability—its payroll taxes—in the 1999 and 2000 audits. The errors came to light in 2003 when the New York State Division of Taxation subpoenaed DBI’s payroll records, and it became clear that the company had not filed or paid its payroll taxes for 1999 and 2000. This put DBI in a precarious financial position, owing the state more than $3 million in unpaid taxes, interest, and penalties. To meet its needs, DBI sought outside investors, including David Overton, who relied on DBI’s statements and Todman’s opinion for 2002 to invest in DBI. When DBI collapsed under the weight of its liabilities in 2004, Overton and others filed a suit in a federal district court against Todman, asserting, among other things, fraud under Section 10(b) and Rule 10b-5. The court dismissed the complaint. The plaintiffs appealed to the U.S. Court of Appeals for the Second Circuit.

Decision and Rationale: The U.S. Court of Appeals for the Second Circuit held that an accountant is liable in these circumstances under Section 10(b) and Rule 10b-5. The court vacated the lower court's dismissal and remanded the case for further proceedings consistent with its opinion. The appellate court pointed out that “Any person or entity,” including an accountant, “who employs a manipulative device or makes a material misstatement (or omission) on which a purchaser or seller of securities relies may be liable as a primary violator under [Section] 10b-5, assuming all of the requirements for primary liability under Rule 10b-5 re mer.” To be liable, one of the requirements is a “duty to speak.” Such a duty arises “when one party has information that the other party is entitled to know because of a fiduciary or other similar relation of trust and confidence between them.” When accountants issue a certified opinion, they create the required special relationships with investors. Thus, accountants have a duty to take reasonable steps to correct misstatements that they discover in previous financial statements on which they know the public is relying. Silence in this situation can constitute a false or misleading statement under Section 10(b) and Rule 10b-5. Among other authorities, the court cited Section 10(b), which covers “any person,” and a United States Supreme Court decision that “labeled a critical element under [Section] 10(b) and Rule 10b-5: reliance by potential investors on the accountant’s omission.

Questions:

a. Did Overton have a valid reason to sue DBI’s auditors?

b. Does an accountant have a duty not only to correct prior certified statements, but also a duty to update those statements?

c. Does an accountant have a duty to correct more than those statements on which it certified an opinion?

d. Apart from issuing a certified opinion, are there other ways in which an accountant creates a duty to disclose certain facts?

Answer 1

a. Todman and Company, the defendants, had audited the financial statements of DBI and had issued an unqualified opinion that DBI’s financial statements were accurate. The defendant was the auditor of the company and it was its legal responsibility to state the truth. However the audit reports issued by the defendant were quite misleading and it risked the investment of the plaintiff, David Overton, who placed his investment decisions on DBI based on the audit reports of the defendant. Hence Overton had valid reason to sue DBI’s auditors.

b. An accountant is legally responsible for the authenticity and credibility of the financial statements of the company. Various investment decisions of customers is based on the financial statements of companies. It is the ethical responsibility of the accountant to report financial statements of a company quite accurately. If by some chance, the accountant overlooked an error in the financial statement in the past, but has realized the mistake, it is duty as well as moral obligation to get the corrections done based on facts and assessments. Otherwise the authenticity of financial statements will become quite questionable.

c. If the accountant has been legally hired to report the financial statements of an organization, then he is legally and morally obliged to correct the statements, which were prior certified. However if the accountant observes a need for correction in the financial statements of a company, which is not under his legal vigilance, he can just inform the correction information to the legal auditor of the company. If the auditor is ignoring his request for correction and the accountant is sure that the corrections are important, the accountant can raise the concern to SEC.

d. The other ways in which an accountant creates a duty to disclose certain facts pertaining to a company, are as follows:

· The accountant can create a blog where he can share his observations and knowledge

· The accountant can monitor the compliance adherence of the company pertaining to financial representations

· The accountant can train and educate employees of the company and encourage them to raise concerns

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