Sleek Corporation is a public corporation whose stock is traded on a national securities e...

Sleek Corporation is a public corporation whose stock is traded on a national securities exchange. Sleek hired Garson Associates, CPAs, to audit Sleek’s financial statements. Sleek needed the audit to obtain bank loans and to make a public stock offering so that it could undertake a business expansion program.

Before the engagement, F. Hedge, Sleek’s president, told Garson’s managing partner that the audited financial statements would be submitted to Sleek’s banks to obtain the necessary loans.

During the course of the audit, Garson’s managing partner found that Hedge and other Sleek officers had embezzled substantial amounts of money from the corporation. These embezzlements threatened Sleek’s financial stability. When these findings were brought to Hedge’s attention, Hedge promised that the money would be repaid and begged Garson not to disclose the embezzlements.

Hedge also told Garson’s managing partner that several friends and relatives of Sleek’s officers had been advised about the projected business expansion and proposed stock offering and had purchased significant amounts of Sleek’s stock based on this information.

Garson submitted an unqualified opinion on Sleek’s financial statements, which did not include adjustments for or disclosures of the embezzlements and insider stock transactions. The financial statements and auditors’ opinion were submitted to the banks Sleek normally does business with, including Knox Bank. Relying on the financial statements and the auditors’ report, Knox loaned Sleek $2,000,000.

Sleek’s audited financial statements were also included in a registration statement prepared under the provisions of the Securities Act of 1933. The registration statement was filed with the SEC in conjunction with Sleek’s public offering of 100,000 shares of its common stock at $100 per share.

An SEC investigation of Sleek disclosed the embezzlements and the insider trading. Trading in Sleek’s stock was suspended, and Sleek defaulted on the Knox loan. As a result, the following legal actions were taken:

• Knox Bank sued Garson.

• The purchasers of Sleek’s stock offering sued Garson.

Required:

a. Would Knox be able to recover from Garson for fraud?

b. Would the purchasers of Sleek’s stock offering recover from Garson

1. Under the liability provisions of section 11 of the Securities Act of 1933?

2. Under the antifraud provisions of section 10(b) and Rule 10b-5 of the Securities Exchange Act of 1934?