Section 11 of Securities Act of 1933: Liability Exposure. Chriswell Corporation decided to...

Section 11 of Securities Act of 1933: Liability Exposure. Chriswell Corporation decided to raise additional long-term capital by issuing $20 million of 12 percent subordinated debentures to the public. May, Clark & Company, CPAs, the company’s auditors, were engaged to examine the June 30, 2015, financial statements, which were included in the bond registration statement.

May, Clark & Company completed its examination and submitted an unmodified auditors’ report dated July 15, 2015. The registration statement was filed and became effective on September 1, 2015. On August 15, one of the partners of May, Clark & Company called on Chriswell Corporation and had lunch with the financial vice president and the controller. He questioned both officials on the company’s operations since June 30 and inquired whether there had been any material changes in the company’s financial position since that date. Both officers assured him that everything had proceeded normally and that the financial condition of the company had not changed materially.

Unfortunately, the officers’ representation was not true. On July 30, a substantial debtor of the company failed to pay the $400,000 due on its account receivable and indicated to Chriswell that it would probably be forced into bankruptcy. This receivable was shown as a collateralized loan on the June 30 financial statements. It was secured by stock of the debtor corporation, which had a value in excess of the loan at the time the financial statements were prepared but was virtually worthless at the effective date of the registration statement. This $400,000 account receivable was material to the financial condition of Chriswell Corporation, and the market price of the subordinated debentures decreased by nearly 50 percent after the foregoing facts were disclosed.

The debenture holders of Chriswell are seeking recovery of their loss against all parties connected with the debenture registration.

Required:

Are May, Clark & Company liable to the Chriswell debenture holders under section 11 of the Securities Act of 1933? Explain. (Hint: Review the BarChris case in this chapter.)