 Hello and welcome to this session. This is Professor Farhad and this session will look at the auditor professional liability and specifically we're going to be looking at the legal environment. This topic is covered in an auditing and attestation course as well as on the CPA exam, auditing and attestation. This will be part of my auditing course which will be listed on my website as well as on my YouTube channel. So let's take a look at why, why do auditors get sued? Now having said so, we have to disclose up front that this is not a common occurrence. So simply put, only 1% of audits are deficient where the auditor is sued. Okay, but the first thing we're going to start with is trying to explain why. What is the background? What is the legal environment for the legality of it? One, the first reason is there's an expectation gap. What do we mean by expectation gap? It's the perception of users versus reality. It's what the users, the users here could be the client, the users here could be the lenders, the users here could be the investors. What do they think what an audit is and what an audit actually is? So there is a wrong perception. Okay, oftentimes clients don't read the contract between them and the auditor. Why? Because the auditor only provide reasonable, not absolute assurance. And people think, well, I'm being audited. I am covered 100%. Well, that's not true. The auditor samples, they don't audit every single transaction in a company. They sample, therefore it's not 100%. And even if someone audit 100%, let's assume as an auditor, you audited 100% of every single transaction, you could also still make a mistake because when you were auditing, you looked at everything, but you made the mistake and interpretation, you made a mistake, you did not read something properly. So mistake could happen. Let alone you don't audit 100%, you sample, you sample. So if that's the case, why do users go ahead and sue the auditor is because the clients suffer losses because the users suffer losses and they expect someone else to pay. And who's going to pay? They want the auditor to pay. Why? Because the auditor, they have the pockets. So that's one of the reasons. Another reason is, I'm sure you, if you watch TV, which is I haven't watched TV in a long time, I don't have cable anymore, is TV ads when the attorney comes and they would say, just contact us. And if you are heard by this company or that company and we will take your case on our own expense. Okay. So attorney and plaintiff awareness of potential rewards. Why? Because what happened is you are going to sue someone and you have no skin in the game. So as a client, what you do is you are working on a contingency fee arrangement. What does that mean? It means the lawyer incur all the cost and the lawyer does not care because if they win the case, they're going to win big and they're going to charge you for every single thing. So there's a contingency fee arrangement, no cost of the plaintiff unless they win the case. Okay. Attorney, what they do once they win, they deduct cost and fees. Also, this is the idea of no skin in the game. The client does not care. I would say, what the heck? If somebody wants to sue the company on my behalf, I have, if I lose, I don't have to put a penny up. So if I win, I will be rewarded. The other thing is class action lawsuit. What happened is this, you might own maybe a thousand dollar or you suffered a thousand dollar of losses in a company. That's all what you suffered. Okay. But you are only one client. So what happened is you are not going to hire someone. You're not going to hire an attorney and pay that attorney thousands of dollars to recover your losses. So what happened in large publicly traded companies, you could have maybe 10,000 clients. Okay. Because, because what happened is large publicly traded companies are owned by the public and each one of them suffered a losses of a thousand dollar. Now it's worth it. Now what happened, the attorney will go to the judge and you'll ask the judge, can I represent all those 10,000 clients in one lawsuit? Okay. And this way now it's worth it for the client, worth it for the lawyer to pursue the case. So this is what the class action lawsuit is. So bundle many plaintiff claim in one case basically. And this happens usually with large publicly traded companies. Now I said, you know, your losses are small, but the lawyer bundle all the losses. Sometimes the lawyer are so greedy, the lawyer are so greedy, like in case of Tesla, Elon Musk, they want to be the losses to be they will not take your case unless your losses are more than a million dollars. And this is October 6th, 2018. If you heard of Tesla, Elon Musk, he made some few comments on tweet. The stock went up. It wasn't really truthful. Then when it was not truthful, the stock dropped, people lost money. So what happened now, this law firm, Shell Law Firm, announces the filing of class action lawsuit against Tesla and reminds investors with losses and access of a million. So a few losses are less than a million. Don't talk to them. They want big money. They want the losses to be a million. And what they would do, they will take on your case. They will, they will represent you and you don't have to pay anything most probably unless they win. Another reason for the auditor being being getting sued easily is something called joint and several liability. Now, bear in mind, this is a state by state law. What, how does it work? Here's what happened. The client collect fully from any defendant, even if those partially responsible. So what happened is this. We have, we have a client. Okay. We have a client, that client went to the bank to borrow money. The client hired the auditor. Also the client, they have banks and there's investors as well. Okay. What happened is the client might have made some bad mistakes and the client went out of business. Now the bank and the investors, they can, they cannot collect from the client. The investors basically the business is gone. So what they do is they will try to go after the auditor. Okay. And in some states, what happened is this auditor or even though auditor are marginally at fault, they can, they'll have to pay for the whole lawsuit. Simply put, management is 95% at fault. Auditor is 5% of fault. In some state, the auditor is responsible for 100% for the losses. Let's assume it's a million dollar loss. Well, guess what? The auditor is partially responsible for that loss. Maybe they made a mistake, but really the company was, was cooking the fraud and the auditor is not really responsible for this. But in some state, although you're 5% responsible, they make you responsible for the full amount. So that's why in certain state, you get sued a little bit more easily. Also, what happened is attorneys, they know that hand side bias of judge and juries are 2020. So when the attorney takes you, when they sue you and takes you to court, they know that they're working with perfect information. Now the jury can see exactly what should have happened. Perfect information is now available. But when, when the, when the consequences were taking place, when you were auditing the company, you did not know what's going on. But now, you know, because you look back. So basically, you are judging information now that happened several years ago. For one thing you may not remember, you may not remember what happened. Let alone, let alone knowing what you should have done at that point. So hindsight is 2020. Therefore, it's easy for the attorney to put you on the spot and question the auditor. More reasons, increase complexity of the audit. Okay. Now we have obviously systems are computerized. Now auditors have to, to audit companies with drones. You have to understand the business, blockchain, robots, all sorts of new technology. You have new technical accounting standards and auditing standard that's going to increase the risk, chance of an audit failure, because every, every time you have something new, you have to learn it, make sure you are implemented properly, it increases your risk. Also, the auditor will have to complete the audit under time and time, time pressure. So perform complex audit with lower fees. Now, Sarbanes-Oxley lessen this pressure because now Sarbanes-Oxley, they ask companies, auditors to focus on quality rather than to make a profit. And now it's easier for the client to pass the cost, for the auditor to pass the cost to the, to the client because it's by law, they have to do certain, they have to undertake certain procedures. Now, how can an auditor be sued? Auditor can be sued under three, three, three categories under contract law, common law and federal statutes. The least concern for the auditor is the contract, contract law, which is the contract between the auditor and the client themselves. We'll talk about the other two, as well as the contract law and the common law, as well as federal statutes in the next, in the next few sessions. Now, bear in mind, there's a lot of federal statutes, we're only going to be dealing with 1933 and 1934. Why? Because those, what's going to be covered in your auditing course and a typical undergraduate or graduate auditing course unless you are a law student, that's a different story. I'm not a lawyer nor I'm teaching to law students. And on the CPA exam, that's the two federal statutes that they mainly cover. They are, you are responsible for those. In the next session, what we'll look at is we'll look at causes of legal action. What are the causes? If you have any questions, any comments by all means email me. This is just an introduction about this chapter. This chapter will be posted on my website. And if you happen to visit my website, please by all means consider donating. Thank you very much. And if you're studying for your CPA exam, as always, study hard.