 Hello, and welcome to this session. This is Professor Farhad. In this session, we would look at the professional liability of auditors, specifically under contract law. This topic is covered in an auditing and attestation course, either graduate or undergraduate, as well as the CPA exam. If you need additional lectures about this topic or auditing and attestation, please visit my website, farhadlectures.com, where I have over 170 lectures about auditing and attestation. So an auditor can be legally liable under three different laws. Contract law, which is the least concerned for auditors, which we will discuss in this session, common law and federal statutes, specifically 1933, 1934, and those what you're gonna be responsible for in a typical undergraduate course, as well as the CPA exam. Now, also, maybe a little bit of Sarbanes, Oxley, and Rico, we'll talk about them later on. But in this session, we're gonna be focusing on the contract law. So when does the auditor violate the contract law? When does it violate the contract law? Guess what? When the auditor fails to meet the terms of the engagement. Where do we find the terms of the engagement? Well, hopefully you all know the terms of the engagement is find in the engagement letter. And for my students, I always ask them to actually draft an engagement letter. This way they see what goes on the engagement letter. So if you violate any of the terms in the engagement letter, then you are in a breach of a contract. Well, what are some of the specific conditions? Well, the audit process, how are you gonna audit the company, deadline, fees, or could be deadlines, many deadlines, fees, those are the things that could be specifically identified in the contract. Also in the contract, what's implied is you're gonna have to do professional quality work. You don't have to spell this out. You don't have to say, I'm gonna be doing professional quality work. You're gonna be doing, it's implied that you're gonna be doing professional quality work. Now, who can sue you under contract law? Who can sue you under contract law? Obviously the client, the parties of the contract. Who's the party to the client? Who's party to the contract? The other party. Now, on rare occasion, you might have a third party. When? Let's assume you have a client, goes to a CPA firm, and they want their financial statements to be audited. But the client tells the CPA firm that they're gonna be going to the local bank to give them the financial statement as a support to the loan. So the bank is relying on your work. Well, if they explicitly, if they explicitly state that those financial statements are being used to support a loan application, then guess what? The bank could be our, could argue that they are part of the contract. Okay, this doesn't happen very often, but it could happen legally, okay? When I was an audit, when I was an auditor, most of the work that we did for our client, because we dealt with medium-sized businesses, what they wanted is, they wanted their financial statements to be audited, so can they take the financial statement to the bank in support of a loan application? Okay, that's fine, but seldom that the bank will be involved at a third party. They could, they could argue, but we're not gonna go into this. But keep in mind that you could have a third party involved in a contract law other than the client themselves, okay? So what are the causes for suing you under the contract law? So we know who the parties are, but what are the causes? Well, the first cause is, you failed to complete the work engagement within the agreed upon time specified in the engagement letter. You told them, I'm gonna be done, let's say May 6th, but you were not done May 6th, whether it's a potential breach, because you were not done on May 6th. What are your defenses under those circumstances as an auditor? We will discuss next, the defenses in case under the contract law, but this is one, one thing that you breached the contract. You did not finish on time. Two, you would drew from the engagement without any sufficient justification. Now, let's talk about this from both perspective. Can the client fire you? Of course the client can fire you. Can you sue the client if you are fired? Yes, you can, you could always sue, but it's that for business. But we're talking about if the auditor voluntarily withdrew from the engagement. Can you do that without sufficient justification? In the answer, if you do so without sufficient justification, then you are in a breach of a contract. But what are considered sufficient justification? Think about it. What are some sufficient justification? Well, think about it. Okay. What if the client is dishonest? What if the client withholding information? What if the client not being cooperative? Guess what? Thank you very much. I'm not interested. I am not interested in working for you because you are dishonest and you don't want to associate yourself with a dishonest client. So that's one reason which is justified reason or you're asking the client for documents for access to the assets and they're not giving you, they're not being cooperative. Going to Florida because you had a bad winter on the East Coast is not a valid reason to withdraw from the engagement. So if we had a bad winter on the East Coast and guess what? As an auditor, I decided to go to Florida early this year. I cannot do the audit. That's not a valid reason. Also causes for sue in you is violating client confidentiality. Remember to have a specific rules for confidentiality. If you start talking about the engagement to, for example, the EPA Environmental Protection Agency, that's, you can do so. Sometime regulatory agency may force you, that's okay. Or if it's a subpoena, it's a law subpoena, you have to talk, that's fine. Otherwise you're gonna have this disciplinary action if you violate the client confidentiality in addition to breaking the law. So you have to be very careful. Also failing to provide professional quality work will also be a cause for sue in you under a contract law, okay? So what are the auditor's defenses? Let's assume you are sued. What are the auditor's defenses? Well, the first one is pretty easy. I did not breach the contract. Simply put, well, let's review the contract. I did everything that I'm supposed to do. It's just a miscommunication. Two, the losses were not caused by the breach. Okay, I see that I breach the contract but your losses, you have to show that your losses were the cost of the breach. Otherwise, if something else caused your losses, it's not my fault. And the client will have to prove that the damages were done by the breach of the contract. Just because you breach the contract, it doesn't mean you are responsible for the losses, okay? The third one, the third defense is the client was contributory negligent. So the client, in a sense, contributed to the breach of contract, okay? What could be an example of this? Again, failing to provide the required material to the auditor on a timely basis, okay? A good case is crazy Eddie, which is Sam Entaur and crazy Eddie, crazy Eddie passed away but Sam, his cousin, is still living. So what happened is when they wanted to audit their company, I'm gonna show you the link later on about the case, the crazy Eddie, what they did, they kept delaying the process. The auditor wanted to finish the work in 10 weeks, even flow. But what happened is they did not give them access to the inventory, they did not give them access to certain material. So the auditor has to hustle through the audit to finish the audit, okay? And by the way, this is my picture with Sam, was taken at one of the universities I teach at in 2013. Obviously this is an old picture, but this is Sam. His cousin, his Eddie passed away, he's too old, but Sam, Sam still, he teaches at, I'm not sure which university he teaches at, but I know he does get seminar about the case. And I'm gonna show you the documentary that he showed us. I'll show you the link to the documentary. He came to this university and he discussed the documentary. In other words, he showed us exactly what happened, how did the fraud took place and he explained everything in the documentary, which was very, very interesting. So what are the court action in case of breach? Let's assume you were breach, you breach the contract, what does the court state? Well, the first thing they state is order the auditor to fulfill the contract, okay? Simply put, they're gonna ask you to come back from Florida if you left early and complete the contract, okay? In case you were discussing this issue with someone, stop discussing the issue, they will order an injunction to prohibit you from continuing the breach, stop breaching the contract, stop talking about the case, safe, the client confidentiality. Or they may ask you to pay compensatory damages, okay? Now, breach of contract, don't make it to the news often. Now think about it, why? Because the breach of contract, it's between the auditor and the client. So there are limited parties involved in the contract and usually limited parties and the dollar amount involved, relatively small. It could be millions of dollars, but if you really think about publicly traded companies, you can't even compare them. So that's why breach of contract, you don't hear about it a lot in the news, although it exists, it happens, but it's not news. It doesn't make it to the national news. Now, this is a documentary, this is not the one that I wanted to show you, but this documentary about Crazy Eddie is made by the Association of Certified Fraud Examiners and just maybe Google Crazy Eddie. This is the Grammy, March 17th, it's gonna be the most earth-gattering, grand opening ever, thousands of free gifts, free t-shirts, Humphrey Flyers, yo-yos. You know that Crazy Eddie has the lowest prices on anything and it brings the whole entertainment equipment well. So as you can tell, it is Crazy Eddie, all right? But in this documentary, it's only 12 minutes. Sam talks in the documentary, this is Sam. So I suggest you view it just for your own good, just to see what happened, how fraud gets committed, what are the motivation behind the fraud, what are the signs of the fraud, and also the documentary that Sam came to discuss with us, it wasn't this documentary, it was this documentary. You can find it under Crime Documentary, I believe it's free, and Masterminds Crazy Eddie 2004. So this is a long documentary, and this is the documentary that he came, he went over, he stopped it at several occasions and he would explain and will have questions. The students will have questions about it. So I strongly suggest you view it for your own mind. And again, as I always say, don't be Jose Gomez and don't be in the shoes of Sam and Tar as well. Be ethical, that's the most important thing for you as an auditor. You can, you know, once you lose your credibility as an auditor, as an accountant, that's it, you are done, you are finished. So make sure you are aware of this. If you're studying for your CPA exam, as always, study hard. If you want more lectures, go to my website for havelectures.com and by all means, if you can, donate or contribute money, good luck, and study hard for the exam, it's worth it.