 Hello and welcome to the session in which we would look at the Securities Act of 1934, from the liabilities perspective of the auditor or of the accountant. Every time we mentioned the 1934, please remember this picture. The 1934 Act deals with the secondary market. It's when investors buy and sell securities amongst each other, not the 1933 where the companies issuing stocks for the first time in a form of IPO. So that's the first thing I want you to remember. So in this session, we're going to look at rule 10B-5, section 18A, very briefly 14A, 14E, and very briefly stocks. So we're going to spend most of the time on rule 10B-5 and section 18A. Now, before I start, if you are a CPA candidate or an accounting student, because this topic is also covered in auditing, please check out my website, forhatlectures.com. I don't replace your CPA review course if you're a CPA candidate, whether you're taken back to Roger, Gleam, or any other course. I can be a useful addition. I set up my courses to mirror image your CPA review course. So it's very easy for you to switch between my material and your CPA review course. I offer you an alternative, a supplement material, and I can add 10 to 15 points to your CPA exam score and help you pass the exam. Your risk is one month of subscription to find out whether my system works or not. Your return is passing the exam, and if not for anything, check out my website to find out how well or not well your university doing on the CPA exam. I do have resources for other accounting courses. Please connect with me on LinkedIn if you haven't done so, and take a look at my LinkedIn recommendation students who used my system over the years to pass the exam. Like this recording, connect with me on Instagram and Facebook. So let's start to take a look at the Securities Exchange Act of 1934. The auditor's liability under this act often revolves around the audited financial statement issued to the public an annual report which they submit to the SEC because once you are publicly traded, you have to submit those annual reports. And often it deals with 10K. It doesn't mean the 10Q. We cannot have issues with it or the 8K. A 10Q is the quarterly report and the 8K is the current event. But usually we're dealing with 10K. The problem occur when you have a 10K. So every company with the SEC that issued stocks to the public, they have to submit those audited financial statements, audited annual financial statements. So obviously when we're looking from a volume perspective, we're looking at a much larger volume when we're dealing with the 1934 because you're issuing those at least annual statement if not quarterly as well. The auditor must perform, remember, for the 10Q you only perform a review before it's filed with the SEC and the auditor is frequently involved in reviewing the information and other reports like the 8K. Therefore, they may be legally responsible. But usually when we're dealing with the auditor's liability, it's about the 10K and inside operating when it comes to the Securities Act of 1934. So few cases involve auditor's report other than the annual audit. So let's take a look specifically at Rule 10B-5. So the principal focus on the CPA liability litigation is under Rule 10B-5. It's called the anti-fraud provision and what does it prohibit? It prohibits any fraudulent activities involving the purchase or sale of any security. So simply put, the accountant can be liable under this rule for intentionally or recklessly. Remember, you have to remember these words. Under 10B-5, there's intention and reckless behavior. Okay? Misrepresent the information intended for third party. So simply put, it's illegal obviously to defraud anyone in connection with the purchase or sale of any security. Okay? Whether or not exempt from registration, although it could be exempt from registration. Remember, we talked about exempt registration in the prior session. Although the transaction is exempt, you are still subject. Whether you are private or public company, you're still subject. If you defraud anyone, that's buying or selling stocks that's using mail, interstate commerce, especially interstate commerce, order stock is listed on a national exchange. It applies both to both private as well as public. So you might be thinking, well, isn't the SEC only public? No. Even if you're a private, remember also the 1933 applies to some private companies. And whether it's a primary or secondary, whether it's an initial issue or a secondary issue, Rule 10B-5 will apply. And it applied to a broad range of people, accountant, lawyer, simply put, any person. Look, it's if you defraud anyone in connection with buying or selling sales, but here we're talking about CPAs because this is our concern, then you are subject to this rule, 10B-5. So what should the plaintiff prove for 10B-5, 1934? And after I go these rules, I'm going to show you the 1933 section 11 that we looked at in the prior session. And on the exam, they try to trick you, and you need to know the difference between the two. I'm going to review them here, but first I have to go over the 1934. The first thing that the plaintiff must prove is they purchase or sale the security. Notice I put sale because you're going to see under section 11 only if you purchase. If you sell it, we'll explain why in a moment, why it doesn't apply. So that's easy. That's easy to prove that you purchase or you sell the security. You'll have a record of it. There's a material, misstatement or a mission of fact. What is material? That means whatever you did, it will change someone's mind. This is what materiality is. There was actual reliance on the statement. You actually relied on the statement. Now, a private plaintiff ordinarily need not reliance in case of a mission. If something is admitted, you didn't even know to rely on it. Now, what about if there's a material misstatement? Indirect reliance is presumed something called fraud on the market theory. And how does this fraud on the market theory work? Because think about it. How would you know that I relied on this information? Simply put, when you buy a stock, the assumption is that stock is fairly priced. Well, therefore, if I found out later that it was not fairly priced because of material misstatement, then I relied. I have an indirect reliance. They can also have the case for actual reliance causation. You have to show that the loss caused by the reliance. So you suffer damages because of that material misstatement or a mission. But this is the hardest one. The defendant was intent to deceive, manipulate or defraud. And this is the hardest thing to prove. You have to prove what's called sientor or fraud. They did this on purpose. And it was involved recklessness, willful disregard, willful disregard to the truth. Not ordinary. Ordinary negligence is not enough. So you have to show the person that revealed this information, we're assuming here the auditor or the CPA, did that on purpose to deceive you. And that's difficult. The most difficult versus the four. And this is what makes section 10-B, 10-B-5 difficult to prove. Okay. Now under section 11, what would the plaintiff have to prove? Let's look at them. First, you have to show that you purchase the shares. Why only purchase and not sale? Because remember, in section 11, 1933, you're dealing with IPO. If you bought it, now once you sold it, you're going to sell it to the public. That's not under 1933. You'll go back to under 1934. But once you purchase the security, that's easy. You have a record of that. That you incurred a loss. That's easy. I bought the stock for $10. Now it's at six. And the third one is the audited financial statement contain material misstatement. And that's all you have to show under the 1933. Simply put, what's the similarities? Both you have to purchase the stock. If you did not purchase the stock, you have no claim against anyone, right? That makes sense. You incurred a loss. If you did not incur a loss, you don't have a case against anyone. So you have to have a loss. And the third one, so notice those are the same. All you have to show under 1933 is that the financial statement contained material misstatement or a mission. You don't have to show that you relied on them or did not rely on them. The auditor was trying to deceive you or not trying to deceive you. The auditor was negligent. You don't care. You don't care what the reason was. All you have to show is it's very, remember I said it's low bar, very low bar so they can easily sue you under the 1933 act. And that's why the auditor is very careful when they are auditing financial statement for a company that's going public because it's very easy for the plaintiff, for the investors eventually to come back and sue the auditor. Okay. The CPA defense under under those circumstances. The first thing is non negligent performance. I did my work. I followed gap. I followed gas. So that's the first one lack of duty that that was not my responsibility. The issue was I was not responsible for that absence of causal connection. Well, guess what? Your loss has nothing to do with the material misstatement and statute of limitation. You know, the 1934 act require a plaintiff to file a suit before the earlier of two years after the discovery or discovery of the false or misleading misstatement or five years after the cause of action arose. So all of those are see could be potentially CPA defense. This is how the CPA will defend themselves. What are the remedies? The remedies under section 10 be monetary damages. Recision or cancellation of securities contract. If you have a contract to buy or sell injunction, you can get a legal action to stop any further damage and make the injured party whole. So you can force them to make you hold under section 11. Usually it's monetary damages. You simply they will give you back your losses. Okay. Now we're going to go from rule 10 be dash five to rule to section 18 a which is also tested on the exam. They're both tested. I'll say worry about those. So I'm going to say one is more important than the other because you would see questions about to section 18 a but I believe rule 10 be dash five is tested more. And especially they they'll try to confuse you between rule 10 be dash five and section 11 1933 versus 1934 remember 1933. It's very easy for the plaintiff to win. Okay. 1934 they have to show that the auditor was not not only negligent. They had the intent to the fraud. Okay. Now let's let's be careful here section 18 a false and misleading and filing. You are filing some paperwork. So there's a penalty imposed a civil penalty for making or causing a false or misleading statement or a mission of a material fact and any filing. What does filing mean means there's there's a physical paper and you gave it to the SEC and that paper that paper is misleading. Well, why is that important? That's important because under rule 10 dash B whether you make a written or an oral for example of the company or of the auditor said something or or the company issued a statement and the statement orally was misleading. Then they're into they could get into a trouble under 18 dash a they have to file with the SEC. What would the plaintiff have to prove? Well, the plaintiff have to prove the following that they either purchase or sell the stock. You know, there's a false misstatement, obviously, or an admission. Again, it has to be material and reliance on the misstatement and buying and selling. Now the reliance is very specific here. You have to actually see the statement itself where you have to physically see it. Okay. That's how you show that you relied on it. Obviously, you have to sew causation and damages. It's much more difficult than the 1933 as well because the 1933 again, it has a low, low bar. Okay. Defense. Well, how could you defend yourself? If you are sued, you acted in good faith and you had no knowledge that the misstatement was false or misleading. What's good faith? You have no intention to deceive them. You have no intention to deceive them because they want to show that you deceive them and you have no intention. You acted in good faith. So this is section 18a. Remember, it deals with filing paperwork with the SEC, some sort of a document. Okay. Now also under 1934, just like under 1933, there's a criminal liability. When does that happen is when you, when you act recklessly and with the intention to mislead. Like you, you issued an unqualified opinion and you knew it was wrong. It's not like you have, you did it in good faith or a mistake. You are, you had disregard, reckless disregard of the truth. You committed fraud. Then you are subject to criminal liability, not by the SEC, by the Department of Justice, but under those rules. Two more rules we have to be familiar with rule 14a that deals with proxy. Remember, a proxy is when, when, when someone else solicit your vote, shareholders can use a proxy solicitor. If they made, sorry, can sue a proxy solicitor. So some proxy solicitor is someone who's trying to solicit your vote, asking you to give them your vote to vote on your behalf. If they made false or misleading misstatement or a mission, not an omission of material fact under the 1934 rule for 14e. It deals with tender offer. It's illegal for any person to make a tender offer by making misstatement of a material fact or omission. Again, omission or engage in any fraudulent or deceptive practice. Again, you can sue them under the 1934 act under those rules that they violated. One more thing we need to be familiar with very briefly, Sarbanes-Oxley Act of 2002. And you have to learn more about this in your auditing course, as well as VEC, they, they touch upon SOC. So, so if you took auditing or BEC, you should be familiar with this. Basically, Sarbanes-Oxley came into effect after the accounting scandals, Enron, Worldcom, Global Crossing 2000, 2001. It establishes the PCAOB, the Public Accounting Oversight Board, to do what? To regulate, inspect and investigate public accounting firms, simply put auditor. CPA firms, now they must register with the PCAOB to be able to prepare any audit report for an SEC registrant. So, you have to basically pay a fee for this board and you're under the regulation of that board. Violators of the PCAOB are violations of the SEC Act of 1934 and you're subject to the same penalties. Okay, you have to have an audit committee that's something new under the PCAOB. The audit committee is the party that hires, fires overseas and compensates the CPA firm, kind of, so they're acting independently. They must include at least one person who's financial expert, CPA will do it, or someone that can show financial expertise. They have to be an independent member. And the CPA firm reported the audit committee. They reported them to show that they are independent from the company. What would they report to them? Many, many things, they provide the audit committee with timely observation arising from the audit that are significant in the financial reporting process. Many things. And you'd learn about these things and auditing just to give you an idea here. Communicate to the audit committee an overview of the overall audit strategy and timing of the audit as well as many other things. Let's talk a little bit about Sarbanes-Axley in case you got a question about this topic. But this is more tested on BEC and AUD audit, specially audit. At the end of this recording, I'm going to invite you again to visit my website, farhatlectures.com. I provide you with alternative explanation. That's what I do for your CPA review course. So you keep those courses. What I do is I set up my courses to mirror yours. So if you have Becker, you know where to find this information. You look at Becker, you look at Roger, you look at clean, but you want another alternative explanation. I'm there to help you. Good luck. Study hard and stay safe.