Deck 6: Legal and Regulatory Obligations in an Ethical Framework

Question 1

The Securities Act of 1933

A)Regulates the auditing of financial statements for publicly-traded companies
B)Limits the financial liability of independent auditors except in the case of gross negligence
C)Regulates the initial offering of securities
D)Regulates which services may be performed for a publicly-traded company by an audit firm

Answer 1

C

Question 2

In the U.S., if the auditor can demonstrate having performed services with the same degree of skill and judgment possessed by others in the profession, it can be said to have exercised:

A)Prudence
B)Scienter
C)Nonfeasance
D)Due Care

Answer 2

D

Question 3

The Restatement (Second) of Torts Approach

A)Expands an accountant's legal liability to third parties identified by the client as intended recipients of work
B)Limits an accountant's legal liability to only those parties with which it has a privity relationship
C)Limits an accountant's legal liability to only those parties that have been named by the client
D)Expands an accountant's legal liability to all possible users of the audited financial statements

Answer 3

A

Question 4

The Credit Alliance v.Arthur Andersen & Co.case established three tests that must be satisfied for holding auditors liable for negligence to third parties.All of the following are tests described EXCEPT

A)Knowledge by the accountant that the financial statements are to be used for a particular purpose.
B)The intention of the third party to rely on those statements.
C)Some action by the accountant linking him or her to the third party that provides evidence of the accountant's understanding of intended reliance.
D)The identity of the third party must be directly known to the auditor.

Question 5

Under the Securities Act of 1933, if damages were incurred and there was a material misstatement or omission in the financial statements, the CPA automatically loses unless

A)The management intentionally deceived the auditors
B)The damages were incurred to a third party that was not a signatory to the contract
C)The CPA can shift the burden of proof to the investors
D)The CPA rebuts the allegations

Question 6

Under the Securities Act of 1933 and the Securities and Exchange Act of 1934, accountants may be subject to criminal penalties for:

A)Obstruction of justice
B)Securities fraud
C)Willful violations of the acts
D)All of the above

Question 7

The most relevant sources of civil liabilities for auditors failing to adhere to the requirements of the laws in carrying out professional obligations include all of the following except for:

A)Securities Act of 1933
B)Private Securities Litigation Reform Act of 1995
C)Securities and Exchange Act of 1934
D)Sarbanes-Oxley Act of 2002

Question 8

A privity relationship means that

A)A party may be a user of the financial statements
B)A party may sue if fraud has taken place
C)A party's financial liability is limited
D)A party has a contractual obligation

Question 9

An audit engagement letter

A)Offers an auditor's services to a client
B)Is required by generally accepted auditing standards (GAAS)
C)Details the SEC's expectations for the audit firm for a specific engagement
D)Formalizes the relationship between the auditor and the client for a specific engagement

Question 10

The legal term for the intent to deceive, manipulate or defraud is

A)Nonfeasance
B)Misfeasance
C)Constructive fraud
D)Scienter

Question 11

The executives of McKesson and Robbins Pharmaceuticals were able to steal around $2.9 million in 1939 because

A)Its auditors did not follow the generally accepted auditing standards (GAAS) of the time
B)The independent audit of financial statements was not required at the time
C)Physical inspection of inventory was not performed by the auditors
D)The auditors were not independent and conspired with management to steal the funds

Question 12

Which of the following would normally be considered sufficient to demonstrate due care on the part of the auditor?

A)The auditor had its work reviewed by another audit firm
B)The auditor cites adherence to generally accepted auditing standards (GAAS)
C)No omissions or misstatements have been found in the client's financial statements
D)The auditor signs a statement expressing its unqualified opinion as to the fairness of the financial statements

Question 13

What is the first general stage in an audit-related dispute as identified by USC Professor Zoe-Vonna Palmrose?

A)The occurrence of events that result in losses for users of the financial statements
B)An investigation by plaintiff attorneys before filing to link the user losses with allegations that material omissions or misstatements in the financial statements
C)The legal process that commences with the filing of a lawsuit
D)A public company engages in deliberate activity to "cook the books"

Question 14

All of the following proof can be used in an auditor's defense against third party lawsuits for fraud except for:

A)The third party was not in contractual privity
B)The auditor did not have a duty to the third party
C)The third party was negligent
D)The third party did not suffer a loss

Question 15

When an auditor acts so carelessly in the application of professional standards that it implies a reckless disregard for the standards of due care is referred to as

A)Scienter
B)Fraud
C)Constructive fraud
D)Negligence

Question 16

The Securities and Exchange Act of 1934

A)Limits the financial liability of independent auditors except in the case of gross negligence
B)Requires the filing of audited annual statements and reviewed quarterly statements
C)Regulates the initial offering financial statements of securities
D)Regulates which services may be performed for a publicly-traded company by an audit firm

Question 17

The Rosenblum case ruling was of concern to the accounting profession because it implied that

A)Full joint and several liabilities would be reinstated.
B)All possible third party users of financial statements must be anticipated.
C)The concept of contractual privity would no longer be important.
D)Financial liability would occur when scienter was a factor.

Question 18

The Ultramares v.Touche case of 1933 held that a cause of action based on negligence could not be maintained by a third party who was not in contractual privity; however, it did leave open the possibility that:

A)Third parties that were "foreseeable" may sue for ordinary negligence
B)Third parties may sue if one of the parties in contractual privity allowed it to
C)Third parties may sue in the case of fraud or constructive fraud
D)Third parties who used the financial statements may sue

Question 19

When courts find accountants liable for constructive fraud, the implication is that

A)Auditors should always be liable when investors lose money due to deceit
B)Accountants may be liable for fraud even when they had no knowledge of deceit
C)Auditors should be able to detect all deceit by management
D)Accountants may be held liable even to third parties to whom they did not have a duty

Question 20

The legal precedent that evolves from legal opinions issued by judges in deciding a case and guides judges in deciding similar cases in the future is referred to as:

A)Business law
B)Tort law
C)Common law
D)Statutory law

Question 21

What is a worrisome consequence under the joint and several liability principles?

A)Each negligent party is liable for the portion of the damages for which it is responsible
B)All negligent parties are always liable for damages
C)Only the negligent party considered to have "deep pockets" is held liable for damages
D)Each negligent party could be held liable for the total of damages suffered

Question 22

"Disgorgement" with respect to legal rulings refers to

A)A defendant being forced to at least partially repay fraudulently gained money
B)An auditor being forced to reveal private client information because fraud has occurred
C)An auditor being held financially liable for investor losses
D)Giving up one's dinner after food poisoning

Question 23

The major purpose of the amended Federal Sentencing Guidelines is to:

A)Allow federal judges to mitigate any sentence imposed on a company according to a mathematical formula
B)Extend the statute of limitations for bringing a lawsuit for fraud against an auditor to seven years
C)Criminalize the bribery of foreign government/officials
D)Allow a plaintiff to bring a lawsuit under the law for managers' or board of directors' breach of fiduciary duty

Question 24

Which of the following would be a logical consequence of the Private Securities Litigation Reform Act of 1995?

A)Each negligent party is only liable for the portion of damages for which it is responsible
B)Each negligent party could be held liable for the total of damages suffered
C)Auditors have tended to neglect their responsibility of due diligence
D)The threat of private enforcement against accountants has increased

Question 25

What is the lesson from "Crazy Eddie" Antar?

A)His prices were insane
B)Do not flee from the police because they will eventually find you
C)Accountants cannot afford to trust anyone
D)Financial fraud will always eventually reveal itself because it is unsustainable

Question 26

The Foreign Corrupt Practices Act (FCPA) forbids which kind of bribery:

A)U.S.business payments to foreign government/official to be awarded a major contract
B)U.S.business payments to a foreign customs official to ensure off-loading of merchandise
C)U.S.business payments to U.S.government official to be awarded a major contract
D)All of the above

Question 27

In the Jacobs v Coopers & Lybrand case, plaintiffs alleged that Coopers:

A)Failed to properly audit the company's accounts receivable from two of its suppliers
B)Turned a blind eye to red flags
C)Failed to follow the standards of ordinary care
D)All of the above

Question 28

What argument can be made that Sarbanes-Oxley may not be effective in reducing fraud?

A)It is not as stringent as international standards
B)The SEC has had many laws for many years that have not seemed to make much of a difference
C)The penalties under Sarbanes-Oxley are especially stringent, so it may not be enforced
D)Civil and criminal penalties are not effective in preventing financial fraud

Question 29

The SEC attempts to control insider trading in part by:

A)Prohibiting officers and directors from buying stock of the company they work for/oversee
B)Prohibiting shareholders from buying stock of affiliated companies
C)Requiring officers, directors, and shareholders owning 10 percent of the class of equity securities registered with the SEC to file reports concerning their ownership and trading of the corporations securities
D)All of the above

Question 30

Martha Stewart was found guilty of which offense with respect to her sale of ImClone stock?

A)Insider trading
B)Obstruction of justice
C)Fraud
D)Dressing poorly when she sold the stock

Question 31

In order for an employee to bring an action under Section 806 of the Sarbanes-Oxley Act in a whistle blowing case:

A)The employee suffered an unfavorable personnel action
B)The employee must be engaged in a protected activity or conduct and the circumstances were sufficient to raise the inference that the protected activity was a contributing factor to the unfavorable action
C)The employer knew actually or constructively that the conduct occurred
D)All of the above

Question 32

How long do management and the audit committee have to act if the independent auditor reports possible illegal acts to them?

A)One week
B)One month
C)Three business days
D)One business day

Question 33

Under section 801 of the Sarbanes-Oxley Act of 2002, anyone who "knowing alters, destroys, mutilates, conceals, covers up, falsifies, or makes false entry in any record, document, or tangible object with the intent to impede, obstruct, or influence the investigation" is subject to certain penalties.How long after the end of the fiscal period in which the audit or review was concluded are auditors required to retain work papers?

A)1 year
B)7 years
C)Indefinitely
D)5 years

Question 34

There are two kinds of whistle blowing,

A)Internal and external
B)Direct and indirect
C)Explicit and implicit
D)Anonymous and public

Question 35

Under the rules of the Sarbanes-Oxley Act of 2002, who must certify the public reports filed with the SEC?

A)The independent auditor
B)The CEO
C)The CEO and CFO
D)The CEO and controller

Question 36

Section 801 of the Sarbanes-Oxley Act makes it a crime to:

A)Knowingly altering or destroying records or documents related to an audit
B)Insider trading
C)Knowingly making a false entry in a record or document with the intent to impede, obstruct, or otherwise influence an investigation with respect to the audit
D)All of the above

Question 37

A payment made to a foreign government official to ensure that s/he does what is expected given their job requirements can be characterized as a:

A)Bribe
B)Asset misappropriation
C)Facilitating Payment
D)Legal Payment

Question 38

Under the Private Securities Litigation Reform Act, if an auditor concludes that an illegal act with a material effect on the financial statements has been reported to, but not dealt with by senior management, the auditor should then report his/her conclusions to

A)The Securities and Exchange Commission
B)The company's board of directors
C)The office of the controller/comptroller for the appropriate state
D)The Federal Bureau of Investigation

Question 39

The Private Securities Litigation Reform Act of 1995 applies the practice of ______.

A)Risk assessment
B)Fraud triangle
C)Lowballing
D)Proportionate liability

Question 40

In the case of Equity Funding, the audit client

A)Fraudulently recorded inventories that did not in fact exist
B)Inflated its earnings by recording fictitious sales of insurance policies
C)Moved liabilities off the balance sheet by using thousands of subsidiaries
D)Recorded inventory below cost, therefore understating costs of goods sold and overstating net income

Question 41

The main focus of the Con-Way case is the company's:

A)Bribery of Philippine customs officials
B)Payments to foreign officials at state-owned airlines doing business in the Philippines
C)Failure to properly record and disclose illicit payments to Philippine customs officials and officials at state-owned airlines doing business in the Philippines
D)All of the above

Question 42

An important issue in the Hewlett Packard case was:

A)Sexting
B)Pretexting
C)Twittering
D)Financial statement fraud

Question 43

A key consideration in deciding whether the shareholders in the Countrywide Corporation case would be successful in their lawsuit against members of the board of directors was application of:

A)Proportionate liability
B)Scienter
C)Business judgment rule
D)Privity rule

Question 44

The best defense for an auditor is to

A)Perform audits in accordance with ethical principles when auditing standards are unclear
B)Strictly adhere to the requirements of the generally agreed auditing principles (GAAS)
C)Perform all work not only in accordance with US GAAS but also international GAAS
D)Always follow the letter of the law when performing audits

Question 45

Negligent nonfeasance would be said to occur when

A)An auditor issues an unqualified opinion for financial statements he or she knows to be materially misstated
B)An auditor fails to use appropriate accounting procedures and thereby fails to discover a client's internal practices
C)An auditor fails to report an instance of financial fraud to the SEC
D)An auditor intentionally skips parts of the audit plan to cut costs and increase profitability

Question 46

The defendant-auditors in the Anjoorian case argued, in their defense, that:

A)To be found guilty to third parties, the court must find that an accountant had contemplated a specific transaction for which the financial statement will be used and that no such transaction was contemplated.
B)They had no liability to third party shareholders.
C)The plaintiff's theory of damages is speculative and against public policy.
D)All of the above.

Question 47

Auditors deserve blame in failing to uncover fraud in the Equity Funding case due to

A)Failing to determine that some journal entries were phony
B)Failing to recognize that many insurance policy files were forged
C)Failing to meet some policyholders in person
D)Failing to secure the audit plan

Question 48

The Knowledgeware case dealt with which accounting issue?

A)Overstated inventory amounts
B)Sham software sales
C)Fictitious invoices
D)Overstated net realizable value of receivables

Question 49

In which type of court case is proving "due diligence" essential to the auditor's defense?

A)Court cases brought under the Securities Exchange Act of 1933
B)Court cases brought under the Securities Exchange Act of 1934
C)Court cases brought by clients under common law
D)Court cases brought by third parties under common law

Question 50

A major allegation in the XTO Energy case was the:

A)Breach of fiduciary duties of the board of directors
B)Insider trading
C)Violation of the FCPA
D)All of the above

Question 51

Which two organizations were formed to deal with the accounting profession's credibility?

A)AICPA and Macdonald
B)Treadway and SEC
C)Treadway and AICPA
D)Treadway and Macdonald

Question 52

What is a payment made to someone in a government agency in order to obtain approval or assistance from that individual or organization called?

A)Facilitating Payment
B)Bribe
C)Grease
D)Legal Payment

Question 53

A unique aspect of the lawsuit in Welch v.Cardinal Bankshares Corporation is it:

A)Was the first case to deal with the certification of false financial statements by the CEO and CFO thereby violating the Sarbanes-Oxley Act
B)Was the first case where an individual brought a complaint against an employer under the whistle blowing provisions of the Sarbanes-Oxley Act
C)Reversed the ruling in Ultramares v.Touche
D)Reversed the ruling in Bily v.Arthur Young

Question 54

Regarding criminal sentences for illegal business conduct, the recommended sentence range depends primarily upon

A)How much money investors lost as a result of the illegal conduct
B)The length of the period in which the illegal conduct took place
C)The number of investors who lost money as a result of the illegal conduct
D)The opinion of the judge as to how egregious the illegal conduct was

Question 55

All of the following are crimes EXCEPT

A)Providing payments to foreign government officials to obtain business.
B)Bribing foreign political parties to promote enacting more advantageous trade legislation.
C)Providing monetary assistance to a foreign political candidate with the understanding that if he or she wins, the company will get a bigger contract.
D)Making payments to a ministerial government employee of a foreign country to obtain a license to do business in that country.

Question 56

Which Act requires firms who engaged in international operations to have internal controls and an audit committee?

A)The Foreign Corrupt Practices Act of 1977
B)The Foreign Exchange Regulation Act of 1973
C)The Foreign Exchange Management Act of 1999
D)The Foreign Management Practices Act of 1977

Question 57

Michael Trent Reznor, the lead singer in the band Nine Inch Nails, filed a lawsuit against Richard Szekelyi and the Navigent Group in the Reznor v JAM, Inc case alleging:

A)Negligence
B)Breach of fiduciary duty
C)Aiding and abetting fraud
D)All of the above

Question 58

The term "manipulative" connotes

A)Gross negligence
B)Constructive fraud
C)Nonfeasance which results in investor losses
D)Intentional or will conduct designed to deceive

Question 59

The difference between an auditor's services regarding reports 10Q and 10K is

A)The auditor provides "limited assurance" regarding 10Q and "reasonable assurance" regarding 10K
B)The auditor provides "reasonable assurance" regarding 10Q and "limited assurance" regarding 10K
C)The auditor provides no assurance regarding 10Q and "limited assurance" regarding 10K
D)The auditor provides "limited assurance" regarding 10Q and "absolute assurance" regarding 10K

Question 60

In the case of SEC v.Halliburton & KBR, the commission charged Halliburton & KBR with:

A)Bribing Nigerian government officials to look the other way while the companies developed and presented fraudulent financial statements
B)Bribing Nigerian government officials in order to obtain construction contracts
C)Bribing Nigerian government officials to off-load merchandise at the country's piers
D)All of the above

Question 61

The Private Securities Litigation Reform Act of 1995 changed the legal climate in the U.S.in a major way.Explain the nature of the changes under the PSLRA with respect to legal liability.Do you believe this act adequately protects shareholders and other third parties that might bring a lawsuit actions auditor and other defendants? Why or why not?

Question 62

A student states that as long as the auditor has followed all applicable laws, then the auditor has been ethical.Do you agree? Why or why not?

Question 63

Explain the accounting issues involved and ethical lapses in one of the following two cases: (a) Equity Funding or (2) Crazy Eddie.

Question 64

Is insider trading always unethical? If you answer that it is explain why such an action violates ethical standards.If you say that it is not, explain why such an action does not violate ethical actions.

Question 65

Auditors may be held liable to both their clients and third parties under common law.
a.What must a client prove to recover its losses from a client under common law?
b.What must an ordinary third party prove to recover losses from an auditor under
common law?
c.How does an auditor's ethical obligations and liability under common law intersect?

Question 66

Distinguish between an auditor's legal liability under the Securities Act of 1933 and the Securities and Exchange Act of 1934.

Question 67

Which of the provisions of the Sarbanes Oxley Act do you think is the most important? Why did you choose that particular provision?

Question 68

The SEC v.Zurich Financial Services case dealt with:

A)Zurich's use of finite reinsurance transactions to inflate improperly financial performance
B)Zurich's use of false insurance invoices to inflate revenues
C)Failure of Zurich's board of directors to carry out its fiduciary duties
D)Failure of the auditors to exercise the degree of care and professional skepticism expected in an audit
Essay Questions

Question 69

Distinguish between an auditor's legal liability under common law and statutory law.Cite specific cases to support your Answer.

Question 70

The Jacobs v Coopers & Lybrand case deals with the issue of just how egregious an accounting firm's failure to comply with GAAS and GAAP have to be to subject that firm to a fraud claim arising out of its audit of financial statements.Describe the facts of the case and evaluate the plaintiffs' alleged violations by Coopers with respect to GAAS and GAAP.

Question 71

Do you think there can ever be enough laws on the books to reduce or eliminate unethical actions that have lead to the many lawsuits discussed in the chapter? Why or why not?

Question 72

What are the best defenses that an auditor can use to defend oneself against charges of fraud? How does ethical behavior relate to these defenses?

Question 73

Explain the duty of care of managers and directors.Include in your explanation the role of ethics in making decisions that support such a level of care.