South-Western Legal Studies in Business

Accountant Commits Securities Fraud by Failing to Correct Financial Problems
Description Appeals court held that an investor presented sufficient evidence of losses incurred when he relied on audited financial statements that contained errors for years. Failure to correct the problem can make the auditor liable for investor losses.
Topic Accountant’s Liability
Key Words Audit; Duty to Correct; Securities Law; Liability
C A S E   S U M M A R Y
Facts Todman & Co. audited the financial statements of broker-dealer Direct Brokerage for several years. Todman stated that the statements accurately reflected the financial condition of the company when, in fact, it failed to uncover payroll tax liabilities. Overton sued Todman for securities fraud, contending he invested $500,000 in Direct, and loaned it $1.5 million, based on audited statements. The district court dismissed the suit. Overton appealed.
Decision

An accountant violates the “duty to correct” and becomes liable under federal securities law Rule 10b-5 when it: 1) makes a statement in its certified opinion that is false or misleading when made; 2) later learns, or was reckless in not learning, that the statement was false or misleading; 3) knows or should know that potential investors rely on the opinion; 4) fails to take reasonable steps to correct or withdraw the statement; and 5) other requirements for liability are satisfied. Overton presented the necessary elements for a securities fraud suit against Todman to proceed. The payroll tax liability issue went on for many years without being uncovered or corrected by Todman.

Citation Overton v. Todman & Co., 478 F.3d 479 (2nd Cir., 2007)

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