Post Audit Loss

A New York court ruled an accounting firm does not have the duty to report losses that occur subsequent to its audit report. The firm issued audit reports on a clients 1993 and 1994 financial statements. These statements were included in the clients prospectus for a public offering of securities. Although the plaintiffs — investors in the client company — did not note any errors in these statements, they did allege that the firm should have reported losses the client incurred in 1995. The plaintiffs cited the firms duty to conduct an S-1 review through the effective date of the registration statement. Such duties should include discussions with management, a review of subsequent interim financial statements and reading the minutes of the board of directors meetings. The plaintiffs alleged that had the firm performed the S-1 review properly, it would have discovered and disclosed the subsequent losses.

The defendant argued that the auditors responsibility pertains only to the period covered by the financial statements it has audited. It also said that an S-1 review is undertaken strictly for the purpose of determining whether changes are required in the financial statements that have been audited and not for reporting on financial conditions subsequent to the audited balance sheet.

The court agreed with the defendants argument. It said that an accurate audit report does not become misleading simply because an issuer suffers a material loss subsequent to the period covered by the report; materially false and misleading information must exist in the report itself. Although accountants are required to take reasonable steps to correct misstatements discovered in previous financial statements, they need not disclose events that occur subsequent to the period they purport to certify.

This case is significant for accounting firms because it absolves them from the duty to be aware of and disclose events occurring postaudit that affect a clients financial statements. Such a duty would have imposed a substantial burden on accounting firms. Firms would have had to monitor existing and former clients postaudit statements. ( Adair v. Kaye Kotts, Inc., 1998 WL 142353, S.D. N.Y. March 27, 1998)

Editors note: Thanks for both cases to Dan L. Goldwasser of Vedder, Price, Kaufman & Kammholz.

—Edited by Wayne Baliga, CPA, JD, CPCU, CFE, president of Aon Technical Insurance Services.