Chapter 4, Problem 27QRA

Gordon & Moore, CPAs, were the auditors of Fox & Company, a brokerage firm. Gordon & Moore examined and reported on the financial statements of Fox, which were filed with the Securities and Exchange Commission.

  Several of Fox’s customers were swindled by a fraudulent scheme perpetrated by two key officers of the company. The facts establish that Gordon & Moore were negligent, but not reckless or grossly negligent, in the conduct of the audit, and neither participated in the fraudulent scheme nor knew of its existence.

  The customers are suing Gordon & Moore under the antifraud provisions of Section 10(b) and Rule 10b-5 of the Securities Exchange Act of 1934 for aiding and abetting the fraudulent scheme of the officers. The customers’ suit for fraud is predicated exclusively on the negligence of the auditors in failing to conduct a proper audit, thereby failing to discover the fraudulent scheme.

Required:

Answer the following, setting forth reasons for any conclusions stated.

1. a.      What is the probable outcome of the lawsuit? Explain.
2. b.      What other theory of liability might the customers have asserted?