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Ultramares Corporation v. Touche, Niven & Company
Until the case of Ultramares Corporation v. Touche, Niven & Company (1931), auditors admitted no liability for negligence affecting third parties. The common law rule was that a negligent professional man could normally be sued only by his clients. Having no contract with outsiders, he had no responsibility to them unless he committed fraud.
In 1924 Touche Niven gave an unqualified audit certificate to a rubber importer, Fred Stern and Company, failing to discover that manage-ment had falsified entries in order to overstate accounts receivable. The auditors supplied Stern with 32 numbered copies of the certified bal-ance sheet, knowing the company would use them in applying for credit. Ultramares Corpo-ration, a factor, made loans to Stern and Com-pany on the basis of these certified balance sheets. When Stern declared bankruptcy in 1925, Ultramares sued the auditors for the amount of Stern's debt on the grounds that a careful audit examination would have showed that Stern was insolvent on the balance sheet date. The auditors were acquitted on a fraud charge but were found guilty of negligence. But the trial judge set even this aside, applying the doctrine of privity, which protected auditors from third party negligence suits. An interme-diate appellate court affirmed dismissal of the fraud count but reinstated the negligence ver-dict. The case then went to the New York Court of Appeals.
Judge Benjamin Cardozo agreed that third parties could not hold an auditor responsible for ordinary negligence, only for fraud. But he then argued that courts could infer fraud from grossly negligent actions and, in so doing, could
subject the auditor to liability from any injured party who relied on the auditor's report, whether or not the auditor knew that the third party was doing so. In short, the greater the negligence, the more widespread the legal re-course. Even an honest mistake or oversight so gross as to support the inference that an audi-tor did not believe his own opinion might jus-tify a fraud verdict and open the door to indefi-nite third party liability.
In Ultramares the substantive question was whether the audit had been so grossly neg-ligent as to constitute constructive fraud. De-ciding that it had been, Judge Cardozo ordered a new trial. Before it could be held, the suit was settled out of court. But the precedent estab-lished has been reiterated in similar cases ever since, until today the auditor's liability to the public at large is nearly as extensive as to his clients.
The Ultramares decision caused changes in the short form audit report. The court had criti-cized Touche Niven for not clearly indicating the scope of its examination, and particularly for failing to distinguish its statement of the audit's scope from its statement of opinion. As a result, the word "certify" was dropped from the audit report. The American Institute of Accountants emphasized that the auditor's cer-tificate was an opinion, not a guarantee. More-over, it was an opinion of the client's actions, not the auditor's. His examination of the books was not intended to prove anything, but simply to put his mind in contact with the company's affairs. His knowledge and his skill in applying audit techniques then allowed him to express a professional opinion of management's financial statements.
Michael Chatfield
ULTRAMARES CORPORATION V. TOUCHE, NIVEN & CO. 593
Object Description
| Title |
History of accounting: An international Encyclopedia |
| Author |
Chatfield, Michael Vangermeersch, Richard |
| Subject |
Accounting -- History |
| Date-Issued | 1996 |
| Source | Originally published by Garland Publishing, Inc. |
| Rights | Copyright and permission to reprint held by: Academy of Accounting Hitorians |
| Type | Text |
| Format | PDF scanned at 400dpi with corrected OCR |
| Digital Publisher | University of Mississippi Libraries. Accounting Collection |
| Date-Digitally Created | 2011 |
| Language | eng |
| Identifier | vangermeersch |
