Question

How does the Securities Act of 1933, which imposes civil liability on auditors for misrepresentations or omissions of material facts in a registration statement, expand auditors' liability to purchasers of securities beyond that of common law?

1) Purchasers have to prove only that a loss was caused by reliance on audited financial statements.
2) Privity with purchasers is not a necessary element of proof.
3) Purchasers have to prove either fraud or gross negligence as a basis for recovery.
4) Auditors are held to a standard of care described as 'professional skepticism.'

Answer 1

The Securities Act of 1933 expanded auditors' liability by eliminating the need for privity between auditors and purchasers and reducing the burden of proof for investors regarding misrepresentations or omissions in audited financial statements. Subsequent legislation like Sarbanes-Oxley Act of 2002 further increased auditor oversight to protect investors.

Step-by-step explanation:

The Securities Act of 1933 significantly expanded auditors' liability to purchasers of securities beyond the traditional common law framework. Specifically, it addresses the issues of misrepresentations or omissions of material facts in registration statements that could affect the decisions of investors.

Unlike common law, which required a direct relationship (privity) between the purchaser and the auditor, or a proof of fraud or gross negligence, the Securities Act of 1933 eased the burden of proof on investors. Under this act, to recover losses, purchasers do not need to prove that they were in privity with the auditors or that the auditors acted with fraud or gross negligence.

Instead, they must only demonstrate that the audited financial statements contained material misrepresentations or omissions and that these were relied upon, leading to the loss.

In response to major accounting scandals like those involving Enron and WorldCom, the Sarbanes-Oxley Act of 2002 was enacted to reinforce confidence in financial information and further protect investors from accounting fraud. These reforms imposed more stringent regulations on auditors, enforcing a standard of care that includes the use of professional skepticism when examining financial statements.