Question

Jenna Corporation approved a merger plan with Cord Corporation. One of the determining factors in approving the merger was the financial statements of Cord, which had been audited by Frank & Company, CPAs. Jenna had engaged Frank to audit Cord's financial statements. While performing the audit, Frank failed to discover fraud that later caused Jenna to suffer substantial losses. For Frank to be liable under common-law negligence, Jenna at a minimum must prove that Frank:

a) knew of the fraud.

b) was grossly negligent.

c) acted with scienter.

d) failed to exercise due care.

Answer 1

For Frank & Company to be liable under common-law negligence, Jenna Corporation must prove that the auditor failed to exercise due care during the audit, which implies a failure to conduct the audit with the necessary skill and carefulness.

Step-by-step explanation:

The question pertains to the liability of Frank & Company, CPAs, under common-law negligence in the context of an audit that failed to uncover fraud affecting a merger decision. Under common law, for an auditor to be liable for negligence in the performance of an audit, the client must prove that the auditor failed to exercise due care. This means that Frank & Company would be liable if Jenna Corporation can demonstrate that Frank did not conduct the audit with the level of skill and care that a reasonably competent auditor would have applied under similar circumstances. Proving actual knowledge of the fraud (knew of the fraud), gross negligence (was grossly negligent), or that the auditor acted with the intention to deceive or with a reckless disregard for the truth (acted with scienter) would suggest a higher degree of fault that might be relevant in cases of fraud or constructive fraud, but for a simple negligence claim, the focus is on the lack of due care.