NO LONGER A RIPLEY TALE

James N. Kinney told a tale out of Ripley's Believe It or Not in the March issue of The CPA Journal (News & Views). It was a true tale, with only the names changed. A CPA firm was found liable for $10 million in damages for resigning from an account before issuing an audit report.

The basis for the suit was breach of contract, which led to the client not being able to obtain financing that was contingent upon the delivery of audited financial statements. The problem was that the client's version of the statements showed profits; the auditor's version would have shown losses. The auditor resigned because the engagement partner had questions about the integrity of the client's management, which would not agree to the auditor's proposed adjustments. After the resignation, two sets of prospective auditors also declined the work based, at least in part, on communications with the defendant firm.

The tale no longer qualifies for Ripley because the decision was reversed by the Court of Appeal in the Fourth Appellate District of California. The reversal of the decision was based upon a number of issues including the failure of 1) the court's instructions to the jury to explain the professional responsibilities and standards under which an auditor may a) resign from an engagement and b) communicate with potential successor auditors and 2) the plaintiff to prove the auditor's resignation caused the potential investor to invest.

Justice and reason have prevailed. The California Appeals Court concluded auditors should not be held for damages when they follow professional standards. But the lesson suggested by Sam Traum, who along with Kinney has been following the case, is that auditors set forth in their engagement letters the conditions under professional standards that the auditor may resign from engagements. By so doing, breach of contract challenges in the event of a resignation would be minimized. *