To expand its operations, Dark Corporation raised $4 million by making a private interstate offering of $2 million in common stock and negotiating a $2 million loan from Safe Bank. The common stock was properly offered pursuant to Rule 505 of Regulation D, which exempts the offering from the 1933 Act, but not the antifraud provisions of the Federal Securities Acts.
In connection with this financing, Dark engaged Crea & Company, CPAs, to audit Dark's financial statements. Crea knew that the sole purpose for the audit was so that Dark would have audited financial statements to provide to Safe Bank and the purchasers of the common stock. Although Crea conducted the audit in conformity with its audit program, Crea failed to detect material committed by Dark's president. Crea did not detect the embezzlement because of its inadvertent failure to exercise due care in designing its audit program for this engagement.
After completing the audit, Crea rendered an unqualified opinion on Dark's financial statements. The financial statements were relied on by the purchasers of the common stock in deciding to purchase the shares. In addition, Safe Bank approved the loan to Dark based on the audited financial statements. Within 60 days after selling the common stock and obtaining the loan from Safe Bank, Dark was involuntarily petitioned into bankruptcy. Because of the president's embezzlement, Dark became insolvent and defaulted on its loan to Safe. Its common stock became virtually worthless. Actions have been commenced against Crea by the purchasers of the common stock (who have asserted that Crea is liable for damages under the Securities Exchange Act of 1934) and Safe Bank, based on Crea's negligence.
a. Discuss the merits of the actions commenced against Crea by the purchasers of the common stock and by Safe Bank, indicating the likely outcomes and the reasoning behind each outcome.
b. How would your answer be different if the client filed a registration statement and the purchasers of the common stock were able to bring suit under the 1933 Act?

  • CreatedSeptember 22, 2014
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