Butler Manufacturing Corporation planned to raise capital for a plant expansion by borrowing from banks and making several stock offerings. Butler engaged Meng, CPA, to audit its financial statements. Butler told Meng that the financial statements would be given to certain named banks and included in the prospectuses for the stock offerings. In performing the audit, Meng did not confirm accounts receivable and, as a result, failed to discover a material overstatement of accounts receivable. Also, Meng was aware of a pending class action product liability law-suit that was not disclosed in Butler’s financial statements. Despite being advised by Butler’s legal counsel that Butler’s potential liability under the lawsuit would result in material losses, Meng issued an unqualified opinion on Butler’s financial statements. Union Bank, one of the named banks, relied on the financial statements and Meng’s opinion in giving Butler a $ 500,000 loan. A couple of months after obtaining the Bank loan, Butler also raised $ 16,450,000 through stock offerings. Shortly after obtaining the Union loan, Butler began experiencing financial problems but was able to stay in business because of the money raised by the offerings. Then Butler was found liable in the product liability suit. This resulted in a judgment Butler could not pay. Butler also defaulted on the Union loan and was involuntarily petitioned into bankruptcy. This caused Union to sustain a loss and Butler’s stockholders to lose their investments. As a result,

• Union sued Meng for negligence and common- law fraud.

• The stockholders who purchased Butler’s stock through the offerings, as well as stockholders who purchased shares subsequently traded on a national securities exchange, sued Meng, alleging fraud under Section 10 (b) and Rule 10b- 5 of the Securities Exchange Act of 1934. These transactions took place in a jurisdiction providing for accountants’ liability for negligence to known and intended users of financial statements.

Required:

Answer the following questions and give the reasons for your conclusions.

a. Will Union be successful in its suit against Meng for

1. Negligence?

2. Common- law fraud?

b. Will the stockholders who purchased Butler’s stock succeed against Meng under the antifraud provisions of Section 10(b) and Rule 10b- 5 of the Securities Exchange Act of 1934?