$20-27$ Astor Electronics, Inc., markets a wide variety of computer$-$related products

$20-5,20-6$ throughout the United States. Astor$$s officers decided to raise $$1$ million by selling

shares of Astor$$s common stock in an exempt private placement offering under Regulation D of the Securities Act of $1933.$ In an exempt offering, debt or equity can be

sold to accredited investors without needing to register those securities with the SEC.

While these transactions do not fall under the $1933$ Act, they do still fall under the

$1934$ Act in terms of auditor liability. In connection with the offering, Astor engaged

Applegate & Company, CPAs, to audit Astor$$s financial statements. The audited

financial statements, including Applegate$$s unqualified opinion, were included in the

offering memorandum given to prospective purchasers of Astor$$s stock. Applegate

was aware that Astor intended to include the statements in the offering materials.

Astor$$s financial statements reported certain inventory items at a cost of $$930,000$

when in fact they had a fair market value of less than $$100,000$ because of technological obsolescence. Applegate accepted the assurances of Astor$$s controller that cost

was the appropriate valuation, despite the fact that Applegate was aware of ongoing

sales of the products at prices substantially less than cost. All of this was thoroughly

documented in Applegate$$s workpapers.

Musk purchased $10,000$ shares of Astor$$s common stock in the Regulation D

offering at a total price of $$300,000.$ In deciding to make the purchase, Musk had

reviewed the audited financial statements of Astor that accompanied the other offering materials and had been impressed by Astor$$s apparent financial strength.

Shortly after the stock offering was completed, Astor$$s management discovered

that the audited financial statements reflected the materially overstated valuation of

the company$$s inventory. Astor advised its shareholders of the problem.

Upon receiving notice from Astor of the overstated inventory amount, Musk

became very upset because the stock value was now substantially less than what it

would have been had the financial statements been accurate. In fact, the stock was

worth only about $$200,000.$

Musk has commenced an action against Applegate, alleging that Applegate is

liable to Musk based on the following causes of action:

$$ Common$-$law fraud.

$$ Negligence.

$$ A violation of Section $10($b$)$ and Rule $10$b$-5$ of the Securities Exchange Act

of $1934.$

The state law applicable to this action follows the Ultramares decision with

respect to accountants$$ liability to third parties for negligence or fraud. Applegate

has also asserted that the actions should be dismissed because of the absence of any

contractual relationship between Applegate and Musk, that is$,$ a lack of privity.

Required:

Ans