Questions

Under present technical standards, would auditors be required to disclose a company policy similar to Nay$$s mail rule that they discover during an audit? Explain. Assuming such disclosure had been required at the time this case took place, would that disclosure have resulted in the mail rule being discontinued?

Ernst & Ernst argued that the mail rule was not relevant to its audits of First Securities since that rule only involved personal transactions of Nay and the escrow investors. Do you agree? Why or why not?

Define negligence as that term has been used in legal cases involving independent auditors. What is the key distinction between negligence and fraud? Between recklessness and fraud? For all three types of professional misconduct, provide an example of such behavior in an audit context.

Assume that the investors defrauded by Nay could have filed their lawsuit against Ernst & Ernst under the Securities Act of $1933.$ How, if at all, do you believe the outcome of their suit would have been affected?

The Restatement of Torts is a legal compendium issued by the American Law Institute. This compendium is relied on by courts in many jurisdictions as the basis for legal rulings. Under the Restatement of Torts, courts have ruled that negligent auditors can be held liable to unknown third parties if those parties belonged to a known group of financial statement users who the auditors were aware would likely rely on the audited financial statements. If this legal principle had been invoked in the Hochfelder case, would the defrauded investors have been successful in pursuing a negligence claim against Ernst & Ernst under the common law? Why or why not?