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The origins of auditor liability to third parties under United States common law

Adelphi University, Baker3{at}Adelphi.edu

Deborah Prentice

North Carolina A&T State University, dprentic{at}ncat.edu

This article traces the origins of auditor liability to third parties under United States common law, with a particular emphasis on the role of Benjamin Cardozo as Chief Judge of the New York Court of Appeals in the period from 1917 to 1932. Prior to the Ultramares decision, written by Chief Judge Cardozo in 1931, auditors were relatively shielded from liability against lawsuits brought by third parties (those who are not the client). In the Ultramares decision, Cardozo opened the door to a possible expansion of auditor liability to third parties through the introduction of a relatively new theory of law, that is that an auditor's negligence was heedless to such an extent that it was equivalent to fraud (that is, gross negligence). Subsequent to Ultramares, it appeared likely that the liability of auditors for negligent acts would be extended beyond their clients to the third parties who rely upon audited financial statements. However, because Ultramares has been interpreted in various ways in different jurisdictions, there has been ambiguity about the exact parameters of auditor liability to third parties under common law. Nevertheless, the Ultramares decision can be identified as the first instance in the United States where the courts opened up the possibility for third parties to sue auditors for negligent acts that were perceived to be so flagrant as to be equivalent to fraud.

Key Words: Auditors' liability to third parties • history of auditor negligence

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