Cornell Law Review Volume 70 Article 7 Issue 2January 1985 Rosenblum Inc. v. Adler CPAs Liable at Common Law to Certain Reasonably Foreseeable Third Parties Who Detrimentally Rely on Negligently Audited Financial Statements William J. Casazza Follow this and additional works at:http://scholarship.law.cornell.edu/clr Part of theLaw Commons Recommended Citation William J. Casazza,Rosenblum Inc. v. Adler CPAs Liable at Common Law to Certain Reasonably Foreseeable Third Parties Who Detrimentally Rely on Negligently Audited Financial Statements, 70CornellL.Rev. 335 (1985) Available at: http://scholarship.law.cornell.edu/clr/vol70/iss2/7 This Article is brought to you for free and open access by the Journals at Scholarship@Cornell Law: A Digital Repository. It has been accepted for inclusion in Cornell Law Review by an authorized administrator of Scholarship@Cornell Law: A Digital Repository. For more information, please [email protected]. ROSENBLUM, INC V ADLER: CPAs LIABLE AT COMMON LAW TO CERTAIN REASONABLY FORESEEABLE THIRD PARTIES WHO DETRIMENTALLY RELY ON NEGLIGENTLY AUDITED FINANCIAL STATEMENTS The Supreme Court of New Jersey, in Rosenblum, Inc. v. Adlert be- came the first court in the United States2 to hold certified public ac- countants (CPAs) liable at common law3 to certain reasonably foreseeable third parties4 who detrimentally rely on negligently5 audited 1 93 N.J. 324, 461 A.2d 138 (1983). 2 Since 1980, England has held accountants liable to reasonably foreseeable third par- ties who detrimentally rely on negligently audited financial statements. In JEB Fasteners Ltd. v. Marks, Bloom & Co., [1981] 3 All E.R. 289 (Q.B.), aj'd,[ 1983] 1 All E.R. 583 (C.A.), the defendant accounting firm negligently audited the financial statements of a manufactur- ing company. The plaintiff, JEB Fasteners, later acquired the financially troubled manufac- turer. The plaintiff subsequently discovered that the audited financial statements of the manufacturing company significantly overstated the company's net worth. JEB Fasteners sued the manufacturer's auditors for negligence. The court held that accountants are liable to all reasonably foreseeable third parties, such as the plaintiff, for negligently conducting an audit. Id. at 300-01. The court, however, granted judgment for the defendant auditors be- cause their negligence did not cause plaintiff's losses. Evidence indicated that the plaintiff would have acquired the manufacturer even if it had known of the financial misstatement. Id. at 304-05. For a discussion of this case by English commentators, see Stanton & Dugdale, Recent Developments in ProfessionalN egligence - If- Accountant's Liability to Third Parties, 132 NEw L.J. 4 (1982). 3 This Note does not analyze in detail auditors' legal liability to third parties under federal securities laws. A brief discussion of this statutory liability, however, is useful for comparative purposes. Under the Securities Act of 1933, accountants are liable for negligence to third parties who purchase newly issued securities if the financial section of the registration statement re- quired to be filed with the Securities and Exchange Commission (SEC) is materially mislead- ing. Securities Act of 1933, § 11, 15 U.S.C. § 77(k) (1982). Under § 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78(j)(b) (1982), mere negligence in the presentation of annual reports and other documents required to be filed under the 1934 Act has been held insufficient to state a claim against a CPA. See Ernst & Ernst v. Hochfelder, 425 U.S. 185, 201 (1976) (to hold CPA liable under the 1934 Act, CPA must have scienter or intent to deceive and manipulate). Accountants are liable under the 1934 Act for recklessness to third parties who buy or sell securities if the financial section of the annual report required to be filed with the SEC is materially misleading. McLean v. Alexander, 420 F. Supp. 1057, 1084 (D. Del. 1976) (liability of accountant who had prepared opinion audit under antifraud provision of Securities Exchange Act of 1934 could properly attach upon a showing of reckless disregard of truth). 4 The New Jersey court did not create an all-inclusive list of what third parties are "reasonably foreseeable." The scope of this class will differ somewhat depending on the na- ture of the audited client's business. For example, the reasonably foreseeable users of a manu- facturing company's financial statements may include suppliers of inventory who sell inventory to the company on credit, or others who factor the company's accounts receivable. Those types of third party users of financial statements, however, would probably not be CORNELL LAW REVIEW [Vol. 70:335 financial statements.6 Even though the principal effect of the auditor's opinion to management about the accuracy of the examined financial statements7 is to influence third parties,8 prior to Rosenblum all state courts severely limited the rights of third parties against negligent CPAs. A minority of state courts still precludes all third parties from suing CPAs for negligence, holding that a CPA's legal duty extends only to those with whom he is in privity.9 The majority of state courts allows only specifically known or intended third party users or classes of users of financial statements'0 to sue CPAs for negligent auditing. The New Jersey ruling is a rational extension of the rights of third parties against negligent CPAs.'2 This state now provides the primary users of audited financial statements, including stockholders, investors, and creditors,' 3 with increased access to its courts to recover economic losses sustained as a result of CPA negligence. The well-reasoned Rosen- blum decision should provide the impetus for other states to modernize'4 reasonably foreseeable in the case of a bank or financial institution. At a minimum, the New Jersey court includes "stockholders, potential investors, creditors and potential creditors" as reasonably foreseeable third parties. Rosenblum, 93 N.J. at 332, 461 A.2d at 142. The CPA, of course, is liable at common law to his client for negligence, see id. at 333, 461 A.2d at 142, and to third parties for fraudulent conduct, see injfa note 27. 5 This Note is concerned with negligence, not recklessness. Many courts already hold CPAs liable at common law to third parties for recklessness. See Rosenblum, 93 N.J. at 349, 461 A.2d at 151. 6 See infra notes 16-18 and accompanying text (discussing auditing and financial statements). 7 See infra notes 19-20 and accompanying text (discussing auditor's opinions). 8 See Comment, Auditors' Responsibility For Misrepresentation: Inadequate Protection For Users of FinancialS tatements, 44 WASH. L. REV. 139, 178 (1968) (audit evaluates "the adequacy and fairness of financial statements issued by management to shareholders, creditors, and others"); see also infra note 40. 9 See, e.g., Investors Tax Sheltered Real Estate, Ltd. v. Laventhol, Krekstein, Horwath & Horwath, 370 So. 2d 815 (Fla. Dist. Ct. App. 1979) (accounting firm cannot be held liable to investing enterprise for negligence when there is no privity); cf.M acNerland v. Barnes, 129 Ga. App. 367, 199 S.E.2d 564 (1973) (accountant not liable for negligence regarding uncerti- fled financial statement to third parties who are not in privity, even though he knew of or could have anticipated reliance). For other cases with similar holdings, see Annot., 46 A.L.R.3d 979, 991-94 (1972). 10 See infra notes 34-38 and accompanying text for definition of "known or intended" third party users or classes of users of financial statements. I1 See, e.g., Rusch Factors, Inc. v. Levin, 284 F. Supp. 85 (D.R.I. 1968) (applying Rhode Island state law) (CPAs liable to third party banking and factoring corporation they knew would rely on negligently audited financial statements in extending credit); Ryan v. Kanne, 170 N.W.2d 395 (Iowa 1969) (CPAs liable to third parties they knew would rely on negli- gently determined accounts payable information); Shatterproof Glass Corp. v. James, 466 S.W.2d 873 ('ex. Civ. App. 1971) (accountant owed duty of care to creditor to whom he knew audit would be given). For other cases with similar holdings, see Annot., supra note 9, at 989-91. 12 See Note, The Enlarging Scope of Auditors' Liability to Rel ing Third Parties, 59 NOTRE DAME L. REv. 281, 295-96 (1984) (concluding that privity rule is anachronistic and that Rosenblum rule is workable alternative). 13 See infa note 40. 14 The "reasonably foreseeable" standard adopted in Rosenblum to define the scope of a 1985] ACCOUNTANTS" LIABILITY their view of the legal duty and liability of auditors to third parties.15 I ACCOUNTANTS AND AUDITING OF FINANCIAL STATEMENTS In the typical audit engagement, financial statements prepared by a company's management are examined, tested, and reviewed by in- dependent CPAs. This independent testing is intended to ensure that financial statements provide reasonably complete, accurate, and unbi- ased information. The availability of such reliable information is essen- tial to the efficient functioning of a free market economy. Unreliable information misleads decision makers and causes inefficient use and al- location of scarce resources.16 A CPA must conduct an audit in accordance with "generally ac- cepted auditing standards" (GAAS).17 The membership of the Ameri- can Institute of Certified Public Accountants has approved and adopted CPA's duty is "already applied as an integral part of general negligence law." Note, supra note 12, at 295. A possible reason that the law of accountants' negligence has lagged behind general negligence law in this respect is the nature of accountants' negligence claims. In cases of accountants' negligence, the CPA is usually neither the only nor the primary wrongdoer. He is usually only a secondary wrongdoer because he has failed, by his negligence, to detect the fraud of his client. See, e.g., Rosenblum, 93 N.J. 324, 461 A.2d 138 (auditor allegedly negli- gent, but client fraudulent). The fact that CPAs are usually only secondary wrongdoers does not justify circumscribing their negligence liability. It must be remembered that one of the specific functions for which the ac- countant is employed is the detection of corporate fraud. Accountants and accounting firms derive substantial economic benefit because of their abilities in this regard. It hardly seems oppressive to require that they perform this task in a professionally reasonable manner. Wiener, Common Law Liability of the CertifiedP ublic Accountant for Negligent Misrepresentation, 20 SAN DIEGO L. REV. 233, 258 (1983). A more common rationale for circumscribing accountants' liability for their negligence is the fear of exposing them to unlimited liability. See inran otes 29, 32 & 33 and accompanying text. 15 Another state, Wisconsin, has adopted a foreseeability standard. In Citizens State Bank v. Timm, Schmidt & Co., 113 Wis. 2d 376, 335 N.W.2d 361 (1983), a bank sued an accounting firm and its malpractice insurer for losses it allegedly incurred when it loaned money to the auditor's corporate client in reliance on financial statements that were negli- gently audited. The Wisconsin Supreme Court reversed a lower court's grant of summary judgment for the auditors and remanded the case to the trial court on the negligence claim. The supreme court noted that the absence of privity should not bar such a claim. It then addressed the question of the extent to which CPAs should be liable to third parties for negli- gence. Citing Rosenblum, decided less than a month earlier, the Wisconsin court noted that even the Restatement (Second) of Torts position, that negligent CPAs are liable to individually known or intended third party users of financial statements and members of a known or intended class of users of such statements, see infia notes 34-41 and accompanying text, was "too restrictive a statement of policy factors for this Court to adopt." 113 Wis. 2d at 386, 335 N.W.2d at 366 (footnote omitted). The court concluded that CPAs will be liable, in Wiscon- sin, for negligence to all reasonably foreseeable third parties, unless the CPAs prove at trial that public policy requires another outcome. Id. 16 A. ARENS & J. LOEBBEcKE, AUDITING: AN INTEGRATED APPROACH 2 (1976). 17 See 2 AMERICAN INSTITUTE OF CERTIFIED PUBLIC ACCOUNTANTS, AICPA PROFES- SIONAL STANDARDS ET § 202.01 (1981) [hereinafter cited as AICPA]. CORNELL LAW REVIEW [Vol. 70:335 ten generally accepted auditing standards that set broad guidelines for CPA audit conduct: GeneralS tandards 1. The examination is to be performed by a person or persons hav- ing adequate technical training and proficiency as an auditor. 2. In all matters relating to the assignment, an independence in mental attitude is to be maintained by the auditor or auditors. 3. Due professional care is to be exercised in the performance of the examination and the preparation of the report. Standards of Field Work 1. The work is to be adequately planned and assistants, if any, are to be properly supervised. 2. There is to be a proper study and evaluation of the existing inter- nal control as a basis for reliance thereon and for the determination of the resultant extent of the tests to which auditing procedures are to be restricted. 3. Sufficient competent evidential matter is to be obtained through inspection, observation, inquiries, and confirmations to afford a rea- sonable basis for an opinion regarding the financial statements under examination. Standards of Reporting 1. The report shall state whether the financial statements are presented in accordance with generally accepted accounting principles. 2. The report shall state whether such principles have been consist- ently observed in the current period in relation to the preceding period. 3. Informative disclosures in the financial statements are to be re- garded as reasonably adequate unless otherwise stated in the report. 4. The report shall either contain an expression of opinion regarding the financial statements, taken as a whole, or an assertion to the effect that an opinion cannot be expressed. When an overall opinion cannot be expressed, the reasons therefor should be stated. In all cases where an auditor's name is associated with financial statements, the report should contain a clear-cut indication of the character of the auditor's examination, if any, and the degree of responsibility he is taking.18 After conducting an audit conforming to GAAS, the CPA expresses his professional opinion about the accuracy of the examined financial statements in a written report that accompanies the financial state- 18 See 1 AICPA, supra note 17, AU § 150.02. The AICPA also frequently issues Statements on Auditing Standards, which are detailed interpretations of GAAS. A. ARENS & J. LOEBBECKE, supra note 16, at 40. CPAs must com- ply with these Statements in conducting an audit in order to conform to GAAS. 2 AICPA, supra note 17, ET § 202.01. "[rmhese AICPA pronouncements should be looked upon by prac- titioners as minimum standards of performance rather than as maximum standards or ideals. Any professional auditor who [relies] only on the standards ... fails to satisfy the spirit of the standards." A. ARENS & J. LOEBBECKE, supra note 16, at 40 (emphasis in original). 1985] ACCOUNTANTS' LIABILITY ments. The CPA's report usually takes the form of an "unqualified opinion," stating that the CPA performed his examination in accord- ance with GAAS and that the financial statements are fairly presented in conformity with "generally accepted accounting principles" (GAAP).19 If the auditor conducts an audit conforming to GAAS and believes that the overall financial statements are fairly presented in ac- cordance with GAAP, with some specific exceptions, he should issue a "qualified opinion." If the auditor conducts an audit conforming to GAAS and believes that the financial statements are not fairly presented in accordance with GAAP, he should issue an "adverse opinion." Fi- nally, if the auditor cannot satisfy himself whether the financial state- ments are or are not fairly presented in accordance with GAAP, he should issue a "disclaimer of opinion. '20 The auditor's report "normally forms the basis for any assertion of liability against [the CPA],"2I because the report usually contains repre- sentations that he has conducted the audit in accordance with GAAS and that the financial statements are presented in accordance with GAAP. An auditor meets the standard of a "reasonable CPA" when he performs audits in accordance with GAAS and presents financial state- ments in accordance with GAAP.22 When a CPA fails to act as a "rea- sonable CPA," he has acted negligently and courts may subject him to legal liability. Conversely, "courts generally hold that an accountant will not be liable if his work conforms to the applicable GAAP and GAAS and the financial statement is informative. '23 19 See A. ARENS & J. LOEBBECKE, supra note 16, at 41-43. "Generally accepted account- ing principles" are the rules, conventions, and procedures of financial reporting, as defined by the accounting profession's standard-setting body, currently the Financial Accounting Stan- dards Board. See id. at 45 for further discussion of GAAP. 20 See id. at 43-45. For a discussion of the rare situations warranting disclaimer by the CPA, see id. at 649-50. For an example of an unqualified opinion, see in/fa note 50. For a detailed discussion of the various types of auditors' reports, see A. ARENS &J. LOEBBECKE, supra note 16, at 643-63. For a thumbnail sketch of auditing procedures, see Fiflis, CurrentP roblems ofAccountants'Respon- sibilities to Third Parties,2 8 VAND. L. REv. 31, 35-42 (1975). 21 Wiener, supra note 14, at 237. 22 Bloch, Inc. v. Klein, 45 Misc. 2d 1054, 1057, 258 N.Y.S.2d 501, 506 (N.Y. Sup. Ct. 1965) ("certified public accountant ...must exercise the care and competence reasonably expected of persons in his profession"); Shahmoon v. General Dev. Corp., FED. SEC. L. REP. (CCH) 94308, at 95,039 (S.D.N.Y. 1973) (generally liability will not attach when audit conforms "with generally accepted accounting procedures as that term is understood by at least a majority of accounting experts"); see in/fa note 23. 23 Volz, Accountant's Liability to ThirdP ersons: Resistance in Negligence, 9 BARRISTER 31, 33 (Fall 1982). See generaly Adams, Lessening the Legal Liability of Auditors, 32 Bus. LAW. 1037, 1046-47 (1967) (fulfillment of professional standards generally suffices to show absence of neg- ligence although the trend may be toward requiring more than mere technical competence); Fiflis, supra note 20, at 62-87 (professional standards are an important factor, but compliance may be insufficient to insulate accountants from liability for negligence); Solomon, Ultramares Revisited. A Modem Study ofAccountants'Liability to the Public, 18 DE PAUL L. REv. 56, 58 (1968) (CPAs must act as a "reasonable CPA" would to avoid charges of negligence). Obviously, in CORNELL LAW REVIEW [Vol. 70:335 II HISTORICAL BACKGROUND OF CPA LIABILITY TO THIRD PARTIES A. The Doctrine of Ultramares v. Touche The landmark opinion regarding CPA liability to third parties is the New York Court of Appeals decision in Ultramares Corp. v. Touche, Niven & Co.24 In UItramares, the plaintiff, a factoring corporation, made loans to Fred Stern & Company (Stern) in reliance on25 Stern's balance sheet and the auditors' certificate26 accompanying it. Although Stern was actually insolvent, one of the balance sheets Ultramares relied on indicated Stem's net worth as over $1,000,000. This overstatement of net worth occurred because a Stern employee had recorded fraudulent sales and accounts receivable in the company's accounting records. Ul- tramares, realizing that its loans to Stern were now uncollectible, sued Stern's independent auditors, Touche, Niven & Co. (Touche), for fraud and negligence. Chief Judge Cardozo reversed the lower court's dismissal of the fraud claim and ordered a new trial on that claim. He denied the plain- tiff recovery on the negligence claim, however, even though he found that the auditors were negligent and that they knew creditors such as Ultramares would rely on the certified balance sheets. Ultramares could not sue Touche for negligence, Cardozo reasoned, because it was not in privity with the CPA firm.27 Cardozo noted that "[t]he assault upon the an audit, it is not reasonable to expect the CPA to examine and test every transaction a client company makes. This task would be insurmountable in most audit engagements due to the volume of companies' transactions each year. Therefore, the auditor must issue his audit report based on something less than a complete examination of every transaction. Due to this inherent limitation in the auditing process, "the auditor is not an insurer or a guarantor of the fairness of [financial statements] . . . ." A. ARENS & J. LOEBBECKE, supra note 16, at 18; see also Solomon, supra, at 89 ("It is clear that the CPA should not be made a guarantor of the absolute accuracy of the financial statements he certifies ....") (footnote omitted); Rosen- blum, 93 N.J. at 344, 461 A.2d at 148 (auditor's review is subject to constraints because he is neither required to investigate every supporting document nor deemed to have the training of a criminal investigator). 24 255 N.Y. 170, 174 N.E. 441 (1931) (Cardozo, CJ.) (unanimous decision). 25 Indeed, receipt of Stem's certified balance sheet was a condition precedent to the loans by Ultramares. Id. at 175, 174 N.E. at 443. 26 The auditors' certificate in Ultramaress tated that the balance sheet "presents a true and correct view of the financial condition" of Stern. Id. at 174, 174 N.E. at 442. Compare this language with the auditors' unqualified opinion in Rosenblum, infra note 50. 27 Cardozo wrote: Our holding does not emancipate accountants from the consequences of fraud. It does not relieve them if their audit has been so negligent as to justify a finding that they had no genuine belief in its adequacy, for this again is fraud. It does no more than say that, if less than this is proved, if there has been neither reckless misstatement nor insincere profession of an opinion, but only honest blunder, the ensuing liability for negligence is one that is bounded by the contract, and is to be enforced between the parties by whom the contract has been made. We doubt whether the average business man 1985] ACCOUNTANTS' LIABILITY citadel of privity is proceeding in these days apace"28 and stated: If liability for negligence [to third parties] exists, a thoughtless slip or blunder, the failure to detect a theft or forgery beneath the cover of deceptive entries, may expose accountants to a liability in an indeter- minate amount for an indeterminate time to an indeterminate class. The hazards of a business conducted on these terms are so extreme as to enkindle doubt whether a flaw may not exist in the implication of a duty that exposes [auditors] to these consequences.29 Courts30 and legal commentators3t have criticized the Ultramares receiving a certificate without paying for it, and receiving it merely as one among a multitude of possible investors, would look for anything more. Ultramares, 255 N.Y. at 189, 174 N.E. at 448. Compare Cardozo's conclusion regarding "honest blunders" in Ultramares with that reached by Dean Prosser. "An honest blunder ... may absolve [the defendant] from moral blame, but the harm to others is still as great, and the actor's individual standards must give way to those of the public." W. PROSSER, HANDBOOK OF THE LAw OF TORTS 146 (4th ed. 1971) (footnote omitted). One commentator believes that Ultramaresd id not limit a CPA's liability for negligence to those in privity. Rather, he postulates that the court in Ultramaresh eld that a CPA can be sued for negligence by the "primary beneficiaries" of the audit, but that these beneficiaries are usually those in privity with the CPA. Regardless of the correct interpretation, the com- mentator notes that Ultramaresi s frequently cited by courts as limiting CPA liability to those with whom he is in privity. Fiflis, supra note 20, at 105. It is intriguing to compare Cardozo's language in Ultramaresw ith his language in the earlier landmark decision, MacPherson v. Buick Motor Co., 217 N.Y. 382, 111 N.E. 1050 (1916). In MacPherson, Cardozo allowed the purchaser of a defective automobile to recover from the manufacturer despite the lack of privity, reasoning that: The contractor who builds the scaffold invites the owner's workmen to use it. The manufacturer who sells the automobile to the retail dealer invites the dealer's customers to use it. The invitation is addressed in the one case to determinate persons and in the other to an indeterminate class, but in each case it is equally plain, and in each its consequences must be the same. There is nothing anomalous in a rule which .imposes upon A., who has contracted with B., a duty to C. and D. and others according as he knows or does not know that the subject-matter of the contract isi ntendedf or their use. Id. at 393, 111 N.E. at 1054 (emphasis added). In explaining the contradiction between Ultramares and MacPherson, one commentator hypothesizes that Cardozo believed that the plaintiffs in Ultramares would surely succeed against the auditors on the fraud claim, so he found it unnecessary to fashion a rule that would permit them recovery on the alternative theory of negligence. Solomon, supra note 23, at 72. Cardozo himself suggested an obvious, if illogical, distinction between the two ap- proaches. He believed that financial loss incurred through reliance on negligently published words need not give rise to the same liability as an act or omission setting in motion a physical force causing personal injury. Ultramares, 255 N.Y. at 181, 174 N.E. at 445. 28 Ultramares, 255 N.Y. at 180, 174 N.E. at 445. 29 Id at 179-80, 174 N.E. at 444. 30 See, e.g., Rusch Factors, Inc. v. Levin, 284 F. Supp. 85, 90-91 (D.R.I. 1968) (Ultramares decision is an "unwarranted inroad" upon established use of foreseeability as defining the scope of one's duty to others); Aluma Kraft Mfg. Co. v. Elmer Fox & Co., 493 S.W.2d 378, 383 (Mo. Ct. App. 1973) ("[R]ejection of the requirement of the strict rule of privity in this case comports with the concepts of the functions and duties of the modern public accountant 31 See, e.g., Besser, Prioity?-An Obsolete Approach to the Liability of Accountants to Third Par- ties, 7 SE;TON HALL L. REV. 507, 541-42 (1976) (accountants' duty should expand to corre- CORNELL LAW REVIEW [Vol. 70:335 doctrine for unreasonably insulating negligent CPAs from liability to injured third parties. Ultramares remains the law in a minority of juris- dictions today,32 however, because some courts still fear that any other standard would lead to almost unlimited liability for CPAs.33 B. The Erosion of the Doctrine of Ultramares v. Touche A majority of courts soon became dissatisfied with the restrictive Ultramares doctrine and abandoned it. These courts replaced the U- tramares doctrine with the rule of the Restatement (Second) of Torts.34 The Restatement provides that negligent CPAs are liable to individually known or intended third party users of financial statements, and to third parties who are not individually known or intended but are members of a known or intended class of users of financial statements.3 5 For there to be a "known or intended" third party or class of third parties, however, the CPA must be explicitly informed36 that the third party or class of spond to their expanded functions); Fiflis, supra note 20, at 107 (Ultramareso bsolete because of current public service status of accountants); Solomon, supra note 23, at 73 (arguing that Cardozo was imprecise when he asserted that services rendered by public accountants are primarily for benefit of client and that they are "public" only in sense that they offer their services to anyone who chooses to employ them); Wiener, supra note 14, at 249-53 (privity requirement does not account for important function CPAs fulfill in economy); Note, Account- ants' Liability for Negligence-A Contemporay Approach for a Modern Profession, 48 FORDHAM L. REv. 401 (1979) [hereinafter cited as Accountants' Liability] (privity shield is no longer appro- priate because audits are more sophisticated and policy goals of products liability laws are similar to those for accountants' liability laws); Note, PublicA ccountants andA ttorneys: Negligence and the Third Party, 47 NOTRE DAME LAW. 588, 604-07 (1972) (discussing policy reasons for extension of liability). 32 See supra note 9 and accompanying text for a sampling of these jurisdictions. 33 Stephens Indus. v. Haskins & Sells, 438 F.2d 357 (10th Cir. 1971) (applying Colorado law) (accountants not liable for negligence to third party absent privity); Investment Corp. of Fla. v. Buchman, 208 So. 2d 291 (Fla. App.), cert. dismssed, 216 So. 2d 748 (Fla. 1968); see supra note 9 (citing other cases). "When the harm. . .caused [by negligent auditing] is only pecu- niary loss, the courts have found it necessary to adopt a more restricted rule of liability [i.e., the Ultramares rule], because of the extent to which misinformation may be . . .circulated, and the magnitude of the losses which may follow from reliance upon it." RESTATEMENT (SECOND) OF TORTS § 552 comment a (1977). 34 See supra note 11 and accompanying text for a sampling of these jurisdictions. 35 The relevant Restatement (Second) position reads in part as follows: Information Negligently Supplied for the Guidance of Others (1) One who, in the course of his. . . profession . . . supplies false informa- tion for the guidance of others in their business transactions, is subject to lia- bility for pecuniary loss caused to them by their justifiable reliance upon the information, if he fails to exercise reasonable care of competence in obtaining or communicating the information. (2) [T~he liability stated in Subsection (1) is limited to loss suffered (a) by the person or one of a limited group of persons for whose benefit and guidance he intends to supply the information or knows that the recipient intends to supply it . ... RESTATEMENT (SECOND) OF TORTS § 552 (1977). 36 Neither the Restatement (Second) nor the courts have addressed the issue of whether only the client can inform the CPA of the existence of a contemplated third party user of the financial statements, or whether it is sufficient that the third party alone inform the CPA that 1985] A CCO UNTANTS' LIABILITY third parties will use the client's audited financial statements. For ex- ample, where a CPA's client expressly informs the auditor, before the audit is completed, that he will be using the statements to negotiate a bank loan, the CPA is liable to a bank that detrimentally relies on negli- gently audited financial statements in extending credit to the CPA's cli- ent, because the bank is a member of a "known or intended" class of third parties.37 The Restatement (Second) requires that the client specifi- cally inform the auditor of third parties that intend to use the financial statements even if the auditor "knows that the financial statements... are customarily used in a wide variety of financial transactions by the cor- poration and that they may be relied upon by lenders, investors, shareholders, creditors, [and] purchasers . . . in numerous possible kinds of 38 transactions. Therefore, despite the role of the auditor in ensuring the availabil- ity of reliable information in today's economy,39 and despite the typical uses made of audited financial statements,40 almost all third party users of financial statements are precluded from suing negligent CPAs at com- mon law. In most cases, stockholders, creditors, and other third parties are merely "reasonably foreseeable" third parties, not "known or in- tended" ones,41 and they, therefore, remain unprotected by the Restate- ment (Second) or by Ultramares. This was the status of the law of accountants' liability for negli- gence to third parties in 1983, when the New Jersey Supreme Court was confronted with the case of Rosenblum, Inc. v. Adler. it will be receiving the financial statements from the client. Although the Restatement (Second) does not explicitly address this issue, the illustrations set forth in the comment to § 552 all have the client informing the CPA. 37 See RESTATEMENT (SECOND) OF TORTS § 552 illustration 7 (1977). 38 See id. § 552 illustration 10 (emphasis added). 39 See supra note 16 and accompanying text. 40 "It is now well recognized that the audited statements are made for the use of third parties who have no contractual relationship with the auditor. Moreover, it is common knowledge that companies use audits for many proper business purposes [involving third par- ties]." Rosenblum, 93 NJ. at 345, 461 A.2d at 149. See also Ernst & Ernst v. Hochfelder, 425 U.S. 185, 218 (1976) (dissenting opinion) ("The critical importance of the auditing account- ant's role . . . cannot be overestimated . . . . [T]he accountant's duty 'is to safeguard the public interest, not that of his client.' ") (quoting In re Touche, Niven, Bailey & Smart, 37 S.E.C. 629, 670-71 (1957)); Solomon, supra note 23, at 74 ("[T]o say that the primary utility derived from the independent accountant's report and statements rests with third parties, such as suppliers, credit lenders, potential and present investors, and financial analysts is cer- tainly no great overstatement."). For an argument that even under Ultramares it is possible that CPAs are liable to third parties for negligence, if third parties are the "primary benefi- ciaries" of an auditor's examination, see Fiflis, supra note 20, at 105. 41 For example, as one court pointed out, the plaintiff factoring corporation in Ut- Iramares was a third party that was "not actually foreseen but only foreseeable." Rusch Fac- tors, Inc. v. Levin, 284 F. Supp. 85, 91 (D.R.I. 1968).