Reference no: EM133092626

Question - Astor Electronics, Inc., markets a wide variety of computer-related products throughout the United States. Astor's officers decided to raise $1 million by selling shares of Astor's common stock in an exempt offering under Regulation D of the Securities Act of 1933. In connection with the offering, Astor engaged Apple & Company, CPAs, to audit Astor's financial statements. The audited financial statements, including Apple's unqualified opinion, were included in the offering memorandum given to prospective purchases of Astor's stock. Apple 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 technology obsolescence. Apple accepted the assurances of Astor's controller that cost was appropriate valuation, despite the fact that apple was aware of ongoing sales of the products at prices substantially less than cost. All of this was thoroughly documented in Apple'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 he 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 Apple, alleging that Apple is liable to Musk based on the following causes of action:

-Common-law fraud.

-Negligence.

-A violation of Section 10(b) and Rule 10b-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. Apple has also asserted that the actions should be dismissed because of the absence of any contractual relationship between Apple and Musk, that is, a lack of privity.

Required - Answer the following, setting forth your reasons for any conclusions stated.

a. What elements must be established by Musk to support a cause of action based on negligence?

b. What elements must be established by Musk to support a cause of action based on a Rule 10b-5 violation?

c. Is Apple's assertion regarding lack of privity correct with regard to Musk's causes of action for negligence and fraud?