The Potential Impact of Knowledge of Market Efficiency on the Legal Liability of Auditors.

Abstract ABSTRACT: Recent research in capital market behavior has received wide exposure in the accounting literature. However, except for a passing comment by Beaver 1973, the potential importance of market efficiency in the realm of auditors' legal liability has been largely overlooked. One of the more important aspects of the professional auditor's environment is the legal system. Law, like auditing, is a malleable discipline that adapts to changing conditions. Thus, when an aspect of the environment that potentially affects both disciplines undergoes significant change, this change should be a matter of considerable interest. The impact of knowledge of market efficiency on the legal responsibility of auditors rests ultimately on the choices made by the courts. To the extent the courts are influenced by the arguments presented and by the re-examination of previous argument in light of new information, the role of market efficiency in subsequent litigation could be considerable. In a monopolistically efficient setting, the role would tend to cloud the significance of the distinction between negligence and fraud and would eliminate the need for a criterion of justifiable reliance. In both a competitive and monopolistic setting, it would narrow the class of shareholders that would be presumed to suffer damages. These are significant changes, indeed, and their effects could be far-reaching.