Gordon & Groton, CPAs, were the auditors of Bank & Company, a brokerage firm and member of a national stock exchange. Gordon & Groton audited and reported on the financial statements of Bank, which were filed with the Securities and Exchange Commission. Several of Bank’s customers were swindled by a fraudulent scheme perpetrated by Bank’s president, who owned 90 percent of the voting stock of the company. The swindled customers were invited to invest in a special investment syndicate. The syndicate did not exist; Bank’s president stole the funds and provided fictitious investment statements to the investors. Bank’s president committed the fraud by directing that all correspondence from customers be received directly by him. Gordon & Groton were unaware of this policy regarding customer correspondence, and did not participate in the fraudulent scheme or know of its existence. The customers are suing Gordon & Groton, under the antifraud provisions of Section 10b and Rule 10b-5 of the Securities Exchange Act of 1934, for aiding and abetting the fraudulent scheme of the president. The customers’ suit for fraud is predicated exclusively on the nonfeasance of the auditors in failing to conduct a proper audit, thereby failing to discover the fraudulent scheme.
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Answer the following questions, including your reasoning in reaching your conclusion:
a. Do you believe the auditors were negligent in conducting the audit?
b. What is the probable outcome of the lawsuit?