Are accountants accountable?
Governments continue to indulge auditors with liability concessions that undermine consumer rights and incentives for responsible behaviour., Prem Sikka
guardian.co.uk, Wednesday 31 October 2007 08.00 GMT ,
Imagine visiting a dentist for some surgery. The dentist charges £200, but botches the surgery and inflicts life long discomfort, pain and further expense. Just when you are getting ready to sue the dentist for negligence you learn that the dentist's liability is 'capped' and that your maximum compensation cannot exceed £2,000, or say 10 times the fee paid.
Such a 'cap' on liability does not yet exist in the UK, but it could be introduced to indulge accountants acting as company auditors. The liability concessions given to auditors cannot easily be denied to doctors, surgeons, dentists, engineers, butchers, supermarkets and producers of food, drink, medicine, automobiles, cigarettes, or anything else. This will be the beginning of the end of the consumer protection principle: that the wrongdoer should suffer the consequences of his/her negligence.
The demand for a liability 'cap' is being pushed by PricewaterhouseCoopers, KPMG, Deloitte & Touche and Ernst & Young. These accountancy firms audit 97 per cent of the FTSE 350 companies, as well as major companies in other countries. Their combined income of US$80bn is exceeded by the gross domestic product (GDP) of only 54 nations. They claim that their survival is under threat, even though lawsuits against negligent auditors are rare. Their annual audited accounts do not provide any meaningful information about their liability costs, insurance cover, legal or out-of-court settlements.
Big firms are using their lobbying muscle to secure even more liability concessions because this would help to increase profits. The European Commissioner for the Internal Market and Services, Charlie Mcreevy, a chartered accountant, has been enrolled to advance their interests even though auditors are already well shielded from negligence lawsuits. They do not owe a duty of care (pdf) to any individual shareholder, creditor, employee or any other stakeholder affected by their negligence. They can already trade as limited liability partnerships and limited liability companies.
The Companies Act 2006 gave accountants "proportional liability", under which auditors can only be held liable for losses arising from their own negligence. Contrary to the auditing industry's propaganda, auditors are not held liable for the negligence of others. For example, following the Nick Leeson frauds and the collapse of Barings Bank, liquidator KPMG sued auditors, Deloitte & Touche, for £791 million. The court decided that even though Deloitte were negligent the loss suffered by the bank was mainly attributable to its management's failures to institute proper internal checks and controls. Deloitte were held liable for only £1.5 million.
The above also shows that big accounting firms are usually busy suing each other. In their capacity as company liquidators they allege that the auditors of the failed company were negligent and then sue them. This mutual suing is lucrative because liquidators are remunerated on the basis of time spent and/or cash recovered. So the longer they take to complete the liquidation the higher the fees they stand to collect. Ordinary shareholders rarely get anything substantial out of these lawsuits. Most of the auditor liability claims are met through insurance cover, and any excess is met by the firms. Concerned by auditor shortcomings and possibilities of large lawsuits, insurance companies have raised their premiums and in some cases are unwilling to provide full cover. Rather than improving the quality of audit work to reduce risks, the auditing industry demands and continues to receive liability concessions to improve its profits.
In other walks of life, the threat of lawsuits and damages encourages producers to improve the quality of their goods and services. In contrast, auditors receive liability concessions to shield them from the consequences of their own negligence. There is no theory or evidence to show that reduced liability somehow encourages producers to improve the quality of their products and/or services. With reduced liability, auditors will have even less economic incentives to be vigilant and improve the quality of company audits. More audit failures are sure to follow.
Commenting on audit failures at Enron, WorldCom, Global Crossing, Qwest and other scandals in his book The Roaring Nineties, Joseph Stiglitz, one time World Bank and President Clinton administration adviser, noted, "there are plenty of carrots encouraging accounting firms to look the other way ... there had been one big stick discouraging them. If things went awry, they could be sued ... In 1995, Congress adopted legislation intended to limit securities litigation ... in doing so, they provided substantial [liability] protection for the auditors. But we may have gone too far: insulated from suits, the accountants are now willing to take more 'gambles'."
Politicians in the UK, US and EU are now all set to go further and place an artificial 'cap' on auditor liability and lay the foundations for destroying consumer rights in almost every field. Those who cannot learn from history are doomed to repeat it.
November 20, 2003