Limited liability may be answer for audit firms

Press, 7 August 1985, Page 33

Limited liability may be answer for audit firms

By

ADRIAN HAMILTON

To abandon partnership and incorporate firms in limited liability companies; to put a legal “cap” or ceiling on the amount of damages that can be claimed against an auditor, as in Germany; or to redefine the role and duties of the auditor? These are the three main avenues being explored by the accountancy bodies as they search for some solution to the explosion of litigation that threatens to engulf them. According to a recent survey by the “International Accounting Bulletin” earlier this year, the “Big Eight” firms have paid out a total of nearly SUSIBOM (SNZ3SOM) in audit-related settlements in the United States alone over the last five years. These are the payments actually made. In terms of the total amount agreed, but yet to be paid or cases still to be settled in court, the figure being set aside as potential risk by the insurance underwriters is more than double that. The sums are large enough to frighten even the •largest firms — and Arthur Andersen has a worldwide fee income of more than £ 1 billion ($NZ2.66 billion) a year — constrained as they now are in the amount of total cover they can obtain. It could prove catastrophic to small and medium-sized companies. Accountants are not alone in this legal travail, of course. All the professions are now being swept by the litigious wind that comes, as an Institute of Certified Accountants officer puts it, “like the weather from America.” Dentists, surveyors, architects, doctors and lawyers have all become the object of larger and larger law suits. And many of these professionals, insurers point out acidly, pay as much at 20 to 30 per cent of their fee income in insurance — well above the 3 to 5 per cent being demanded of accountants. “I can’t say I have that much sympathy for them,” says Robin Jenkins, one of the leading indemnity underwriters at Lloyds. “They’re squealing because they’re having to pay more than they’re used to. Fine. So let them pay. They can afford it. “How can it be fair,” asks Graham Stacey, of Price Waterhouse, “for an accountant who has carried out a £ 5000 audit to be liable for £ 50M? “There must be a socially justified case for limiting the amount of damages that can be claimed to a multiple of the fees paid, as in Germany, or a total limit of, say, £2SM ($NZ66.5M).” Others in the profession are doubtful whether it would be advisable for accountants to be singled out for favoured treatment in this way or whether it is practicable, given the problems of legislation. For them, the most practical route to alleviating their pain is to end the partnership basis on which professional firms have been based for centuries and turn themselves into limited liability companies. “Not only would it prevent the partners being left

without a roof over their heir head,” suggests Brandon Gough, managing partner of Coopers, Lybrand, “but it has other advantages as well. “As accountants become more and more multi-dis-ciplinary, with bankers and others being brought in, the legal structure is starting to get out of line with the business structure.” Not all like the idea, particularly the more traditional in the industry who fear the loss of individual responsibility that comes with partnerships and doubt the greater financial protection. They also worry precisely about the diversification of the firms that are most enthusiastic about incorporation and the capitalisation that comes with it. If accountants are so keen to sell “bolt-on” advisory services for everything from tax to raising new finance, they are hardly likely to upset their clients with a ruthless audit. “All this talk of independence is exaggerated,” retorts Graham Stacey. “It is the broader knowledge of a company’s affairs that gives an accountant his real value. “It’s a trade-off like everything else. Do you want a high grade auditor who may not appear completely independent, or do you want total independence which may lack competence?” Yet many of the wisest heads in the industry believe that the problem of responsibility thrown up by litigation is a real one. “Perhaps,” says Dob Hanson, managing ’ partner of Arthur Andersen, “we have let the audit become too much of a commodity rather than the core of our business. “The claims could, if they do nothing else, create a major shift in emphasis back towards making the audit a much more specialised and important part of our work.” “One thing we should do as a profession,” suggests Brandon Gough, “is listen

more to what the user needs from an auditor, not just the shareholder but the banks, the creditors and employees. “What they seem to be asking for is greater assurance not just that the accounts are right as accounts, but that the audit is flagging problems of administration and of management as they develop.” This, indeed, may be the most important fall-out of today’s troubles. In the shortrun, there is not much that can be done except to wait for the insurance market to find a balance. On the specific issue of fraud, the Scottish Certified Accountants have already advised some specific changes in responsibility for reporting fraud and the English accountants are due to publish their conclusions shortly. These should be incorporated in the Financial Services Bill to be introduced in November. The question of incorporation, which the Institute of Certified Accountants is now pursuing with a sympathetic Department of Trade, will have to be decided by the time the E.E.C. directive on auditing has to come into force in 1988. But it is unlikely to find an early passage into law. The role of audits is, in the meantime, to be considered by a new committee of the Institute under the chairmanship of Mathew Patient of Delloite Haskins and Sells. It is an issue on which the profession holds widely differing views. A number of practioners would not mind the JMB case or another like it coming to court just so that the judiciary could define a code of conduct for them. “A lot of my colleagues, are nervous about widening their role precisely because it will widen their financial responsibility,” says Brandon Gough. “But that is what the plaintiffs are asking for in the courts and the courts, in their approach, are the reasonable' man.” — Copyright, OFNS.