Most of us feel that auditors should indeed be worried now. After all, none seem to have been raising any alarms over the extent of bad loans accumulated by major financial institutions, or over risks that banks exposed themselves to through entering into derivatives contracts they claimed they understood but did not. And now many hold auditors at least partially responsible for the ensuing debacle.

For some audit firms, the time of reckoning seems to be approaching fast. However the degree of their concern over legal action will depend on where the firms are operating, and global or US-based firms are at greatest risk of coming under close scrutiny in the courts of law.

Ernst&Young in court: Over in the US, one of the biggest accountancy firms Ernst&Young is being sued over the collapse of Lehman Brothers. If it goes badly for the accountants, this case could spell disaster for E&Y, a global firm, in a way similar to what happened to Arthur Andersen over the Enron fraud.

For those involved in this matter, one of the key questions is whether E&Y knew how bad Lehman’s affairs really were in the run-up of the latter filing for bankruptcy on 15th Sept 2008. Worse still is a fleck of suspicion – which needs to be proven in court – that E&Y might have used some creative accounting techniques to cover up the bad state of affairs in the last sets of accounts. For more info check click here.

US legal framework: Professional advisory firms operating in the US have much to fear in the aftermath of the global financial meltdown. Existing securities laws make auditors vulnerable to class actions by shareholders. It appears that the legal position in the US is that auditors can owe a duty of care to investors if they are aware of going concern problems their client is experiencing (i.e. that the client is struggling to keep afloat and is beyond rescue). Apparently, the last set of Lehmans accounts audited by E&Y is conspicuously missing the standard “going concern” commentary. Whether or not it is a careless omission, a black-and-white reference to serious problems, or a Freudian slip remains to be seen.

In addition, over in the US lawsuits will also be spurred on by the Securities and Exchange Commission which is currently extremely keen to be seen to be doing something proactive, if only to detract attention away from itself following its own failure to act to prevent the meltdown.   

UK legal framework: Across the pond in the UK, however, the legal position is that auditors do not owe the duty of care over accurate accounts preparation to individual shareholders, as their contract is with company. This means that lawsuits are notoriously more difficult to bring to court unless by the company or its liquidator. In comparison, the ultra-competivite US prosecuting system is not hindered by this legal limitation. Of course, on top of this, there is also much less of a litigation culture in the UK at present, although it is getting more prevalent.

In terms of regulators, UK’s FSA is a much tamer regulatory body compared to the SEC and these days, FSA seems to be quite quiet. Maybe its staff have all locked themselves away busy formulating a policy response to the current crisis…!

Impact to auditors: Taken the above into consideration, large global audit firms whose clients include “A-list” investiment banks that are currently in trouble have much to worry about from US litigators at present. It is possible more of them will be called to account in US courts. However smaller UK-based audit outfits are on safer ground with no american investments banks on its client list, and no hungry US prosecutors likely to go after them. And whilst I am not saying they have necessarily been slack in any of their recent audits, I am sure that knowledge of this fact is quite a relief to many UK firms. 

And, on a more general note, the bigger question is, will the audit profession get a wake-up call over these events and think long and hard about its recent role in the financial meltdown, and act upon it to bring about positive change to repair its credibility? As the latter has taken a serious knock in 2008 for auditors based on both sides of the Atlantic which I am sure the profession will want to address.

 

Copyright 2009 by CuriouslyInspired

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