Accountancy and Management: When being the auditor can be a liability: Roger Trapp reports on fears that expensive negligence lawsuits could cross the Atlantic

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The Independent Online
IT HAS long been said that what happens in the United States will reach Britain five years later. Usually, the dictum is summoned in a threatening manner to refer to race riots, drug plagues and the like. But for some time now, those in the professions have been talking with the same foreboding about liability in law suits.

Doctors and accountants have generally been most concerned. However, anybody who could potentially be sued for negligence in the way he or she carried out his or her business has been casting nervous glances across the Atlantic.

Visions have been conjured of a land of aggressive 'ambulance-chasing' lawyers acting on a contingency, no-win, no-fee basis, where class actions are the order of the day and juries hand out telephone-number damages awards.

Although there are instances of exaggeration, this portrait has more than a little basis in fact. Until recently, the medical profession has borne the brunt of the practice, but accountancy firms are feeling increasingly at risk.

According to a position paper put out by the big six firms last month, their expenditure on settling and defending lawsuits in the US rose 18 per cent in 1991, to dollars 477m ( pounds 235m), which accounted for 9 per cent of their auditing and accounting revenues in the country.

While other factors were involved, the liability burden was the overriding reason behind the collapse in 1990 of Laventhol & Horwath, the seventh-largest firm. These costs, combined with some large judgments and settlements, have fuelled speculation about the survival of even the largest firms, the paper continues.

Now the firms have banded together to get something done. Their campaign calls for a fundamental reform of the 'out of control' tort liability system in America.

But more serious as the situation undoubtedly is there, the problem is not confined to the United States. For years, British accountants - and other professionals - have been voicing their concerns. However, apart from sympathetic noises from high places, little appears to have been done. It is as an attempt to return the subject to the public arena that Brandon Gough, senior partner of the country's biggest firm, Coopers & Lybrand, has - in a speech to this year's conference of the Institute of Chartered Accountants and in an article in the Independent - made a link between liability and widening the scope of the company audit as envisaged by the Cadbury report.

While accepting that there are opportunities available to accountants ready to satisfy the public interest by expanding the remit of the audit, he maintains that this entails moving into areas where judgment can be easily challenged. 'And you can't do it if it's going to jack up the risk because there's not much room for that.'

The answer, he says, in common with the Americans, is to attack the concept of joint and several liability, which makes each defendant fully liable for all the damages in a case, regardless of the degree of fault. In practice, this means a company's auditors are generally brought into a case in which fraud is alleged because - in the words of Roy Chapman, UK managing partner of Arthur Andersen, 'it is perceived that they are insured and have deep pockets'.

This perception also gives rise to what Mr Gough terms 'a kind of greenmail' whereby firms are induced to make settlements to avoid the punitive cost of taking claims to court.

Although they, along with senior partners at the other leading firms, draw distinctions between the British system and what one described as the 'vicious' situation in the United States, they are encouraged by the moves made by their counterparts across the water.

The absence, for now, of contingency fees, combined with the principle of the loser paying the winner's costs, does make greenmail-type tactics less attractive in Britain. In addition, the Caparo judgment limits the number of people who can sue an auditor. But a trend towards litigation has already produced some big payouts, notably by Peat Marwick over Ferranti, and is putting pressure on insurance cover.

A decade ago liability insurance was taken out on the basis that the risk of needing it was remote and the premium was correspondingly low, Mr Gough said. 'Now it is very difficult to obtain in large amounts and very expensive.'

It is reckoned that a firm's cover only extends to about pounds 50m - which was a lot of money 10 years ago, but today pales in comparison with the value of modern takeover bids. Anything above this figure, a firm has to find itself.

Top of the US recommendations for reform is the replacement of joint and several liability with proportionate liability, whereby the court bases the award of damages against a particular defendant on his degree of fault. But since this is complex to administer there is also support for such notions as using a multiple of fees or a fixed sum to limit the amount of damages.

But with the Bank of Credit and Commerce International and Maxwell affairs threatening to unleash a torrent of lawsuits, anything that reduces the likelihood and cost of legal action is sure to be welcomed. And for once auditors are looking to America in hope rather than in fear.

Meanwhile, many in the large firms are likely to share the sentiments of Mr Chapman. 'The prospect of losing your life savings for a case with which you have nothing to do - which for the most part is the case - is too high a price to pay.'

(Photograph omitted)