Accountancy & Management: Auditors hit back on liability: More responsibility for detecting fraud will mean higher fees, says Roger Trapp

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The Independent Online
THOSE with a casual interest in City affairs as well as the more dedicated users of company accounts will have given a nod of approval to the publication this month of the first Statement of Auditing Standards from the Auditing Practices Board.

Not before time, from later this year, auditors will have to provide far more information than before.

For instance, there will have to be an explanation of auditors' and directors' responsibilities, a list of matters to which the auditors wish to draw shareholders' attention and details of any uncertainties that the auditors deem to be 'fundamental'.

The new rules have been described by Nigel Macdonald, president of the Scottish Institute of Chartered Accountants and chairman of the APB working party responsible for the standard, as 'the most fundamental change in financial reporting for a generation'.

It is the least you would expect of a body that caused such a stir with the McFarlane report on the future development of auditing and that has in Bill Morrison a chairman who brings the same rigorous approach to the issue as his counterpart at the Accounting Standards Board, David Tweedie.

But theirs is not the only show in town. While the APB was sounding the death-knell of the familiar 'subject to' prefix that has enabled auditors to sign off accounts over the years without resolving all uncertain matters, Ernst & Young, a big six firm, was warning that any attempt to make external auditors responsible for detecting fraud would lead to huge increases in audit fees.

Pointing to a survey by the firm showing that more than half of UK companies have reported frauds of more than pounds 50,000 in the past two years, David Lindsell, a partner, said: 'Although auditors could extend their tests specifically to detect fraud, I do not think management has any conception of how time-consuming and expensive it would be if auditors had to conduct all audits on the basis that all fraud, if it exists, should be detected.'

This comes on top of widespread reluctance to follow up the recommendations in the report of Sir Adrian Cadbury's Committee on the Financial Aspects of Corporate Governance about such issues as commenting on a company's management. Behind it all, of course, is the small matter of liability. This has been a cause of much grief for the larger accountancy firms in particular for some time. But talk of extending their role in response to the spectacular company failures of recent years has hardened their resolve to get something done about the seemingly instinctive urge to sue auditors for huge sums when things do not work out.

Last year, a campaign started in the United States, where the situation is naturally worse, and soon gathered enough momentum to cross the Atlantic.

Figures on the size of the problem are not readily available in Britain, but some idea may be gained from the position paper put out by the leading firms in the United States.

In 1991, it said, their expenditure on settling and defending lawsuits rose 18 per cent, to dollars 477m ( pounds 235m) - or nearly a tenth of their auditing and accounting revenues in the country.

Not surprisingly perhaps, there is - as Roy Chapman, UK managing partner of Arthur Andersen, accepts - a realisation that reform of the liability situation is the quid pro quo for the auditing profession playing ball with any attempt to change its ways.

And, in a neat symmetry, the campaigners have started to step up the pressure for reform just as the Caparo case, which helped to define the audit expectations gap in this country, returned to the headlines.

Mr Chapman, who is an unofficial spokesman for the group comprising the big six, plus BDO Binder Hamlyn and Grant Thornton, dismisses the re-emergence of the Caparo case as a further 'red herring'.

But the fact remains that - whether or not Swraj Paul gets another day in court - the case was instrumental in turning many people against auditors and in turn putting them on the defensive.

In the original case, the House of Lords ruled that Touche Ross had no case to answer when Mr Paul sued it, alleging negligent auditing of the books of Fidelity, an electronics company his own Caparo group acquired in 1984.

The reason was that since Mr Paul was not a client of Touche the firm did not owe him a duty of care. Now, Mr Paul hopes to avoid this obstacle by making Fidelity - now called Intersound Consumer Electronics - the plaintiff.

The firm's approach to defending this second assault is likely to be complicated by the fact that, although the judgment was initially welcomed in the accountancy profession, it is now widely seen as providing too much protection.

Indeed, this perceived injustice could spur those who are entitled to sue. And, as Mr Chapman will attest, there are plenty of them. The leading firms are unusually banding together because they all know what it is like to have a large writ hanging over their heads.

'Most of it is 'deep-pocket litigation', where they are suing the insured party,' Mr Chapman said. However, because the number of claims has escalated in recent years, insurance cover is not available for these sorts of awards; the money must be found by the firms themselves.

The auditors are particularly incensed by the notion of joint and several liability under which they can be held liable for the whole award even thought they may be, say, only 10 per cent responsible.

Having held meetings with the Institute of Chartered Accountants to gain support, the group is seeking an audience with the Department of Trade and Industry. It hopes to persuade ministers and officials that they have 'an opportunity' to act decisively.

In particular, the campaign group wants a statutory cap on liability to stop its members being forced to face 'disproportionate' awards. It says this could be done through an amendment to the 1985 Companies Act to allow auditors to limit their liability by means of a contract with the client in the same way as other professional advisers are able to do.

While giving up partnership in favour of incorporation would protect individuals within the firms from financial ruin, it would not deal with the disproportionate part of the problem, Mr Chapman said.

Whether students will be deterred from becoming auditors if, as seems likely, this reform is not quickly forthcoming is difficult to predict. But Mr Chapman is surely right when he says that the whole profession is under threat.

Because, with increasing numbers of people spotting the green shoots of recovery, it is becoming increasingly urgent that some means, no matter how imperfect, be devised of putting a brake on the follies of the past. Not resolving the liability issue is the sure way to make sure that history repeats itself.

(Photographs omitted)

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