Accountants given some measure of leeway in auditing.

Accountants may be a little more comfortable doing audits during 1993, due to a state Supreme Court decision last year clarifying an auditor's liability in third-party lawsuits, experts said.

Before Bily, all foreseeable users of audit reports, including shareholders, banks and other types creditors, could sue accountants for varying types of negligence, such as an error in a financial statement, or outright fraud.

The court ruled last August in a case entitled Bily vs. Arthur Young, now Ernst & Young, that an auditor is a "watch dog, not a bloodhound," in effect limiting an accountant's exposure to third party litigation. The court found that an auditor "owes no general duty of care regarding the conduct of an audit to persons other than the client."

The case is expected to have its strongest impact statewide in Los Angeles, due to the sheer size of the county and the large number of accountants and companies based here, accountants said.

While the decision did not offer blanket immunity to accountants, it may curb unreasonable lawsuits by third parties not directly involved with the auditor's client, lawyers said.

"Before this decision, you could get sued by people who weren't in anyone's mind, people who were not even on the horizon," at the time of the audit, said Gene Erbstoesser, assistant general counsel with Ernst & Young in Los Angeles.

"Certainly the profession as a whole was gratified and pleased," by the decision, said Erbstoesser. "The fact that the state's highest court adopted a reasonable rule of liability to non-client third parties makes accountants more comfortable about doing their job."

The Bily decision is the culmination of years of litigation arising from the demise of Osborne Computer Corp., which failed in the early 1980s.

The plaintiffs -- venture capitalists who had invested in a private offering by the company and others who had privately purchased company shares from other shareholders -- sued Arthur Young, claiming that errors in 1982 audited financial statements constituted fraud and negligence. The state Court of Appeal found the accounting firm liable for professional negligence and awarded damages of $4.3 million. However the state high court reversed that ruling, limiting the scope of accountants' liability to third parties.

"Bily represents a quantum leap forward in allowing us to serve the client," said Janice Vincent, president of the California Society of Certified Public Accountants, who spoke at a conference on Bily and liability issues in Los Angeles last week.

She said in a telephone interview that many accountants are concerned over rumors that the state Legislature is expected to attempt to introduce legislation in 1993 designed to overturn the Bily decision.

While the decision may make accountants more comfortable, at least one local accountant said it will not significantly alter the way they do business.

"It does not change the standard of performance for accountants," said A.B. Poladian, managing partner of Southern California with Arthur Andersen & Co., in Los Angeles. "It will not change the way we do our work one iota."

However, Poladian said the ruling was viewed favorably by accountants because California was one of only four states in the United States not to have some type of law or ruling similar to Bily on the books.

"The accounting community in California was pleased, largely because we're finally getting into synch with the rest of the country," said Poladian. "It's viewed as something that's just fair."

Miles N. Ruthberg, a litigation partner in the Los Angeles office of Heller, Ehrman, White & McAuliffe, who represented Arthur Young in the case, said Bily "is an important step in limiting what has been an overwhelming trend for holding accountants liable for business failure."

He said the ruling will particularly affect small accounting firms and could save them "millions of dollars," in liability and defense costs.

Ruthberg said accountants have been a popular deep-pocket defendant, but because of the Bily case, they are now "less subject to suits by third parties. It accordingly makes them less reluctant to perform audits."