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The ugly face of auditor liability.

The issue of auditor liability will not go away. In one of the more publicized cases of recent months, an Arizona jury ordered Price Waterhouse to pay $338 million to a British bank that blamed a bad investment decision on a misleading audit. The amount awarded was three times the loss claimed by the plaintiff and 1,000 times the fees for the audit.

This followed a Time report that "U.S. accountants now face 4,000 liability suits--double the number in 1985--and more than $15 billion in damages."

Abusive lawsuits both undermine the U.S. economy and threaten the viability of the auditing profession, said three FEI spokesmen at a press briefing held recently in Washington. "What we're talking about are abusive suits," said Robert Butler, senior vice president and CFO of International Paper, who has been following the auditor liability issue. "Auditors are being hit financially far out of proportion to their culpability. What this is going to do is end up destroying the profession."

Butler cited three concerns: first, a misunderstanding of the limits of the audit, that it does not offer a guarantee of corporate profits, shareholder profits, or the success of an enterprise; second, the quality of independent audits being compromised by major defections of partners, by increased difficulty in recruiting top graduates, and by firms restricting audit clients or eliminating high-risk industries; and, third, the ability of small companies to absorb increased audit costs and ultimately pass them on to the consuming public.

"We need to clear up a dangerous misconception in the courts," stressed FEI Chairman Chris Christie, "that 'no one will get hurt, the insurance company will pay.' Punitive damages," he noted, "are not covered by insurance, in fact are precluded from being covered in most states."

The irony, said Christie, "is that accountants have always intended to accept personal responsibility for their acts, but they did not contemplate a legal system that would look past the responsibility and make awards based on one's ability to pay."

The legal doctrine of joint and several liability in many states allows just one of many defendants found at fault in a lawsuit to be forced to pay much or all of the damages awarded, regardless of its culpability. As a result, the defendant perceived to have the greatest resources is often required to pay the award.

These damage awards, increased legal costs, and higher liability insurance "boost audit fees and reduce the availability of audits," said FEI President P. Norman Roy. "This will further impair the ability of U.S. businesses to compete in world markets." FEI, he said, supports general tort reform. Such reform would:

* Establish a principle of proportionate liability--under which each defendant's share of damages would match its share of responsibility--and eliminate or restrict joint and several liability.

* Adopt a variation of the so-called "English rule" that requires unsuccessful plaintiffs to pay the defendant's legal expenses and court costs.

Roy cited an FEI program to (1) inform the public and its members of the seriousness of the liability issue, (2) encourage major accounting firms to communicate their efforts to strengthen quality controls and influence legislative reform, and (3) call for the accounting profession to educate regulators and the public about what an audit is and is not.

FEI has also helped establish guidelines for internal control systems and the prevention of fraud, as an active participant in The Committee of Sponsoring Organizations (COSO) of the National Commission of Fraudulent Financial Reporting ("the Treadway Commission"). COSO's final report, "Internal Controls--Integrated Framework," will be issued by the end of September.
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Title Annotation:From FEI
Publication:Financial Executive
Date:Sep 1, 1992
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