The number of recent claims against audit firms, some of them running into billions of Rands, for alleged ‘audit failures’, is a stark reminder of the problems facing the auditing profession in the absence of some protection offered by an equitable apportionment of liability regime. This constant threat of seeking to be held liable as a first resort for the failure of a business is having a serious effect on the auditing profession.
In essence, the auditing profession is prevented from concentrating on the job at hand, i.e. providing the best auditing assurance possible without fear or favour; the right calibre of people are not being attracted to the profession (or remaining in the profession) for fear of being caught up in a massive claim for damages; the ability and desire to expand auditing and other assurance services to the business and investing community, thereby providing stability and credibility to the investment market for the benefit of South Africa as a whole, is being stifled; and lastly, the opportunity for mid-tier firms to expand into the upper end of the market, and thereby create greater choice for users, is also dampened by this threat of litigation.
The question of limiting the liability of professionals in general and, in particular, that of Registered Auditors has long been a vexing one. In any attempt to do so, how does one balance the interests of the public with those of the auditing profession?
The major problem facing all professionals is that modern society, now operating in a global economy, places increasing pressures on them. High standards are naturally demanded of them. On the one hand, they must keep abreast of the latest developments in their field of expertise and, on the other hand, there are more clients who insist on rapid services.
No easy solution to the problems surrounding professional liability is available. The direction adopted by the courts is to require that professionals have to comply with a minimum standard of skill and exercise reasonable due care in providing their services. The courts in South Africa have so far been reluctant to grant compensation to somebody that has not suffered physical harm if the granting of damages would encourage droves of plaintiffs also to institute claims.
Perhaps the reason for this conservative approach is that the courts realise that it is necessary to keep the number of claims within manageable limits so that the courts are not over-burdened with claims to such an extent that the administration of justice is prejudiced. The civil courts are already struggling to deal with an overburdened caseload and it was estimated that in early 2008, the number of civil matters awaiting Court time, was 57 000.
SAICA has long been concerned about the liability situation affecting professionals in South Africa, and has made numerous submissions to the relevant authorities over the years. It has now released a new discussion document, entitled The equitable apportionment of Registered Auditors’ professional liability and is calling for comment from interested parties. The gist of the arguments put forward in the document is as follows.
The need for reform
It has been said that in contrast with other traditional professions such as the medical and legal profession, the auditing profession has been seeking to protect itself from civil liability as far as possible. The reason for this is that the position of auditors is unique. The extent of exposure, the nature and type of risk of auditors to unlimited liability to a wide range of potential claimants far exceeds that of any other category of professionals. The liability of auditors should be both equitable and realistic. Auditors throughout the world are being asked to bear the full financial risk of corporate failures, irrespective of their degree of responsibility or fault.
The public interest
The present situation clearly threatens the public interest, which requires a strong auditing arm of the profession to be maintained. The reasons which compel this include the following:
• The annual audit plays an essential part in ensuring the integrity of corporate reporting, which is in the interests of the business community in South Africa and its international competitiveness.
• Corporate fraud is increasing, and while detection of fraud is not the primary responsibility of the auditor, there is little doubt that the auditor has an important role to play in the detection of such fraud.
• The audit provides a reliable basis for the assessment of corporate taxation, to the benefit of the Fiscus and taxpayers generally.
• Competition among the major firms has reduced the real cost of the audit, to the benefit of their clients, but concerns over liability could lead to defensive increases in the amount of audit work resulting in increased costs.
Furthermore, auditors are under pressure to extend their responsibilities into new areas of reporting and to a wider range of stakeholders. This could only further increase the auditors’ exposure to “deep pocket” litigation, which takes little account of fault or blame. Therefore, while auditors broadly support proposals for a wider scope of reporting in the interests of improved investor protection, they are reluctant to accept any wider responsibilities unless a way is found to apportion their liability equitably, particularly so, as recoveries from the directors of collapsed companies have been rare.
It is not disputed that auditors should be accountable for their conduct and that they should bear responsibility for the consequences of their actions, without limit if they are guilty of fraud or dishonesty. But it is manifestly unfair that auditors should bear the whole of the liability in cases when they are blameless or only partly to blame, while those at fault, who are not necessarily members of a profession, get off scot-free.
Some reforms that are proposed include the following:
• Eliminate joint and several liability in favour of a system of proportionate liability. As a result of the system of joint and several liability, even if an auditor commits only a small degree of fault, the auditor (and his partners) must bear the entire financial burden of damages. Under proportionate liability, defendants are required to pay only in proportion to their involvement in any wrongdoing. This enables the courts to assess awards that reflect the degree of responsibility of each defendant.
• Allow auditing firms more organisational options. Auditors need flexibility in selecting forms of practice that can help them to maximise their business opportunities but minimise their personal risk. By allowing accounting firms to take advantage of organisational forms such as Limited Liability Companies and Limited Liability Partnerships, the personal assets of partners not involved in malpractice wrongdoing may be protected from unsatisfied malpractice claims against the firm.
• Allow auditors to limit liability by contract with the audit client, also called capping of liability. This would enable a company and its auditors to agree on a reasonable limit of liability. It would help to ensure that a company’s management also assumed its rightful responsibility for ensuring the accuracy of the financial statements.
• Adopt a statutory requirement for professional advisors and directors of companies to have adequate insurance cover. This would help to ensure that the liability burden is spread more fairly among those who may be responsible for the loss.
• Adopt a statutory limitation or “cap” on professional liability for negligence. Such caps exist in Austria and Germany, and were recently introduced in federal Australia. As a result of these caps, the auditing profession in Austria and Germany is not subject to massive claims, and frivolous lawsuits are discouraged.
Continuation of the current situation may well lead to the collapse of one of the medium to large firms in South Africa, a fear already expressed in the United Kingdom and experienced in the United States. Such a failure would be highly disruptive to the whole business community, could lead to higher audit costs and a reduced standing of the auditing arm of the profession, with talented people seeking other careers. This would have a detrimental affect on the extension of the auditors’ reporting responsibilities, investor confidence in South African corporate reporting, fraud detection and tax assessment and collection.
The issues raised in the discussion document need to be addressed as a matter of urgency. A starting point would be a clear directive that the principle of proportionality should apply to all claims against professionals, however arising. In the auditors’ context, it would mean that the auditors’ liability would be limited to their share of the losses suffered by the claimant, as determined by a court of law and taking into account the liability of others who may be involved, such as directors, officers and trustees of companies or trusts. In making a determination of the auditors’ proportion of liability, the courts should:
• apply the established legal principles of factual and legal causation in deciding whether or not the auditors are guilty of an offence or legislative contravention; and
• determine the respective degrees of negligence of each of the parties.
The above principles are already entrenched in the Apportionment of Damages Act, 34 of 1956, and case law exists (and continues to evolve) on the subject matter. At the end of the day, the “punishment must fit the crime” and should not be lethal and destructive, both to the individual auditor concerned or to the entire auditing firm which might have been caught up in one individual’s criminal or negligent actions.
A strong auditing profession is an important part of an effective capital markets structure. We all have a stake in maintaining that strength.
SAICA has published a paper on this subject titled “A Discussion Paper on the Equitable Aportionment of Registered Auditor’s Professional Liability”. For a free copy of this, please send an email to email@example.com.
Jan Dijkman, BA LLB, LLM, H Dip Tax, ADL, CFP, is a Certified Ethics Officer and Project Director: Ethics and Discipline, SAICA.