Dada Adefolami:
“Legal liability of an Auditor is the ‘responsibility of the auditor to the client and third parties relying on the accountant’s work. Accountants can be sued for fraud and negligence in performance of duties’. Chartered Accountants opinions affect their clients and their judgments can further affect investors, stockholders, firm creditors, or even partners.”
Dada Adefolami.
The International Auditing and Assurance Standards Board is an independent standards body which issues standards, like the International Standards on Auditing, quality control guidelines and other services, to support the international auditing of financial statements. It is a body supported by the International Federation of Accountants.
Legal liability of an Auditor is the “responsibility of the auditor to the client and third parties relying on the accountant’s work. Accountants can be sued for fraud and negligence in performance of duties”. Chartered Accountants opinions affect their clients and their judgments can further affect investors, stockholders, firm creditors, or even partners
In 2006, the International Auditing and Assurance Standards Board (IAASB), together with the American Institute of Certified Public Accountants (AICPA), embarked on a project to enhance the communicative value and relevance of the auditor’s report and to accommodate evolving national financial reporting regimes, while ensuring that common and essential content was communicated. After almost a decade of deliberations, research and consultation, a new and revised set of auditor reporting standards was issued by IAASB in January 2015. The revision to the auditor’s report is effective for audits of financial statements for periods ending on or after 15 December 2016.
Accountants and auditors are responsible for detecting and deterring fraud by evaluating accounting systems for weaknesses, designing and monitoring internal control
Auditor’s Responsibilities
1. Enhanced representations relating to misstatements arising from fraud or error.
2. Exercise of professional judgment and scepticism throughout the audit.
3. Appropriateness of management’s use of the going concern basis of accounting.
4. Communication with those charged with governance regarding the planned scope and timing of the audit and significant audit findings, including any significant deficiencies in internal control.
5. For audits of financial statements of listed entities, a statement that the auditor has complied with relevant ethical requirements regarding independence.
6. For audits of financial statements of listed entities and any other entities for which key audit matters are communicated in accordance with ISA 701, the auditor determines those matters that were of most significance in the audit of the current period.
Internal control, as defined in accounting and auditing, is a process for assuring achievement of an organization’s objectives in operational effectiveness and efficiency, reliable financial reporting, and compliance with laws, regulations and policies. A broad concept, internal control involves everything.
Liability
Auditors are potentially liable for both criminal and civil offences. The former occur when individuals or organisations breach a government imposed law; in other words criminal law governs relationships between entities and the state. Civil law, in contrast, deals with disputes between individuals and/or organisations.
This content will narrate the impact on the competitiveness of the audit market and some of the methods available to limit exposure to expensive litigation.
Criminal offences:
Like any individual or organisation, auditors are bound by the laws in the countries in which they operate, so under the criminal law auditors could be prosecuted for acts such as fraud and insider trading. Audit is also subject to legislation prescribed by the Companies Act of the respective countries. This includes many sections governing who can be an auditor, how auditors are appointed and removed and the functions of auditors.
One noteworthy offence from the Companies Act is that of ‘knowingly, or recklessly causing a report under (auditor’s report on company’s annual accounts) to include any matter that is misleading, false or deceptive in a material particular. This means that auditors could be prosecuted in a criminal court for either knowingly or recklessly issuing an inappropriate audit opinion.
Civil Offences
There are two pieces of civil law of particular significance to the audit profession; contract law and the law of tort. These establish the principles for auditor liability to clients and to third parties, respectively.
Under contract law, parties can seek remedy for a breach of contractual obligations. Therefore shareholders can seek remedy from an auditor if they fail to comply with the terms of an engagement letter. For example, an auditor could be sued by the shareholders, which was the case in the PWC settlement to Tyco shareholders.
Under the law of tort, auditors can be sued for negligence if they breach a duty of care towards a third party who consequently suffers some form of loss. Auditor liability is not only in terms of audit quality and the reputation of the profession but also in terms of the cost to the industry and the barriers this creates to competition within the audit market.
Dada Adefolami:
“Under contract law, parties can seek remedy for a breach of contractual obligations. Therefore shareholders can seek remedy from an auditor if they fail to comply with the terms of an engagement letter. For example, an auditor could be sued by the shareholders, which was the case in the PWC settlement to Tyco shareholders.”
Cases
The application of the law of tort in the auditing profession, and the way in which auditors seek to limit their exposure to the ensuing liabilities, has been shaped by a number of recent landmark cases. The most notable of these are Caparo Industries Plc (Caparo) v Dickman (1990) and Royal Bank of Scotland (RBS) vs Bannerman Johnstone MacLay (Bannerman) (2002).
Caparo Industries plc v Dickman UKHL 2 is a leading English tort law case on the test for a duty of care. The decision arose in the context of a negligent preparation of accounts for a company. Previous cases on negligent misstatements had fallen under the principle of Hedley Byrne v Heller. This stated that when a person makes a statement, he voluntary assumes responsibility to the person he makes it to. If the statement was made negligently, then he will be liable for any loss which results.
In the first case Caparo pursued the firm Touche Ross (who later merged to form Deloitte & Touche) following a series of share purchases of a company called Fidelity plc. Caparo alleges that the purchase decisions were based upon inaccurate accounts that overvalued the company. They also claimed that, as auditors of Fidelity, Touche Ross owed potential investors a duty of care. The claim was unsuccessful; the House of Lords concluded that the accounts were prepared for the existing shareholders as a class for the purposes of exercising their class rights and that the auditor had no reasonable knowledge of the purpose that the accounts would be put to by Caparo.
It was this case that provided the current guidance for when duty of care between an auditor and a third party exists. Under the ruling this occurs when:
1. The loss suffered is a reasonably foreseeable consequence of the defendant’s conduct
2. There is sufficient ‘proximity’ of relationship between the defendant and the pursuer
3. It is ‘fair, just and reasonable’ to impose a liability on the defendant.
Several Liabilities
The guidance for when an auditor may be liable, either under criminal or civil law appears to be clear and largely uncontroversial. The same cannot be said of the nature of the fines and settlements.
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