Auditors will exert even less effort and more scandals are sure to follow

by

*Prem Sikka

*Professor of Accounting at the University of Essex.

(Published in The Herald, 11 Oct 2004, p. 20)

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The responses to recent accounting scandals highlight the different ways in which the Americans and the British deal with the issues.

In the US, following the Enron scandal, the Securities & Exchange Commission (SEC) secured a criminal conviction of Arthur Andersen after it shredded crucial documents. It was closed down. PricewaterhouseCoopers (PwC) were fined $5 million for violation of auditor independence rules.

The accountancy industry’s race to the bottom is being checked by the SEC. It prosecuted Ernst & Young for violation of auditor independence rules. The judgement recorded that the firm partners “acted recklessly and negligently in committing wilful and deliberate violations of well-established rules that govern auditor independence standards ….”. In April 2004, the firm was banned for six months for winning any new audit business.

The US Senate Committee on Governmental Affairs censured KPMG because the firm “devoted substantial resources to, and obtained significant fees from, developing, marketing, and implementing potentially abusive and illegal tax shelters that U.S. taxpayers might otherwise have been unable, unlikely or unwilling to employ, costing the Treasury billions of dollars in lost tax revenues”. The firm marketed over “500 tax products”, which may have cost the US Treasury $85 billion in lost tax revenues. All of the Big Four firms are facing federal and state civil and criminal investigations over the sale of tax shelters.

Britain is estimated to be losing between £25 and £85 billion a year from aggressive tax avoidance schemes. Major accountancy firms are the leaders. Neither the government nor any parliamentary committee cares to investigate them though the government will be frightening the firms by fining them £5,000 for failure to register tax avoidance schemes, equivalent to just 48 seconds of PwC’s UK income.

In the absence of an SEC, accountancy trade associations, funded and dominated by major firms, regulate the accountancy business. The outcome is unsurprising. Despite a High Court judgement, no action has been taken against the firms laundering money. There has been no independent investigation of the audit failures at the Bank of Credit and Commerce International (BCCI), Polly Peck, Barings, Wickes, Wiggins, Resort Hotels, Levitt Group of Companies, Transtec and other headline scandals. Despite mega auditing scandals, the Department of Trade and Industry (DTI) has failed to prosecute any firm. Instead the firms are rewarded with lucrative government contracts.

Rather than making auditors personally responsible for audit failures, the DTI is keen to reduce auditor liabilities and make it almost impossible for injured stakeholders to secure proper compensation from negligent auditors. Auditors can trade as limited liability companies. They can also trade as limited liability partnerships, which enable partners to share profits but shield them from the consequences of each other’s negligence and losses. Auditors do not owe a ‘duty of care’ to any individual shareholder, creditor, employee, pension scheme member or any other stakeholder.

Following the principle of ‘contributory negligence’ they are only held liable for a fraction of the losses to investors. For example, in the case of frauds at Barings, instead of the headline figure of £791 million auditors only paid £1.5 million for the losses arising from their negligence on the grounds that the company was mismanaged. However, major firms want more. They want auditor liabilities ‘capped’ and also a system of ‘proportional liability’, both already ruled out by the Law Commission as being against the public interest.

Neither the EU nor the US is offering any further liability concessions to auditing firms. However, the UK government and opposition parties are keen to further indulge accounting firms. The DTI supported the idea of a ‘cap’, but the Office of Fair Trading (OFT) opposed it. Then during the parliamentary passage of the Companies Bill, the government announced that it now supports “limiting liability on a proportionate basis by contract”, having already ruled it out in its December 2003 consultation paper. Under this, directors and auditors could fix the amount of auditor liability regardless of the extent of auditor negligence or losses suffered by stakeholders. One hopes that the parliamentary recess and the party conference season would encourage ministers to reflect on the folly of these proposals.

With reduced liability auditors will exert even less effort and more scandals are sure to follow. The demands of accountancy firms cannot be seen in isolation. Anything given to accountancy firms must sooner or later be demanded by engineers, doctors, dentists, surveyors, producers of food, cars, medicine, drink, financial services, cigarettes, and everything else. The only sure losers in the race-to-the-bottom are ordinary people.