Accountants' Liability Briefing

Rising to the Challenge

The last twelve months will not be remembered as the happiest of periods for the accountancy profession, least of all in the United States. A series of high-profile corporate collapses has dealt a blow across the world to public confidence in existing systems of corporate governance and financial reporting, and in the role played by accountants in auditing and advising their clients

The UK accountancy profession has been fighting hard to avoid an excessive, knee-jerk response. Much has been said about the distinguishing features of UK accounting standards, and the advantages that their principles-based approach has over the more rules-based approach adopted in the United States. Nonetheless, change is on the agenda, and the ICAEW has already introduced new recommended best practice on audit independence, including a two-year cooling-off period before an auditor joins a client. The issues of audit firm rotation, and the extent to which auditors should perform or even offer other services, continue to be debated.

What the last twelve months have particularly demonstrated is the growing importance of the global regulatory context. There is an increasingly international dimension to the regulation of accounting and auditing and the establishment of workable systems of corporate governance, and the review of the legal and regulatory framework in this country cannot fail to be influenced by the reforms which have been implemented with almost indecent haste in the United States. Moreover, the Sarbanes-Oxley Act has raised the spectre of UK accountancy firms concerned in the audit of US listed companies becoming subject to the extra-territorial jurisdiction of US courts and to the authority exercised by the SEC and a new independent regulatory board.

The last twelve months have also provided a chilling reminder of the impact that can be wrought on any firm by a single engagement, and the importance of proper risk management. Legislative change to enable auditors to limit liability remains a distant prospect, particularly as the Government has held back from making detailed proposals on the subject in its White Paper while it considers the fallout from recent events. But legislative change of this nature could not in any event protect firms from the catastrophic consequences which befell Andersen as a result of Enron.

The message is clear: auditors must expect issues involving independence and other ethical criteria to attract ever- increasing scrutiny from regulators. It is perception of independence which will be most important, whatever the underlying realities of the situation, and this means that even greater care will have to be given to whether it is appropriate to accept particular clients or jobs, and to the making of difficult audit judgements which may have some impact on the auditor/client relationship. Firms of every size should give serious consideration to strengthening their consultation and other risk management procedures in these areas.

Caparo Revisited - Or how to take on duties to banks without even realising

Royal Bank of Scotland v Bannerman Johnstone Maclay

A recent Scottish legal decision may prompt risk management teams in the audit sector to reassess their firms' legal exposure to audit clients' principal lenders. In a judgment handed down on 23 July 2002 Lord MacFadyen, sitting in the Outer House of the Court of Session (the equivalent of the English High Court), refused to strike out a claim against auditors by a bank which asserted that it had relied on audited accounts in deciding whether to lend funds to a customer. The auditors concerned had not been approached directly by the bank and had probably never considered that they might be at risk of a claim. Nonetheless, the Judge held that it was arguable that the auditors had sufficient knowledge of the bank's reliance for a duty of care to arise

The Claim

The Royal Bank of Scotland ("RBS") was principal lender to APC Limited, a plant hirer to the construction industry. It was a requirement of RBS's facility letters that APC provide audited financial statements within six months of its financial year-end. APC's auditors, Bannerman Johnstone Maclay ("BJM"), gave clean opinions on its accounts for the periods ended 30 November 1995 and 31 March 1997. These audited accounts were passed by APC to RBS, which contended that it relied on them in extending further loans to APC and taking an equity stake in the business.

In September 1998, while BJM were working on their audit of a further year's accounts, RBS appointed receivers to the business. After trying unsuccessfully to recover its loans and investment, RBS started proceedings against BJM contending that the 1995 and 1997 accounts had been wrong and BJM's audits had been negligent. It claimed that BJM owed it a duty of care on the following basis:

BJM were closely involved in the financial affairs of APC, knew that it was a cash-hungry business and knew that RBS provided its working capital;

It could be assumed that for the purpose of considering whether APC was a going concern BJM would have obtained copies of RBS's facility letters, from which they would have seen the requirement that audited accounts be supplied to it, together with monthly management accounts;

BJM accordingly knew or should have known that RBS would rely on the audited accounts as a cross-check on the management accounts and in particular in deciding whether to maintain, increase or withdraw its financial support.

BJM sought to strike out the claim on the basis that the facts asserted by RBS were not sufficient to give rise to a duty of care. They argued in particular that a duty of care could not arise in such circumstances unless the auditor intended that the bank should act in reliance on the information supplied.

THE DECISION

The Judge held that the facts pleaded by RBS were sufficient in law to give rise to a duty of care. Relying on passages in the judgments of...

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