Equitable Life: E&Y spared the worst

The lasting legacy of Ernst & Young’s audit of Equitable Life may be
increased fees and lengthier audits as firms come to grips with when and how to
disclose legal liabilities.

The final chapter of the Equitable saga ended last week when an appeal ruling
was published on disciplinary charges brought against E&Y over the Equitable
audit. Costs and fines amounted to more than £9m in the original ruling.

he appeal reduced that to just under £3m and reversed a ruling that the firm
and auditor Kevin McNamara had sacrificed their objectivity and independence
during the audit.

The firm stumbled on a key accounting principle which governs how liabilities
arising from court cases are disclosed to shareholders.

In Equitable’s case, E&Y agreed it was very unlikely a key court case –
the Hyman case – would be lost and therefore no liability was recorded in the
Equitable accounts.

The case rested on E&Y accepting legal advice obtained by Equitable
instead of seeking further advice.

Under current accounting rules companies record a liability if the chances of
losing a court case, or having to pay out funds, is greater than 50%. The value
recorded in
the financial statements represents the company’s “best estimate” of this
liability.

Following last week’s verdict, industry figures close to the case believe
auditors may now second guess legal advice provided by their clients – a common
practice according to auditors and lawyers.

Seeking professional legal advice can be among the costliest exercises during
an audit. Seeking a second or third legal opinion from a reputable firm, some
feel, may considerably add to the cost of an audit.

One legal expert told Accountancy Age that such secondary advice would be
unnecessary in most cases.

There remains divergent approaches among corporations about how much
information to disclose about legal liabilities. Lawyers say while some firms
will disclose all information in the public domain, including information in
court documents and in the press, others will opt for a minimal approach.

A liability figure is only disclosed if there is a chance a company may have
to pay out at the end of a litigation. The amount is based on how much a
reasonable entity might pay to be rid of the liability.

Auditors agree on this figure in consultation with their client and sometimes
their client’s lawyers. A close observer of the Equitable tribunal said the
decision may add to the pressure in these circumstances to make the “right”
decision, despite the uncertainty and speculation which often surrounds major
court cases.

E&Y’s appeal was centred on the claim that the firm and its auditor
lacked objectivity and independence.

The appeal tribunal concluded: “In order to amount to a breach of the
fundamental principles of objectivity and independence something sigificantly
more serious is required than mere incompetence or inadvertence on the part of
the auditor in relation to specific audit issues.”

E&Y issued a statement which said: “We extend our sympathies to the
policy holders of Equitable Life, who have been impacted by the near collapse of
the society, following events which lay outside of our control and the remit of
our role as auditor.”

Further reading:

Equitable ruling leaves audit
guessing over legal liabilities