Litigation funding: foul play?

Auditors, long seen as having the deepest pockets by litigants looking to
recover cash from collapsed businesses, are facing a new threat. Previously,
liquidators could pursue a court action against a former auditor, only if they
had enough money for what are generally very costly cases. But more cases
against auditors look set to be brought in the future by litigants funded by
third parties that hope to get a share of the damages.

The case that has set the cat among the pigeons concerns Moore Stephens and
an action brought by former client Stone & Rolls, now in liquidation.

S&R claims that Moore Stephens failed to pick up fraud at the company,
and has the financial backing of IM Litigation Funding to pursue the claim.

The claim was initially for as much as £90m. An award of that magnitude could
cripple Moore Stephens, which has a turnover of just over £100m.

On the attack

‘This case illustrates the growing trend of seeking to blame auditors for the
results of fraud in companies. In that context, litigation funding is a concern
to auditors and their professional indemnity insurers,’ says Peter Ellingham, a
partner at City law firm Kennedys.

‘On the one hand, no one would suggest it is fair that a bona fide claim
should be constrained by a lack of funds. On the other, in general terms, and
with no reflection on the specifics of this claim, there is an inevitable
concern when an action is funded by a third party with a purely financial
interest in the outcome,’ he argues.

There is, however, some good news for auditors. The case has already been
through preliminary hearings, and though Moore Stephens had hoped to get the
claim struck out, it has succeeded in at least limiting it. Stone & Rolls
had hoped to claim for compound interest.

Lawyers for the bankrupt firm argued that losses that were caused by the
fraud had had to be made good with debt, and that therefore the nature of the
loss meant compound interest was justified.

The trial judge said that the compound interest portion of the claim appeared
to be from ‘cloud cuckoo-land,’ and dropped it. That reduced the claim by about
£40m. And, in the broader framework, it is still early days.

Peter Wyman, head of professional affairs at PricewaterhouseCoopers, says
that he knows of no other claims that are being brought. ‘It’s potentially very
concerning,’ he says. ‘But it’s early days. Certainly [at PwC] I’m not aware
that we have had any potential litigation that has arisen because somebody is
offering to fund it.’

Possible replay

There is only one case in play, but IM Litigation Funding was said to have
looked at hundreds of possible actions before deciding on Stone & Rolls. The
worry is that this claim is the tip of the iceberg, and if this case is
successful, others will surely follow.

Wyman thinks we should stop seeing auditors as deep pockets. He argues that
if firms do start going under as a result of claims, then auditors will cease to
become such attractive targets.

But the worry must still be there as it was with Equitable Life. The life
assurer launched huge claims against former auditor Ernst & Young and its
former directors.

While some of the directors were millionaires, it was certainly no honey pot.

The largest auditors, on the other hand, turn over £2bn a year, and are
reckoned for that reason to be juicier targets. Pleading that they do not have
deep pockets is probably unlikely to convince potential litigants.

As for the case itself, a further hearing is expected early in the New Year,
where more details of Moore Stephens’ alleged negligence will be thrashed out.
Commentators will also want to argue that success on the part of Stone &
Rolls could be damaging in many other ways.

Whatever happens, it’s fair to say that Moore Stephens won’t be the only ones
fretting on the outcome.

Unsporting behaviour

The case against Moore Stephens is not just worrying some because it
threatens to bring more cases against auditors – but also because it may be a
threat to what is perceived as a British way of doing business.

‘I got back from New York this morning. Every time you are there you are
reminded of the unhealthy litigation culture. We could go down that road,’ says
Peter Wyman of PricewaterhouseCoopers.

‘What worries me about litigation is that it creates a broader defensiveness.
Directors and auditors thus become less useful.’