Equitable ruling leaves audit guessing over legal liabilities

The door has been closed on the investigation into Ernst & Young’s audit
of troubled insurer Equitable Life, however lingering questions remain which
could have auditors second guessing their decisions for years to come.

Last week’s release of the Joint Disciplinary Scheme Appeal Tribunal’s report
brought with it fines and costs of less than £3m for E&Y, but opened the
door to questions around legal liability.

E&Y argued its objectivity and independence was not lacking during the
audit, but did not contest a finding of incompetence over its failure to
challenge its client on a critical court case.

Equitable’s near collapse came following the loss of the Hyman case, which
challenged the practice of reducing bonuses for policyholders on guaranteed
pension schemes.
At the time the Equitable board believed their chances of losing the case were
remote and did not tell shareholders about the corresponding financial
liability.

At the height of the press coverage Liz Kwantes, who had £300,000 in family
funds invested in Equitable, received a comfort letter by director Alan Nash
urging her to ignore the media speculation.

“Nash said everything was just tickety-boo,” she said. “I think this letter
had an enourmous effect on people.”

Nash, and the Equitable Board, were selling the same message to E&Y. Any
concerns E&Y had about the case were eased by legal advice, obtained by
Equitable’s lawyers.
The advice was eventually proven wrong. For those years, during 1998-99, about
£4.7bn was invested into Equitable.

The Hyman loss had a catastrophic effect on Equitable’s finances. Zero growth
was imposed retrospectively for 2000-01. In July 2001, Equitable reduced the
value of all policies by 16% and, to discourage people moving their funds,
policy holders were hit with financial penalties of up to 12% of their total
savings they left for to another provider.

Had E&Y forced Equitable to disclose the potential liability,
shareholders, and eventually policy holders, may have had some fore-warning of
what may happen if the Hyman case succeeded. E&Y decided against this by
relying on advice from their client’s lawyers. The firm maintains nothing in
their audits caused Equitable or the policyholders any loss or damage.

The tricky area of legal liabilities is one where the numbers men must
somehow negotiate with the lawyers. If a board, with their auditor’s approval,
believes there is only a remote chance it will lose a court case, it does not
need to disclose the possible liability which may follow.

This is to protect a company from disclosing potentially frivolous law suits.
A board must make a decision, based on advice from its lawyers, on whether to
disclose the potential cost of a court-related liability. At times an auditor is
given access to internal legal advice, subject to strict confidentiality, to
make its decision. An auditor can even sit down with its client’s lawyers, in
the presence of a company representative.

The Equitable case may significantly raise the bar for auditors when deciding
whether a court case should remain on or off the balance sheet as a liability.
These can prove costly areas in audits. Lawyers also quietly suggest that
sometimes court cases simply go bad and, on any case, predicting court outcomes
is a flawed science.

Lawyers will tell you that an opinion from a reputable law firm is usually
enough to quell an auditor’s concerns. It was enough to satisfy E&Y that
Equitable had made the right decision. However the firm failed to seek advice
itself from the counsel.

Furthermore the advice it did receive was not sufficiently recorded in a
manner that could underpin a proper judgment by E&Y’s auditor Kevin
McNamara, according to last week’s report.

Kwantes who runs the Equitable Life Support Group (ELSG), is not sure whether
she would have pulled her money out had she known the full, potential impact of
the Hyman court case. Ten years after Equitable’s near collapse she still runs
the ELSG website where she regularly receives emails from policy holders.

One arrived last week . “I am in utter despair about the [Equitable]
compensation, we are undoubtedly in line for being ripped off yet again. Better
make the best of everything and anything we may be enjoying now, for I reckon a
year or so down the line we’ll have nothing left.”

Further reading:

Equitable Life: E&Y
spared the worst