The Big Four firm had audited the accounts of Britain’s oldest mutual for more than a century. But would, for example, the debacle have been avoided if compulsory audit rotation was applied across the profession?
Some certainly believe this to be the case.
Last year, our sister title Financial Director surveyed more than 800 FDs to ask their opinion on the subject. More than 60% said companies should be forced to rotate their auditor every seven years, a move that would surely solve some difficulties, while at the same time introducing others.
The problem is that the relationship between an auditor and a client is notoriously close, which can be seen in two lights. On the one hand, it allows the accountant to get a better handle on a client’s business.
On the other, there’s the possibility that complacency can creep in.
This issue is at the heart of Equitable’s litigation against former auditor Ernst & Young over the years 1997, 1998 and 1999.
The Hyman case, in which the House of Lords eventually ruled against Equitable in July 2000, sided with 90,000 pensioners to whom Equitable had tried to offer reduced bonus payments, despite them buying a guaranteed annuity rate scheme.
Equitable claims that Ernst & Young should have made provisions for losing the case in the statutory accounts. While E&Y included the possible liabilities in the regulatory returns for the years in question, there was no mention in the accounts.
And the figures in question are by no means small: £900m for 1997, £1.4bn for 1998 and £1.1bn for 1999. If, as Equitable asserts, its directors had been aware of such potential liabilities, alarm bells would have sounded and the Society would have been put up for sale in 1998.
The loss of a chance for sale will be difficult for Equitable Life to prove conclusively. It must assert its belief that the Society was worth the value placed on it. It must also prove that someone would have produced such an offer.
Ernst & Young lawyers will certainly try to rubbish Equitable’s claims by saying that any buyer would have recognised the potential liabilities in the returns, and decided not to go ahead with the purchase. Or if it did, at a drastically reduced rate.
But this rests on a number of points. Where does the final responsibility lie for such oversights – if indeed it is agreed that leaving such provisions off the statutory accounts can be classed as negligence?
Is it the responsibility of the auditors, or is it the responsibility of the directors at the company in question?
While ultimate responsibility must lie with the company’s directors, it may be that auditors have a significant enough role and a relationship that is close enough to warrant taking at least some of the blame.
Of course, the audit profession will argue that the only reason E&Y is being sued is because it is the only organisation around with deep enough pockets to warrant an attack.
This is a fair point, but it’s difficult on that basis to argue that this means Equitable should not be able to make such a claim. It, and others, believe E&Y was negligent in its duties. Legal opinion seems divided.
The only profession that seems to be siding with E&Y is the audit profession itself.
With trade secretary Patricia Hewitt looking into auditor liability as part of the company law review, the ongoing battle will be of great interest to her department.
It is a perfect example of why the audit profession feels it needs some sort of liability cover to protect it against such destructive claims.
While a liability cap has been unofficially dropped from the wish list of the Big Four and a proportional approach adopted as the more realistic option, they still assert that the profession cannot continue with the threat of such monumental law suits hanging over them like a guillotine ready to fall. No Big Four firm could survive a hit of the magnitude of Equitable.
And so Nick Land, chairman of E&Y, is facing a nervous 12 months. While outwardly confident of the prospect at taking the issue to the High Court, in private he is bound to be more than a little worried. If the press is to be believed, 300 UK partners face personal bankruptcy should Equitable win.
But if a liability escape clause is introduced, best practice could suffer as a result. Surely the threat of insolvency is the biggest deterrent to auditor laziness?
Perhaps, or perhaps not. But the fact is that a Big Four is only just sufficient to deal with the world’s audit needs. A Big Three would be difficult to envisage, especially when we take into account statistics such as no FTSE-100 company is currently being audited by a firm outside the Big Four.
That said, the current legal wrangling is unlikely to have the same devastating effect as Enron did on Andersen – the UK arm of E&Y would not be enough to bring down the whole global firm. But with legal experts expecting E&Y to offer to settle some time in the New Year, it will certainly be felt.
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