UK should adopt US civil approach

Two leading academics have added their voice to the call for the removal of
the ‘knowingly or recklessly’ clause in the Company bill, shortly due before
parliament.

In an article for the Financial Times, Stella Fearnley, a professor
of accounting at Portsmouth Business School, and Shyam Sunder, professor of
accounting, economics and finance at Yale School of Management, said the US
civil approach to audits, avoided reckless penalties, which could be costly for
those who had already lost their money.

The Companies bill is set to replace ‘joint-and-several’ liability by
‘proportional’ liability’, established through contract. And ‘knowingly or
recklessly’ issuing a false or deceptive audit will be a criminal offence
subject to a fine, but not imprisonment.

Fearnley and Sunder point out that in 1995, changes in US federal law eased
the litigation regime for claims against professionals related to work on listed
companies.
‘Interestingly, the quid pro quo for liability reform in the US focused on
improvements in audit quality, not on criminal penalties,’ they said.

‘The economic effect of criminalising the “knowing and reckless” issuance of
a misleading audit report needs more careful thought… Criminal law is intended
to punish transgressions against society. Those who have lost money as a result
of financial statement fraud or malpractice expect to be compensated for the
loss in a timely fashion,’ they said.

According to the authors, the US regime differs in that the authorities take
on only the most serious cases for criminal prosecution.

‘Where the right to practise before the SEC is at risk, the standard of proof
is the same as in UK civil disciplinary proceedings. Where fraud is involved or
where “civil” penalties are imposed via the federal courts, a higher standard of
proof (“clear and convincing evidence”, which is lower than criminal standard)
is applied. Many cases are settled before trial,’ they said.

Without the need to prove criminality, cases can be resolved expeditiously
and shareholders can get on with claiming their compensation.

Fearnley and Sunder warned that criminal proceedings will draw more defensive
resources and cause delay.

‘Given the higher (beyond reasonable doubt) standard of proof required for a
criminal conviction, such proceedings are less likely to succeed than civil
cases… The threat of criminal prosecution may induce auditors to pursue a
legalistic, defensive, box-ticking approach,’ they said.