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Accountants’ Professional IndemnityIssues and Liability Exposures

Accountants’ Professional IndemnityIssues and Liability Exposures

By Simon KonstaBy Simon Konsta

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Basic Insurance RequirementsBasic Insurance Requirements

ICAEW requires any member holding a practising certificate to take out professional indemnity insurance

Minimum levels of cover - 2.5 x gross fee income, minimum £50,000

PII must be obtained from a Participating Insurer

ICAEW requires any member holding a practising certificate to take out professional indemnity insurance

Minimum levels of cover - 2.5 x gross fee income, minimum £50,000

PII must be obtained from a Participating Insurer

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Basis of CoverBasis of Cover

Civil liability incurred in conduct of professional business

Development in range of services provided an issue:

Investment advice

D&O

Management Consultancy

IT Consultancy

Corporate Finance

The need for adequate understanding of business services, nature of client base etc

Civil liability incurred in conduct of professional business

Development in range of services provided an issue:

Investment advice

D&O

Management Consultancy

IT Consultancy

Corporate Finance

The need for adequate understanding of business services, nature of client base etc

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The Nature of the RiskThe Nature of the Risk

Sample

Claims or circumstances referred to this firm

Period - May 2000 to May 2001

Population - overseas claims excluded

- sole practitioners to “Big 5”

Assumption

Informed assessment of maximum potential exposures, net of costs

Sample

Claims or circumstances referred to this firm

Period - May 2000 to May 2001

Population - overseas claims excluded

- sole practitioners to “Big 5”

Assumption

Informed assessment of maximum potential exposures, net of costs

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Source of Claims Source of Claims

Activity %

Tax 33.3 Corporate and personal

Audit 29.0 Private and public companies

Transactional 16.6 M & A, corporate finance/reporting and due diligence

Insolvency 7.5 Liquidations, receiverships and other insolvency functions

Accountancy 5.5 Valuations and general accounting

Trusts 3.7 Trustees and executors

Consultancy and Others 4.4 Predominantly IT

Activity %

Tax 33.3 Corporate and personal

Audit 29.0 Private and public companies

Transactional 16.6 M & A, corporate finance/reporting and due diligence

Insolvency 7.5 Liquidations, receiverships and other insolvency functions

Accountancy 5.5 Valuations and general accounting

Trusts 3.7 Trustees and executors

Consultancy and Others 4.4 Predominantly IT

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Degree of ExposureDegree of Exposure

Banding of claims or circumstances

(a) Less then £50,000

(b) More than £50,000, less than £100,000

(c) More than £100,000, less than £500,000

(d) In excess of £500,000

Tax, consultancy and other categories - general spread amongst bands.

Audit - 50% in (d) category but otherwise evenly spread amongst (a) - (c).

Transactional - 88% in category (d) with a greater potential for catastrophic losses.

Banding of claims or circumstances

(a) Less then £50,000

(b) More than £50,000, less than £100,000

(c) More than £100,000, less than £500,000

(d) In excess of £500,000

Tax, consultancy and other categories - general spread amongst bands.

Audit - 50% in (d) category but otherwise evenly spread amongst (a) - (c).

Transactional - 88% in category (d) with a greater potential for catastrophic losses.

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Other FeaturesOther Features

Fraud

significant contributing factor in 20.3% of cases

significant contributing factor in 28% of audit claims

Insolvency: 27% of cases connected to insolvency or client failure

Institute or other regulatory involvement: 16%

Fraud

significant contributing factor in 20.3% of cases

significant contributing factor in 28% of audit claims

Insolvency: 27% of cases connected to insolvency or client failure

Institute or other regulatory involvement: 16%

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The statistics in contextThe statistics in context

Developments in the duty of care

The Caparo influence - restriction on statutory auditors’ duties of care

Invaluable tool for discouraging and disposing of third party audit-derived claims

But not an accountants’ charter

audited company suffering recoverable losses may still sue

statement of tortious principles applied to establish duties to third parties

Developments in the duty of care

The Caparo influence - restriction on statutory auditors’ duties of care

Invaluable tool for discouraging and disposing of third party audit-derived claims

But not an accountants’ charter

audited company suffering recoverable losses may still sue

statement of tortious principles applied to establish duties to third parties

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Risk Assessment Post Caparo Risk Assessment Post Caparo

Transactional Work

Myriad of duties and potential duties

ADT v. Binder Hamlyn

Audit derived but multiplied exposure

Negligent misstatement

Rigorous risk management procedures

Transactional Work

Myriad of duties and potential duties

ADT v. Binder Hamlyn

Audit derived but multiplied exposure

Negligent misstatement

Rigorous risk management procedures

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Risk Areas Post Caparo (2)Risk Areas Post Caparo (2) Killick & Arthur v. PricewaterhouseCoopers

Benfield Greig Group Plc

Buy-back valuation

Alleged duty owed to shareholders

HELD: duty owed on Caparo grounds.

Regulatory Work

CAA v. Kounis Freeman

Law Society v. KPMG

Conclusion?

Enhanced risk associated with regulated clients

Killick & Arthur v. PricewaterhouseCoopers

Benfield Greig Group Plc

Buy-back valuation

Alleged duty owed to shareholders

HELD: duty owed on Caparo grounds.

Regulatory Work

CAA v. Kounis Freeman

Law Society v. KPMG

Conclusion?

Enhanced risk associated with regulated clients

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Causation and Loss Causation and Loss

Recent decisions reflect judicial reluctance to make professional advisers warrantors that

(a) a company or business will be profitable; or

(b) a transaction will be successful

The Courts will not contemplate an outcome by which the professional is deemed to underwrite a transaction or a company’s business fortunes

Recent decisions reflect judicial reluctance to make professional advisers warrantors that

(a) a company or business will be profitable; or

(b) a transaction will be successful

The Courts will not contemplate an outcome by which the professional is deemed to underwrite a transaction or a company’s business fortunes

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Causation and Loss (2)Causation and Loss (2) Scope of Duty

South Australian Asset Management Corporation -v- York Montague Limited [1997] AC 199

“But for” test not sufficient in itself

what consequences are attributable to the wrongful act of the accountant?

Causing loss vs occasioning the opportunity for losses to arise

Galoo Limited -v- Bright Grahame Murray [1994] 1 WRL 1360

Was the loss, as a matter of law, caused by the breach of duty?

Trading losses held to be irrecoverable

Scope of Duty

South Australian Asset Management Corporation -v- York Montague Limited [1997] AC 199

“But for” test not sufficient in itself

what consequences are attributable to the wrongful act of the accountant?

Causing loss vs occasioning the opportunity for losses to arise

Galoo Limited -v- Bright Grahame Murray [1994] 1 WRL 1360

Was the loss, as a matter of law, caused by the breach of duty?

Trading losses held to be irrecoverable

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Causation and Loss - What will be recoverable?Causation and Loss - What will be recoverable?

Overpayments

Money wrongly paid out

Audit - dividends paid out of capital due to overstatements of profit

Galoo tempered by Sasea Finance -v- KPMG (trading losses occasioned by fraud)

Defalcations by director or employee

Overpayment of tax and penalties

Wasted accountancy costs and management time

Plant & Planters (London) Ltd v. K J Fisher

Overpayments

Money wrongly paid out

Audit - dividends paid out of capital due to overstatements of profit

Galoo tempered by Sasea Finance -v- KPMG (trading losses occasioned by fraud)

Defalcations by director or employee

Overpayment of tax and penalties

Wasted accountancy costs and management time

Plant & Planters (London) Ltd v. K J Fisher

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Company Law Review - Key ProposalsCompany Law Review - Key Proposals

Status of Caparo

“For some time, the basis of this ruling [Caparo] has been regarded as outdated and in need of reform to accord with the demands of a modern economy, where those who attach importance to the audit of financial statements include future investors/shareholders, suppliers, employees and creditors (including banks) to name but a few” - Developing the Framework - March 2000

Auditors’ duty of care to be extended to creditors and potential creditors and investors in their capacity as such if legislation capable of being drafted

Status of Caparo

“For some time, the basis of this ruling [Caparo] has been regarded as outdated and in need of reform to accord with the demands of a modern economy, where those who attach importance to the audit of financial statements include future investors/shareholders, suppliers, employees and creditors (including banks) to name but a few” - Developing the Framework - March 2000

Auditors’ duty of care to be extended to creditors and potential creditors and investors in their capacity as such if legislation capable of being drafted

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Company Law Review - The Volte-FaceCompany Law Review - The Volte-Face

“In view of the weight of these responses and the arguments raised we do not believe that the case has been made out for statutory extension of the duty of care of auditors in the way suggested in Completing the structure.”

“It is widely recognised that auditors’ so called “deep pockets” have ensured that, of the possible targets of professional negligence claims for financial loss caused by mis-statement in accounts, they are the favourites. This field of litigation has expanded hugely over the the last 35 years. Auditors’ exposure is now very great. It would be exacerbated by our recommendations widening their functions”. - Final Report - June 2001.

In short, development of the law of auditors negligence to be left to case law.

“In view of the weight of these responses and the arguments raised we do not believe that the case has been made out for statutory extension of the duty of care of auditors in the way suggested in Completing the structure.”

“It is widely recognised that auditors’ so called “deep pockets” have ensured that, of the possible targets of professional negligence claims for financial loss caused by mis-statement in accounts, they are the favourites. This field of litigation has expanded hugely over the the last 35 years. Auditors’ exposure is now very great. It would be exacerbated by our recommendations widening their functions”. - Final Report - June 2001.

In short, development of the law of auditors negligence to be left to case law.

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Company Law Review - Additional Protection from Abuse

Company Law Review - Additional Protection from Abuse

Limiting liability

Repeal of Section 310 Companies Act

Ability for auditors contractually to limit their liability subject to shareholder approval in general meeting and disclosure in audit report

Attribution

Fraud and breach of duty of directors and employees

Enhanced obligation of disclosure on directors in audit context

Limiting liability

Repeal of Section 310 Companies Act

Ability for auditors contractually to limit their liability subject to shareholder approval in general meeting and disclosure in audit report

Attribution

Fraud and breach of duty of directors and employees

Enhanced obligation of disclosure on directors in audit context

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Risk Management - What is the profession doing?Risk Management - What is the profession doing?

Enhanced focus on risk management meeting:

Client expectation

Readiness to litigate

Departure from core auditing and accounting and auditing functions

ICAEW roadshows

Education, Guidance and Direction

Enhanced focus on risk management meeting:

Client expectation

Readiness to litigate

Departure from core auditing and accounting and auditing functions

ICAEW roadshows

Education, Guidance and Direction