Question

Assignment Topic – Auditors and Legal Liability
Read the following extract from the ACCA (the Association of Chartered Certified Accountants)
website, which is the global body for professional accountants, as stated:
“Over the past two decades the bill for litigation settlements of Big Four audit firms alone has run
into billions of dollars. Examples include Deloitte’s 2005 settlement of $250m regarding its audit of
insurance company Fortress Re and PwC’s $229m settlement in the lawsuit brought by the
shareholders of audit client Tyco in 2007.”
“Auditor liability is increasingly concerning, both in terms of audit quality and the reputation of the
profession but also in terms of the cost to the industry and the barriers this creates to competition
within the audit market.” (Source: www.accaglobal.com)
Required
Given the importance of professional liability to auditors and the negative publicity this creates for
the profession as a whole, research a recent case (Post 2000) where an auditor/audit firm was sued
for professional negligence. Students may research cases from the UK, USA, NZ or Canada in addition
to Australian cases.
With reference to the facts of the selected case, the significant Auditing and Accounting issues and
the final judgement handed down in your selected case:
• Provide a brief description of the key events and the factual issues behind the case
• Explain the culpability or which parties were deemed responsible and why. Outline the
damages imposed or the penalties and consider whether they were appropriate.
• investigate and explain the relevant issues in Auditing and Accounting raised by the case,
• The root-cause of the issues such as; market pressure, organisational culture, fraud etc.
• any problems, mistakes or misrepresentations made by the defendants, which contributed to
the adverse judgement and the awarding of damages,
• Finally, provide recommendations and possible improvements to:
o the Audit Strategy,
o the Audit Program,
o Other effective measures;
which would prevent the recurrence of the same litigation in the future and maintain
the professional reputation of auditors

Answer 1

The case we have considered is Livent Inc. Vs Deloitte & Touche (2016, Canada)

The Facts of the case are:

Two of Livent's directors manipulated the company's financial records to make it appear more solvent than it was. Livent engaged Deloitte as its auditor, who performed the following services from 1997-1998:

• the preparation and approval of a press release and comfort letter circulated in advance of a public debenture underwriting in October 1997 (the "Offering Documents"); and
• the preparation and approval of Livent's audit for 1997, which was completed in April 1998 (the "Audit").

While performing these services, Deloitte identified irregularities in Livent's accounting. Although Deloitte raised concerns with Livent, Livent denied the irregularities. Deloitte was forced to either resign or continue to provide services which it knew might be inaccurate. Deloitte chose to continue. As a result, the Offering Documents and Audit contained inaccuracies. In November 1998, the accounting irregularities were discovered by new management, who retracted the Audit and issued restated financial reports. Livent went into receivership in September 1999.

The receiver of Livent, a publicly-traded live theatre production company, brought a claim against Livent’s auditors, Deloitte, for failure to discover a fraud being perpetrated at the direction of Livent’s former CEO and CFO, with the assistance of its accounting and IT departments and to the knowledge of most of Livent’s audit committee. Livent hid its unprofitability through accounting manipulations, assisted by computer software it had designed to carry out these manipulations without a trace. After a change in management, Livent’s accounting staff confessed and the fraud was discovered.

Damages and Penalties imposed

The trial judge held that Deloitte owed a duty of care to provide accurate information to Livent’s shareholders. He held that Deloitte failed to meet the standard of care under this duty, either when it failed to discover the fraud and act on that discovery in August 1997, or when it signed off on Livent’s 1997 financial statements in April 1998. The trial judge held that the measure of damages was the difference between Livent’s value on the date on which Deloitte should have resigned and Livent’s value at the time of insolvency. He reduced this by 25 percent to account for contingencies or trading losses, which he held were too remote to make Deloitte liable. The trial judge consequently awarded damages to Livent for breach of its duty of care, and alternatively for breach of contract, in the amount of $84,750,000. The Court of Appeal upheld the trial judge’s award and dismissed Deloitte’s appeal and Livent’s cross‑appeal. hile the amount of the award remains significant at $40,425,000, this is less than half of the $84,750,000 initially awarded by the lower courts.

The Damages seem to be appropriate as they were upheld by the upper courts as well.

Root Cause of the Issue

Founded in the early 1990s by Garth Drabinsky and Myron Gottlieb, Live Entertainment Corporation of Canada, or Livent, was by all appearances a highly successful developer of popular stage productions, including the long-running Phantom of the Opera. Behind the scenes, however, Drabinsky and Gottlieb (with the help of other senior managers and many of the company’s accounting staff) were manipulating the company’s financial records to make Livent appear more profitable than it was in order to attract much needed funding from the capital markets. When new management discovered and exposed the fraud in 1998, Livent’s dire financial situation was revealed. The company soon filed for bankruptcy protection and was placed into receivership. Drabinsky and Gottlieb were fired and ultimately convicted of fraud.

Problems, Mistakes, Misinterpretation

Deloitte had argued that corporate auditors would be forced to resign from audits in order to minimize the risk of "catastrophic" damages. "We are pleased with the Supreme Court of Canada’s decision to allow Deloitte’s appeal in part, reducing the damage awarded against Deloitte and the scope of auditor liability," said a Deloitte spokesperson today to Canadian Accountant. "At the same time, we need to carefully review the decision to better understand what the Court concluded and the longer term implications for the profession."

The Chartered Professional Accountants of Canada, which held intervener status in the case, had argued that “the legal and practical impact of an expansion of auditor liability will bring the likely consequences of indeterminate liability into sharp relief.” In a statement today to Canadian Accountant, CPA Canada said it "respects the decision of the courts. We will need to study the ruling in depth and make a full assessment before we can provide any informed view."

The Canadian Coalition for Good Governance (CCGG) also held intervener status in the case. "The Supreme Court of Canada's decision today in the Livent case is consistent with the Court's holding in the Hercules case 20 years ago," said CCGG Executive Director Stephen Erlichman, "confirming that the purposes of an audit are to protect the company from the consequences of undetected errors or possibly wrongdoing and to assist the collectivity of shareholders in their task of overseeing management. The Court confirmed that an auditor's negligence in auditing a company can result in damages that are recoverable by the company in a derivative action."

Added Erlichman, "The Court also stated that it would not be in the public interest in this case to allow the fraud of directors and management of the company to be a defence."

Ways to reduce professional liability

1)   Get rid of high risk clients and troublemakers. Continuing to serve clients that are risky, that require constant hand-holding, that are uncooperative or that argue over fees limits productivity of CPA firm personnel and often creates a “crisis-oriented” culture. It also builds a client portfolio of less-than-quality clients and increases the likelihood of lawsuit!
2)   Make sure in-charge accountants and engagement leaders know what they are doing. Due to employee turnover, business growth or other reasons, staff personnel are frequently promoted to these leadership positions without adequate experience and training. The strongest defense against the likelihood of performing substandard work is the knowledge and experience of in-charge accountants and other engagement leaders. Training investments are the best malpractice insurance!

3)   Tailor engagement practice aids to meet the needs of clients. Professional judgment is now required for both audits and reviews. Professional judgment cannot be demonstrated by simply completing all forms and checklists from a canned set of practice aids. Documentation of thinking and reasoning is required!
4)   Preach professional skepticism. Familiarity with a client can enhance professional judgment. Excessive familiarity can diminish professional skepticism. Staff personnel must be taught how to develop a questioning attitude and to maintain a high level of professional skepticism on all engagements.
5)   Carefully manage cookie-cutter approaches to audits. Standard approaches to attest engagements without carefully considering the facts and circumstances of each can increase the possibility errors or fraud going undetected. Particularly for engagements in certain industries such as HUD supported projects, small broker dealers or other specialized entities, standard approaches can increase efficiencies. On the other hand, auditors and accountants should continually be alert for unique policies, procedures, risks and other issues that may require special attention.
6)   Engagement leaders should never delegate their quality control responsibilities. Even when staff personnel are highly qualified and experienced, engagement leaders are responsible for managing engagement planning, performance and completion. The continual involvement of the engagement leader ensures the work is performed correctly and increases engagement profitability!
7)   Engagement leaders should deliver and discuss engagement letters. Engagement letters are contracts, the enforceability of which depends on both parties understanding the contents. Engagement letters understood by both parties can eliminate lawsuits against CPA firms due to misunderstandings. The engagement leader can obtain information about possible fraud, negative economic effects and changes in an entity’s operations during discussions with client CEOs or CFOs. Communicating this information to engagement personnel can help ensure engagement quality, increase efficiency and reduce professional liability!
8)   Restrict the use of reports in high risk circumstances. Normally, restrictions on the use of reports are appropriate when the accountant or auditor has concern about unqualified or unauthorized persons utilizing financial statements and footnotes. For reports on financial information in specialized industries, and for other high risk circumstances, professional liability can be reduced by restricting the use of audit, review or compilation reports.
9)   Offer the lowest level of assurance on supplementary information whenever possible. Compiling supplementary information for reviews and disclaiming assurance on supplementary information for audits reduces the amount of the accountant’s or auditor’s work and also limits professional liability.
10)   Quality control policies and procedures should be integrated into engagements. These policies and procedures are intended to produce high-quality engagements and to decrease exposure to legal liability. Engagement documentation should contain evidence of how applicable quality control policies and procedures were applied on the job. This documentation can reduce time spent by peer reviews and ensure compliance with professional standards.