Home Accounting and Auditing Auditors: beware the legal consequences of a failed project

Auditors: beware the legal consequences of a failed project

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A curious feature of the SA Companies Act is that no limit is placed on the liability of audit firms or their partners for damages.

Professor Steven Firer CA(SA), in a 2012 article A New Auditor Liability Regime for South Africa, compares the SA regime to those overseas.

“Austria, Germany, Greece, Belgium, Slovenia and Australia have audit liability caps. Legislation whereby an agreement could be agreed upon between the company and the auditor has recently been introduced in the United Kingdom. In respect of the United Kingdom, Austria, Germany, Greece, Belgium and Slovenia, the introduction of legislation limiting the liability of the auditor has placed these countries in conformity with the recently finalised European Commission Recommendation on the civil liability of statutory auditors.”

That leaves SA audit firms out in the cold. Professor Firer argues for similar caps (or Legal Liability Agreements between auditor and client) to be legislated in SA, but to date that has not happened.

What this means is a rogue auditor could potentially bring down an entire firm, since the personal assets of the partners can be attached in a damages claim.

Here’s Firer again: “Section 19 (3) of the Companies Act 71 of 2008 has the impact of ensuring that audit firms and auditors in South Africa operate as unlimited liability companies in which all assets of the auditing firm, as well as personal assets of the partners/proprietor, are at risk if the firm were found to be liable in a court of law.”

In other words, innocent partners could be held to account for the malfeasance of a single rogue auditor. The result could be the collapse of one or more audit firms. No-one wants this outcome, since a failed audit profession imperils the entire economy. The government will enact legislation should the audit profession face such a threat.

Yesterday, I wrote that 2018 was a shocking year for auditors, given the frequency of corruption and fluffed audits. I am aware of several damages claims now being prepared by litigants, not against the bankrupt companies at fault, but against the auditors. If the law allows it, guaranteed it will happen.

This poses a scary future for audit firms. Trevor Manuel, former finance minister and current chairperson of chairperson of Old Mutual Emerging Markets, speaking at a SA Institute of Chartered Accountants (SAICA) shindig in June last year, rounded on auditors. He singled out liquidated audit firm Nkonki Inc, which was acquired by Gupta associate Salim Essa through Trillian Capital (another firm linked to corrupt Gupta dealings).

It’s not hard to imagine what kind of audits would have been emanating from Nkonki, no matter how diligent and well-intentioned the staff doing the grunt work.

Manuel pointed out that SA’s audit profession had become too comfortable being ranked first in the World Economic Forum’s Competitive Index for six years. “Everyone was comfortable … but when we fell from there, we fell to the bottom,” he said.

The SA Independent Regulatory Board for Auditors (IRBA), which polices the audit profession, was created in the wake of the Enron scandal. For those too young to remember, Enron was a US energy trading company that collapsed in 2001 as a result of accounting fraud, taking down Arthur Andersen, then one of the world’s “Big Five” accounting firms.

In other words, there is a precedent for this kind of thing. Corruption and fraud inevitably seep like a cancer into the economic body. A major scandal has brought down one major audit firm in recent history.

Manuel had a dig at IRBA which, like SAICA, had disciplinary issues going back seven years. “If justice is delayed, it is denied,” reported Fin24.

So, should we limit the legal liability of auditors?

Almost certainly. Firer cites Bryan Smith in writing for the Seattle Law Journal: “The limited liability company is a necessary vehicle for returning to a level of sanity regarding the legal status of professionals in our society. To deny these individuals the legal protection they deserve is unfair, inefficient, and irresponsible.”