Liability for firms’ financial errors comes under scrutiny

Date: 04/07/1996

By Fiona McHugh

ACCOUNTANTS may soon have to pay for the sins of rogue traders such as Nick Leeson, if member states decide to apply British auditing rules throughout the EU.

In a Green Paper examining the role, position and liability of auditors, the Commission asks whether or not accountants should be made liable for financial errors which they fail to detect in a company's books.

But it provides no answer to this delicate question.

Publication of the discussion paper, which is due later this month, comes hot on the heels of a series of high-profile company collapses caused by wild-card traders.

Leeson, for example, sprung to notoriety last year when he single-handedly brought the UK's oldest merchant bank Barings tumbling to its knees.

Currently serving six years in a Singapore jail, Leeson lost the company a spectacular one million ecu by gambling on the derivatives market without obtaining authorisation from his bosses.

In spite of the huge sums of money involved, Leeson's fraudulent activities remained undetected.

Although they cannot be held responsible for losses incurred by others, many companies feel that auditing firms ought nevertheless to pay a price for failing to spot any bookkeeping irregularities.

Some member states, such as the UK, Ireland and the Netherlands, already insist on so-called 'joint and several liability'.

But other governments believe auditing firms should only be made liable for losses in proportion to their responsibility. In Germany, auditors are held responsible, but only for a fixed amount of money.

“Liability rules vary considerably from country to country, and each set of rules is deeply engrained in each country's financial culture,” explains John Hegarty of the European Federation of Financial Institutes (FEE).

Given the sensitivity of the subject, the Commission is likely to adopt a hands-off approach, allowing national governments to decide which laws they impose, rather than proposing a Union-wide system.

“The Commission would prefer to limit action by the EU as such to what is strictly necessary for ensuring the functioning of the single market, in accordance with the principle of subsidiarity,” Monti explained in a recent speech to the FEE.

The approach is likely to be welcomed by the FEE, which has fought hard to avert the threat of EU-wide 'joint and several' responsibility rules.

“I think the Commission has realised that if a company goes bust, then it is not just the auditors' fault but a corporate governance issue,” says Hegarty.

That is a view shared by most accountants, who argue that shareholders, managers and directors must also shoulder some responsibility.

“The statutory audit is only one element of good corporate governance. It is linked with the responsibilities of each part of the overall corporate governance structure,” insists David Darbyshire, vice-president of the FEE.

In the UK, where accounting firms face claims amounting to billions of ecu, there is mounting opposition to full liability rules. But, so far, the Department of Trade and Industry has refused to review the law. That may change, however, as more and more accounting firms set up shop in countries with laxer laws, taking both jobs and money with them.

Over the coming months, the Commission hopes to clarify the extent to which auditing firms should be made responsible for reporting illegal acts.

“We need to know when to notify the police. If, for example, an accountant notices a hundred-ecu error in the books of a multi-billion-ecu multinational, should he report it? And if the auditor gets it wrong, can he be sued by the company in question?” asks Hegarty.

More importantly, the paper will seek to establish a single market in accountancy. At the moment, auditing firms may only establish themselves on a national, and not an EU-wide, basis. “Even though we are auditing multinational companies, we must work on a country by country basis,” says Hegarty.

The paper will also stress the need to develop a single set of global accounting standards. Currently, European firms must publish a separate American set of accounts if they want to list themselves on the New York stock exchange.

The paper is due to be adopted by the Commission on 17 July, and interested parties will then be given approximately three months to respond to the questions it raises.