Director, Officer, Auditor Liability Claims Seen Likely To Increase

Now, he reasoned, "I think there has been a revelation that accountants are humans, subject to the same greed, to the same fear of losing their positions. I don't think judges will be so quick to say if there was a certification of financials, that goes a long way towards knocking out a lawsuit."

Accountants have become less risk averse, asserted Thomas Newkirk, associate director of the U.S. Securities and Exchange Commission, noting that financial fraud and issuer reporting cases brought by the SEC, which grew from 79 in 1998 to 112 in 2001, are "headed to Mars."

He pointed to the Private Securities Litigation Reform Act of 1995 as the driver of their less cautious behavior.

With the Reform Act, Congress in-tended to end the "race to the court-house" in which "frivolous" lawsuits were brought as soon as stock prices fell, by raising procedural hurdles for federal securities class-action filings. The Act also eliminated joint and several liability for auditors.

Accountants, Mr. Newkirk believes, looked at the Act and thought it would provide "substantial insulation to accountants" in litigation. "In the world of traffic safety, people who have airbags and antilock brakes drive more aggressively," he said, drawing a parallel.

"My guess is that 90 percent of the auditors have never heard of PSLRA," countered Phillip Rotner, general counsel for Big Five accounting firm Deloitte & Touche in New York. "Thats not to suggest that auditors never do anything wrong, [but] the idea that certain reforms switching from joint and several to proportionate liability and tougher pleading standards" changed auditors behavior "just doesnt make sense," he said. "No auditor wants to get involved in any shareholder class action at all."

Has the quality of audits of Americas corporations declined, Mr. Snow asked, suggesting that the greater complexity of the business world might have something to do with an increase in the number of accounting restatements in recent years.

"I don't know the answer to that. It would be easy to say no, but what I would say [instead] is that the nature of audits has changed considerably in the last 10 years," Mr. Rotner said. "I dont know if they are any better or worse."

Noting that audits today are more technology-driven, he said that they have also become less detailed. A smaller percentage of transactions may be checked, but hopefully procedures have been put in place to make checking more sensible, targeting areas of risk more efficiently, he said.

Agreeing that accounting restatements are up significantly, Mr. Rotner said restatements "are the plaintiffs' best friend." They allow plaintiffs "to start a case from day one with a major element of their claims already established."

Mr. Snow noted that before the PSLRA was passed, 40 percent of securities fraud cases were filed with allegation of accounting violations. In 2001, he said, the percentage was over 66 percent, with 19 percent of post-Reform class actions involving restatements.

Cases based on restatements are damaging because they can come only out of errors, Mr. Rotner said, noting that changes in accounting methods, for example, dont result in restatements. But even if there is a restatement, it doesn't necessarily mean that there is fraud, he said.

"If you're an auditor, you can defend your audit. You can do a good audit and still not detect errors in the financial statements," he said.

In some cases, there might be a restatement even though an accountant believes that no errors exist, he said, going on to cite what he characterized as a rare case in which the SEC forced a restatement that Deloitte so vehemently disagreed with that it resigned from the account.

As a result of Enrons collapse, the regulation of the accounting profession is one of the hottest topics on Capitol Hill, Mr. Rotner reported.

Among the more high-profile proposals are one calling for the immediate repeal of the PSLRA and another, "The Accountability For Accountants Act," introduced by Rep. Edward Markey, D-Mass., which restores joint and several liability and overturns a 1994 Supreme Court decision, among other things.

That Supreme Court decision, known as the Central Bank case, eliminated liability for aiding and abetting, noted Arthur Abbey, plaintiffs lawyer for Abbey Gardy in New York.

Noting that the Enron situation not only had auditors signing off on financial statements that later had to be restated, but "banks participating in creating offshore entities," he said these outside advisors are all "part of the mosaic," adding that "they all should be in there [sharing in the damages]. There would be a lot of deep pockets."

In the Enron situation, "I don't know where all the money's going to come from to cover $80 billion worth of losses. There's only about $200-300 million in directors and officers insurance," he said.

Turning to Mr. Rotner, he asked, "How much insurance do accounting firms have?"

"Very little," Mr. Rotner replied. "If anyone in the audience has any real risk-transfer insurance, let me know. I'm in the book."

Reproduced from National Underwriter Property & Casualty/Risk & Benefits Management Edition, February 25, 2002. Copyright 2002 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.

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