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ALI-ABA Panelists Discuss Accountants' Liability

Richard Swanson, with Arnold & Porter LLC, and one of the planning chairs for ALI-ABA's recent program on accountants' liability, pointed to the irony of the accounting profession having lost its credibility in the 1990s and now the talk is about liability caps. There are still enormous problems in the industry, but the debate has changed, he said. There are still basic questions about financial reporting and disclosure, but also about whether litigation is the way to ensure transparency or a drag on the capital markets. Another irony is that the profession's disrepute has led to more accounting firm leverage, more work, more revenue and a greater ability to say no.

Swanson pointed out that the PCAOB has not brought any major financial statement audit enforcement proceedings. He said the model the Board seems to have adopted is the NASD's in which the SEC "takes on the big stuff." The problem is that there aren't any small audit cases, he said. He questioned whether the PCAOB's model works. At least the PCAOB now knows that it is constitutional, he said, referring to a recent court challenge.

The sharp diminution in nonaudit services has had a dramatic effect on the auditing profession, according to Swanson. A lot of work has been pushed down to the lower tier firms, he said, and consulting firms also have benefited.

Swanson mentioned that the PCAOB seeks input on priorities from the prominent members of its Standing Advisory Group, but has had little time to consider their recommendations because of the internal controls initiative.

Swanson said that FASB faces numerous challenges and pondered whether it will eventually be converged out of existence. Its process is confusing and slow, he said, and dissatisfaction is driving the convergence debate. The convergence of accounting standards is moving much faster than anyone contemplated, in his view.

Deloitte & Touche's Robert Kueppers noted that accountant liability has been a hot topic for a long time. The size of the claims can be staggering, he said. The nature of the plaintiffs has changed. Kueppers noted that accounting firms do not have large stockpiles of cash because of their limited partnership structures, so the large cases are settled. The small cases may be litigated but it is too dangerous to litigate the large ones, he said. Kueppers welcomes the debate about litigation, and said it is good to address this matter before it becomes a true crisis. The failure of another big accounting firm would have a significant impact on the capital markets, he said, and there is no "plan B."

Kueppers predicted a large number of restatements by mutual funds due to incorrect accounting for inverse floaters. Issuers have to rely on experts to get a quality audit done, he said. Due to the complexity of the accounting standards, it is almost impossible to get it right every time. He noted that the SEC is looking at accounting complexity and said it is on the verge of announcing an initiative. Convergence may be the answer, he said. If complexity is not addressed, the number of restatements will continue to go up and confidence in financial statements will be undermined.

Leo Beus, with Beus Gilbert PLLC, provided the plaintiffs' perspective on litigating an accountant's liability case. Beus said he is troubled by what has happened in the last few years. He is amazed by the Department of Justice/SEC brief in the Tellabs case, he said. Beus accused the Commission of reversing seven decades of rulemaking that protected investors. The SEC has taken steps to protect corporations, executives and accounting firms, in his view.

Beus said that accounting firm structures must be changed with respect to the staff ratio to partners. No real lesson has been learned from Enron, he said, because firms are still "having kids do audits." Kids do not bring enough professional skepticism to the task, in his view, and do not understand the industry.

Thomas Riesenberg, the deputy general counsel for Ernst & Young LLP, discussed the PCAOB's inspection process, which has been criticized for its delay in issuing reports. The Board is trying to speed the process. Riesenberg said that foreign inspections pose a very heavy burden on the Board. He noted, for instance, that E&Y has registered 55 firms around the world and the other Big Four firms have similar numbers.

The PCAOB plans to work with foreign regulators and conduct joint inspections. Riesenberg said the foreign inspection reports will be interesting to see. Countries around the world are developing independent oversight bodies. If the regimes are considered robust enough, the PCAOB has said that it will defer to home country regulators or work with them. Riesenberg said the roadmap on auditing convergence and the creation of the International Forum of Independent Audit Regulators are good developments.

Thomas Finnegan, the associate general counsel for PricewaterhouseCoopers LLP, said that the first year of PCAOB inspections was a bit rough, but firms and the PCAOB have now developed good relationships. Still, it is a nerve-wracking experience for the auditors involved, he said. Finnegan noted that plaintiffs in Georgia had tried to obtain the nonpublic portion of a PCAOB inspection report but PwC was successful in keeping it out of the case.

While the number of suits against accounting firms has declined, Finnegan said the dollar value is astronomical, even firm-threatening in some cases. He believes it is an outcome from the business cycle rather than a result of the Sarbanes-Oxley Act. There are more state court derivative actions, he said, and more bankruptcy/trustee cases.

Sanford Dumain of Milberg Weiss & Bershad LLP reviewed the Tellabs case and suggestions that the SEC has changed since Christopher Cox became the chairman. Dumain noted that Cox was the author of the House bill that led to the Private Securities Litigation Reform Act, which he said was much worse than the Senate version. Considering Cox's history, Dumain said what is going on at the SEC is no surprise. Dumain added that auditors have plenty of protection under PSLRA and the Central Bank and Dura decisions.