18(b). Impact of Litigation
[Context] Meeting of the Investor Discussion Group of January 13, 1993. Part of the meeting was devoted to the topic of value information. During the discussion, a comment was made on the impact of litigation.
Participant I-7
Is there a concern on the part of the accounting profession that if market value is disclosed in footnotes, that if the information turns out subsequently not to be correct, that it could be used against the people who make the fair value adjustments? [Also included in 4] [TI 1/13, p. 16]
[Context] Meeting of the Investor Discussion Group on January 13, 1993. Part of the meeting was devoted to the topic of disclosure about operating opportunities and risks. During the discussion, a comment was made on the potential impact of disclosing too much information about operating risks.
Participant I-11
If you set a very low materiality threshold, let's say 1%, don't you run the risk of having so much risk to disclose that people will tend to treat it as litigation protection and ignore it, and it becomes valueless? [Also included in 10(b)] [TI 1/13, p. 53]
[Context] Meeting of the Investor Discussion Group on March 17, 1993. Part of the meeting was devoted to the topic of auditor involvement. During the discussion, comments were made on the impact of litigation on auditor involvement.
Committee/Staff/Observer
[Participant I-16], how important is that liability insurance policy to you? [Also included in 17(a)] [TI 3/17, p. 3]
Participant I-16
I think it's very important. There has to be some accountability. I'm not in favor of lawsuits but unless somebody suggests another way to make auditors accountable, I think we have no choice. [Also included in 17(a)] [TI 3/17, p. 3]
Committee/Staff/Observer
Your affection for the liability is to put a burden of responsibility on the auditor as opposed to the ability to collect financial benefits? [Also included in 17(a)] [TI 3/17, p. 3]
Participant I-16
Yes. [Also included in 17(a)] [TI 3/17, p. 3]
Participant I-7
If there's a significant mistake on the part of the profession, then liability is called into action; there's a reason for it. The investor who has taken the statements as a basis for making an investment should benefit by that particular liability. [Also included in 17(a)] [TI 3/17, p. 3]
Participant I-16
And the liability has to be tempered by what was involved. Was this just not the greatest work in the world, which isn't a huge liability; nobody guarantees that they're perfect. If there was some kind of collusion, then the liability is quite clear. [Also included in 17(a)] [TI 3/17, p. 4]
Committee/Staff/Observer
I don't think anybody disagrees on the latter, criminal intent and things like that. [Also included in 17(a)] [TI 3/17, p. 4]
Participant I-16
But the standards of performance are subject to some sort of debate. [Also included in 17(a)] [TI 3/17, p. 4]
Participant I-7
Isn't there some debate on the RICO act relative to the profession? Wasn't there something recently indicating that the profession may not be subject to the RICO act? [Also included in 17(a)] [TI 3/17, p. 4]
Committee/Staff/Observer
There was a court case a week or 10 days ago that came down in favor of [name deleted] that said that RICO was intended to go after organized crime, not organized accountants, and that it just went too far in that case. Good plaintiffs counsel have used RICO for 10 years as a sword over the profession. This is the first major case that said that it doesn't apply. [Also included in 17(a)] [TI 3/17, p. 4]
Participant I-7
They have done it in our industry also. [Also included in 17(a)] [TI 3/17, p. 4]
__________
Participant I-7
Our profession, certainly the sell-side, has the same independence problem. When given the choice of two directions, unless the liability issue is significantly raised, the auditor, like the analyst, will take the choice that is more favorable to management. [Also included in 17(a)] [TI 3/17, p. 8]
__________
Participant I-16
If I were not aware of it previously, I would probably have lost my job 10 years ago. This is not meant to be disparaging, but my impression is that this is done by the auditor to protect himself from liability rather than to inform investors. At the point where the auditor puts that note in, it's so well known that it doesn't add anything to the basic knowledge that is in the public domain. [Also included in 17(c)] [TI 3/17, p. 24]
[Context] Meeting of the Investor Discussion Group on March 17, 1993. Part of the meeting was devoted to the topic of structure and process.
Committee/Staff/Observer
Question 14 deals with the impact of litigation on the quality of external reporting. On page 18 of the meeting materials, we give you arguments about why litigation has helped and has hurt external reporting. Our first question is: on balance, do you believe that the current litigation environment has a net beneficial or detrimental effect on the quality of external business reporting? Please separately address the quality and cost of audits of financial statements in answering. [TI 3/17, p. 58]
Participant I-16
Yes and no. The only way you promote quality is to reward quality and punish its absence. Unless somebody has another way of punishing malfeasance or poor performance, legal liability is the only one I can think of right now. [TI 3/17, p. 58]
Committee/Staff/Observer
Suppose we did find something, for example, a system that would take people out of the profession. [TI 3/17, p. 58]
Participant I-16
With the amount of damage that could be done before someone is taken out, I'm not sure that that would be enough. I think financial penalty has to be there. If you can think of a fair arbitration system that is not dominated by someone being judged, I'm willing to give that a shot. But I think there has to be some kind of sanction of a financial nature that keeps quality control upmost in the minds of the profession. As far as question (b), current litigation improves the quality but it has to raise the cost. The cost of litigation and the cost of insurance has to be passed through to those being audited. I think it's a price that theoretically is worth paying. I'm not defending the size of the awards but I think we need something. We're far from the ideal system but I don't think we can scrap it and not replace it with something. [TI 3/17, p. 58-59]
Committee/Staff/Observer
There is a vast difference between penalties and fines and punitive awards. [TI 3/17, p. 59]
Participant I-16
I have a hard time with using RICO for things that are clearly not criminal in intent; that should go by the wayside. Also, the size of some of the awards are ludicrous compared to what is being done. But having meaningful financial penalties doesn't strike me as being out of line and I can't think of anything else to insure quality. [TI 3/17, p. 59]
Participant I-7
I would second what [participant I-16] said. [TI 3/17, p. 59]
Committee/Staff/Observer
Some analogy is drawn from time to time between the NASD type of regulation versus what the professionals do; some system that would make more sense than trying to solve all the quality issues in the courts. [TI 3/17, p. 59]
Participant I-12
It's a dilemma. There is an impact on management and the operating decisions that they make coming out of this litigation environment which concerns me. In some respects, reasonable opportunities may be turned down for fear that management will be sued in the future for bad decisions. Every decision entails risks and this litigation environment is discouraging taking risks. [TI 3/17, p. 59]
Participant I-16
Risk means if we make the right decision, you're rewarded, if you make the wrong decision, you're penalized. That's the definition of risk. [TI 3/17, p. 59]
Committee/Staff/Observer
But the current litigation environment may change the dividing line for what's a reasonable risk. [TI 3/17, p. 60]
Participant I-16
But that's a different issue from saying that there should not be any legal liability for professionals. For better or worse, you are members of a profession that is legislated. If I am a publicly-owned company, I have to hire an independent auditor and the reason for the legal requirement is that you are presumed to have a certain level of expertise and objectivity. In return, you have to take on certain public responsibilities, which is liability. [TI 3/17, p. 60]
Committee/Staff/Observer
I don't think anyone disagrees with that. My question is what the penalty should be. Right now, it's all your capital, your home, your car, every asset you have. [TI 3/17, p. 60]
Participant I-16
We sympathise with the points you're making. [TI 3/17, p. 60]
Participant I-5
I haven't seen a place where the threat of litigation is chilling. [TI 3/17, p. 60]
Participant I-12
Banking, lending to real estate. Do you know what [one regulator] is doing to the accounting profession, to bank lenders? This has a chilling effect on any lender decisions. [TI 3/17, p. 60]
Participant I-16
Am I missing something? I read recently that fourth quarter earnings were at record levels for banks? [TI 3/17, p. 60]
Participant I-12
Yes, but it's not because of loans. Loans are down. [TI 3/17, p. 60]
Participant I-16
Secondly, somebody in the banking industry or the S&L industry did lose a lot of money, which implies that one of two things at least is true: there was a lot of incompetence or a lot of malfeasance. [TI 3/17, p. 61]
Participant I-12
There was a lot of incompetence. The point I'm making is that there is a chilling effect on current business decisions because of this litigation. [TI 3/17, p. 61]
Participant I-16
I don't think that has anything to do with litigation. The problem is when you give a government guarantee to people, it's very difficult to hold them accountable for what they do with public money. If you eliminate the fear of litigation, you're just giving people a blank check. [TI 3/17, p. 61]
Participant I-12
I'm not talking about eliminating the fear of litigation. The pendulum swings; for a long time, there was inadequate oversight and way too much incompetence. The pendulum has swung in the other direction. My observation is that there is a chilling effect that I can see in my work on fundamental operations. [TI 3/17, p. 61]
Committee/Staff/Observer
It has had a chilling effect on auditors; I know of many firms, maybe not the big 6 but hundreds of firms in the U.S., that have given up auditing public companies. I think it has had a chilling effect not only on the auditing profession but on business in general by having fewer choices and all the other public considerations that go along with that. [TI 3/17, p. 61]
Participant I-16
It's very difficult being in a situation where you get a relatively limited amount of money in fees for performing a service that can cause enormous harm to people if done incorrectly. That's the basic problem. To say that the award should be consistent with the fees misses the point; the amount of damage that you can do with an improper audit is a lot more than what your fees can conceivably be. Which is not to argue that it hasn't gone way too far on the other side. [TI 3/17, p. 61-62]
Committee/Staff/Observer
I still don't know if I have an answer to the question. The basic question was: does the litigation environment have a beneficial or detrimental effect currently on the quality of external business reporting? [TI 3/17, p. 62]
Participant I-16
I said yes. [TI 3/17, p. 62]
Participant I-5
Beneficial. [TI 3/17, p. 62]
Participant I-11
Detrimental. [TI 3/17, p. 62]
Participant I-12
Detrimental. [TI 3/17, p. 62]
Committee/Staff/Observer
Why detrimental? [TI 3/17, p. 62]
Participant I-11
Cost. I don't think anybody is talking about eliminating legal responsibility for auditors. We're talking about the recent trends in litigation where the plaintiff's bar chooses who to sue based on their net worth, and RICO. It has created an environment where auditors, investment bankers, lenders, and corporate management all make decisions not based on what their best business judgement is, but based on what is least likely to get them in a court of law. Anyone that doesn't see that is not looking too clearly. [TI 3/17, p. 62]
Participant I-16
I don't see it. [TI 3/17, p. 63]
Participant I-12
I would agree with [participant I-11]. There has been a visible decline in the quality of financial reporting; companies are far more cautious about how and when they disclose things. Maybe it's better ultimately, I don't know. We have to participate in monthly conference calls; the things that management is willing to talk to us about have changed. We get less of a feel for what's really going on. [Also included in 2(d)] [TI 3/17, p. 63]
Committee/Staff/Observer
You're getting less as a result? [Also included in 2(d)] [TI 3/17, p. 63]
Participant I-12
Yes. This environment has got to the point that if you have a bad quarter, the shareholders sue you for withholding information. It's being used far more than is reasonable. [Also included in 2(d)] [TI 3/17, p. 63]
[Context] Meeting of the Creditor Discussion Group on December 8, 1992. Part of the meeting was devoted to the topic of creditors' objectives and approaches. During the discussion, a comment was made on the impact of litigation.
Participant C-10
Sometimes we will get a company giving us a private placement, and then they'll put in a second package their projections. And first we're given the choice of do we want it, or sometimes they'll mail it, we'll mail it right back, because we don't want to be tied down. So we'll just work with the document that doesn't have the projections, and say we don't want it. Because otherwise we end up signing a letter of confidentiality, and our lawyers give us all sorts of hassle about how long that says we're tied down. There is a big issue here legally in terms of how far are you tied down and when are you released? [Also included in 1(c), 1(d), and 12] [TC 12/8, p. 72]
[Context] Meeting of the Creditor Discussion Group on March 11, 1993. Part of the meeting was devoted to the topic of auditor involvement. During the discussion, comments were made on the impact of litigation on auditors and auditing.
Committee/Staff/Observer
How many others see the world as [participant C-4] sees it [that is, one of the benefits of audits is the ability to sue the auditors]? [Also included in 17(a)] [TC 3/11, p. 3]
Participant C-5
I would say we're exactly the opposite. We have not pursued that avenue in any situation and it just doesn't even enter into our judgment. We're looking for more the assurances as to the practice and the procedures, and have never really looked at the depth of the pockets. So, I would take almost a contrasting view that it just doesn't even enter the thinking process. [Also included in 17(a)] [TC 3/11, p. 3]
__________
Participant C-11
I think it's good to know that the auditors must be nervous about the fact that somebody might sue them, and use a little bit more diligence than they might otherwise do. So I think the auditors should feel a little nervous. That they'd better really get into the stuff or they might be sued. I think that is helpful. On the internal controls, I do think that there's some difficult areas that I would want to feel comfort about, as to what kind of examination really did take place. And I'm thinking of some of these huge off-balance sheet items, such as the foreign exchange contracts, hedging type things. I think it's an interesting avenue to think about. The standard audit letter does not give any feeling one way or another that the critical areas have been looked at in depth. [Also included in 17(a), 17(c), and 19] [TC 3/11, p. 4]
__________
Participant C-4
Just one other point about the ability to sue auditors. We see that more as a club, and as a possible incentive for auditors. We, in a number of instances, find situations where a CPA may be reluctant to change from a review to an audit, because of some of their concerns. And that provides useful information for us in those instances. So, the real use is as a lever against the auditor. [Also included in 17(a)] [TC 3/11, p. 5]
__________
Participant C-2
I wanted to raise a different issue in answer to this question, and that is in terms of what's the greatest disappointment. The issue of privity and the underlying implication that unless you are in privity with the accounting firm, you may not rely on the information contained in the audit. When I was with a different bank, with a great number of banks in different states, we had a couple of banks in states where privity had to be established. And again, I want to tie on to the comments that have been made earlier: it is not a bank's intention necessarily to sue the accounting firm. However, you do always want to try to preserve your rights. And in those particular banks, we developed some credit policies to try to at least get the banks in privity with accounting firms but we had very little luck getting the accounting firms to return letters basically acknowledging that we were in receipt of the statements delivered by the customer, and could in fact rely on the information in the audits. I do feel that there should be some classes of statement users considered to be automatically in privity with the accounting firms. [Also included in 17(a)] [TC 3/11, p. 16-17]
__________
Participant C-5
I believe that the fact that those areas [like MD&A] are not opined on is a risk mitigant for the auditor as opposed to a need for scope expansion. Quite frankly, the detail auditors get into in other stuff is no more severe than what they get into on the supplement and the MD&A type disclosures. It's just that whatever you can do to reduce that liability factor is the driver behind not making affirmative statements. Obviously as you move down the scale in the quality of the audit firm, some smaller and medium sized firms will clearly just disregard those sections and make their disclaimers and don't treat it. But in a Fortune 500 type company, I find it very difficult to believe that auditors don't take a sense of ownership and accountability, and probably charge for scope work associated with review of that activity, regardless of the opinion that's issued or the disclaimers. I also want to touch on section (e) in the meeting materials. For mid-size companies, I basically get a consolidated statement (holding company and operating subsidiary) without the detail as to operating subsidiary reporting and so forth. The only thing I guess that could get me over that without having to do a report on the individual operating company itself is to clarify the intercompany transactions which are awash in consolidated reporting. That at least would give me a better comfort level as to the integrity of the operating company financial statements, if I can at least eliminate some of the intercompany and the non-external transactions, and understand the depth of those and sort of the issues between them. [Also included in 17(b)] [TC 3/11, p. 23-24]
__________
Participant C-12
Being more of a cynic than an idealist, I throw out the idea that advocating a less standardized approach, given the business and legal environments in which we all work and the realities of the marketplace, it's going to be difficult to say certain things, both in terms of what management will accept in terms of the business relationship and particularly in terms of what the lawyers are going to allow to be said. And I fear that in the end it's a good idea. What we get is boilerplate; we think we have information but what we have is boilerplate. [Also included in 10(d) and 17(c)] [TC 3/11, p. 31-32]
Committee/Staff/Observer
With that cynical view, then would you just advocate staying where we are? [Also included in 10(d) and 17(c)] [TC 3/11, p. 32]
Participant C-12
I would tend to, yes, because I think in the end if we try to broaden what we get, the lawyers and the business relationship is going to give us boilerplate. [Also included in 10(d) and 17(c)] [TC 3/11, p. 32]
Participant C-14
Why would it necessarily be boilerplate? Are you saying that every opinion would have the same three issues? Or that because of pressure from management they'd pick issues that aren't truly significant? [Also included in 10(d) and 17(c)] [TC 3/11, p. 32]
Participant C-12
I tend to think we'd get the three easy ones raised in a way that waters them down a lot. We've been through this with merger letters and we've seen them expanded greatly. But there's no additional information there. There's more stuff but there's no useful information in this greatly expanded letter. Because the lawyers get hold of it. [Also included in 10(d) and 17(c)] [TC 3/11, p. 32]
Participant C-17
It tends to violate the two things I hold dear. One is the independence issue and the other's the consistency. When you start trying to do the hit list for the year and you have some kind of predetermined format, it just becomes subject to all kinds of constraints from the legal end or boilerplate; it tends to have very little value when it comes out. [Also included in 10(d) and 17(c)] [TC 3/11, p. 32]
[Context] Meeting of the Creditor Discussion Group on March 11, 1993. Part of the meeting was devoted to the topic of the impact of litigation on auditing and external reporting and other matters related to structure and process.
Committee/Staff/Observer
Question 15. Fundamentally, the question talks about many sides of the litigation risk issue and it asks several different kinds of questions that are all basically: does the risk of litigation, either upon the preparer or the auditor, in some way interfere with the financial reporting process or does it enhance it? Now you could see that from the point of view of making auditors more nervous. You can also see that from the point of view of making MD&A more cautious. We're looking for some kind of sense of balance from you of where the litigation risk on the whole makes a difference in terms of the information you get from preparers and what you think auditors are doing as they're performing the service. [TC 3/11, p. 61]
Participant C-15
Maybe the information that we get would be better but we'll get less information over time. [TC 3/11, p. 61]
Committee/Staff/Observer
I think it's one of the concerns that people have. As users do you see that concern or is that basically somebody else's problem which is not having a lot of impact on you? [TC 3/11, p. 61]
Participant C-4
We see it as CPAs giving into client pressures. The whole question of independence is one of our concerns. As long as we can have some ability to go after inadequate audit procedures we feel we are actually getting better quality reports. It does drive up the cost but we think it's a necessary cost in the current account environment to ensure quality. [TC 3/11, p. 61]
Participant C-5
I realize the dilemma in what we get in that it does constrain. I know from the other side of the fence that it constrains us in the way of disclosures for both management and then the accountants. And it gets back to conservatism; you're unlikely to be sued for being conservative. I think in any attempt to remove this, what you need to do is increase the disclosure, not of the actual financials but the disclosure of the work that's been conducted. There's still a lot of flexibility on the part of individual firms to make their own determinations. In our environment, the potential for us to suggest a CPA change is almost nonexistent. [Also included in 2(b)] [TC 3/11, p. 62]
Participant C-11
I think this is a necessary component. If there is any value to the audit, there has to be the ability to go to court if something has not been done properly. The issue is a broader social issue. We have huge problems with product liability and malpractice liability. Whereas in earlier years people could do outrageous things and never get sued, now it's clearly the other way. And up until now, Congress has not found a way to have reasonable limitations on reckless court proceedings. But I don't think you can avoid the liability question and should not. [Also included in 17(a)] [TC 3/11, p. 62]
Participant C-7
I have mixed emotions. The threat of litigation has made the accounting profession more quality conscious but I also see that the added cost that that's entailed has led to a lot of boilerplate coming into the financial reporting. And then the movement away from audited statements, in part because the accountants are coming back to the client saying this is what it's going to cost you for an audit now to protect us and so they're saying we don't want to bear that cost so step it back for us. I think there's a net loss in that respect. [Also included in 17(e)] [TC 3/11, p. 62]
Committee/Staff/Observer
I'd like to hear any comments you have as well about whether the risk of litigation you believe hampers management's talking in MD&A or financial statements or anyplace else? Or do you feel that that's not much of a pressure as far as getting information you need? [TC 3/11, p. 62-63]
Participant C-1
I don't think that's a real pressure for management. I think people would be hard pressed to find that you'd sued someone based on what they said in an annual report. You're more likely to find that maybe management said something at the time of issuance of a security than in an annual report or even a quarterly report. [TC 3/11, p. 63]
Participant C-15
I think that the threat of being sued might make management actually disclose more because I think [name deleted], if I'm not mistaken, was sued not by the public but by the SEC for not disclosing the impact that a change in their cruziero/dollar rate would have on their operations down in Brazil. So I think, because of that type of possibility companies would probably expand what they're saying in the MD&A section. [TC 3/11, p. 63]
Committee/Staff/Observer
Nobody has ever suggested nor would it be realistic to assume that there would be no threat of litigation and liability. [TC 3/11, p. 63]
Participant C-17
I think in everybody's mind it's a necessary tool to have. I perceive it as having an effect. I don't know what to do about it in terms of fairness and that sort of thing. [TC 3/11, p. 63]
Participant C-10
I would say that both for the auditor and for the user and for the preparer, I would view the threat of litigation as detrimental overall. [TC 3/11, p. 63]
Participant C-17
The lenders have their own concerns, just in terms of lender liability suits. I would find it difficult to argue that there aren't situations where perhaps it was appropriate but where do you cross over from appropriate to a weapon? It's really the same scenario reversed. [TC 3/11, p. 63-64]
Participant C-2
I think we've all had to learn how to do business a little differently because of the threat of litigation. And in some cases, there may have been a positive side to it. [TC 3/11, p. 64]
Committee/Staff/Observer
[Participant C-10], you obviously took a position that is different from what some have said and you're seeing it as detrimental; why? [TC 3/11, p. 64]
Participant C-10
It's causing overreaction on the part of the auditors and overreaction on the part of the managers. [TC 3/11, p. 64]
Participant C-17
When I think about it sometimes I wonder why isn't there a penalty, for instance? If you're a litigant, you're going to sue someone in any spectrum, business or personal. You have everything to gain and nothing to lose. [TC 3/11, p. 64]
__________
Participant C-5
By using the differential standard framework for private companies, small companies, negotiated lenders, private transactions, by having some different disclosure standards what you really are doing is not changing the standards but you're forcing certain populations to migrate as they grow. That would be one possibility. The other is over the passage of time you might cut the thresholds and force people to migrate accordingly. The other aspect is this concept of levels of assurance associated with the disclosures. I can accept less assurance on certain items. And that hopefully obviously would translate into cost; less assurance, less liability, therefore less cost if we assume that the big component of this is the litigation issue. We hear all the time about the small end borrower shifting to review, shifting to compilation. They are using a migration already and they're transitioning backwards. [Also included in 2(d) and 18(c)] [TC 3/11, p. 65-66]
[Context] Responses to the postmeeting questionnaire to the March 17, 1993 Investor Discussion Group meeting.
QUESTION 19
Companies and their public accountants today face significant litigation related to their association with external financial reporting. All parties generally agree that companies and auditors should be responsible for their actions, and that legal remedies for misconduct are an appropriate and powerful inducement to professionals to adhere to proper standards of conduct. However, some believe that the current legal environment is seriously out of balance and results in unintended costs that exceed the benefits. They argue for certain reforms that they believe will restore balance. Those reforms include adopting a separate and proportional liability rule in place of the existing joint and several rule, shifting the prevailing party's attorneys' fees to the losing party, and permitting the incorporation of accounting firms. Others disagree that the existing system is out of balance. They believe that the existing principles and rules are necessary to provide the appropriate inducement to professionals, and to fairly compensate victims of misleading reporting for their losses.
a. What positive effects do you believe the current threat of litigation has on the auditors' work and/or on financial reporting? (Check as many boxes as are appropriate.)
1. It forces the auditors to 4
increase the quantity of auditing
tests and procedures.
2. It forces the auditors to 5
elevate the quality of their work.
3. It forces companies to disclose 2
more information about potential
"downside" risks.
4. It forces companies to elevate 3
the quality of their financial
reports.
5. Other. Please describe: Participant I-9: Most fraud that I
have been involved with relateds to
current assets or liabilities.
Auditors must be accountable for
certifying inventories, net
receivables, reserves are
appropriate.
b. What negative effects do you believe the current threat of litigation has on the auditors' work and/or on financial reporting? (Please check as many boxes as are appropriate)
1. It imposes unnecessary legal 3 costs on companies and increases the costs of audits (costs which are ultimately borne by the users of financial reports). 2. It provides auditors with a 1 disincentive to associate themselves with "riskier" clients (perhaps because of the nature of the client's industry or the client's financial condition at one point in time). 3. It reduces companies' 2 willingness to experiment with new disclosures that could be helpful to users of financial reports. 4. It leads to a detailed 3 "cookbook" approach to accounting that emphasizes strict "legalistic" compliance with detailed rules rather than focusing on broad reporting objectives that better reflects the economic substance of a company's business activities. 5. It creates an attitude toward 3 financial reporting that encourages "over-conservatism" to protect the preparer and auditor. 6. Other. Please describe:
c. On balance, do you believe that the current litigation environment has a net beneficial or detrimental effect on the quality and cost of external financial reporting?
BENEFICIAL 4 DETRIMENTAL 1
d. Do you believe that the current litigation environment has a net beneficial or detrimental effect on the quality and cost of audits of financial statements?
BENEFICIAL 3 DETRIMENTAL 1
Participant I-16: Incentives encourage better performance. For some, such as auditors, it is difficult to measure performance (absence of mistakes) and create incentives. It may be appropriate to pay substantial fees and impose sanctions for poor performance in the form of legal liability for mistakes. Joint and several liability is wrong and the English rule of loser paying all court costs would be appropriate.
COMMENTS Participant I-9: Auditors must use reasonable common sense as business in determining how far to go in an audit - i.e. check out invoices and inventories of a second-rate discounter in poor financial more than [names deleted]. This should not be unduly burdensome and this expense is one that shareholders would not object to.
[PMQI 3/17, p. 33-35]
[Context] Responses to the postmeeting questionnaire of the March 11, 1993 Creditor Discussion Group meeting.
QUESTION 19
Companies and their public accountants today face significant litigation related to their association with external financial reporting. Some believe that the threat of litigation has a net positive effect on the auditors' work and on financial reporting in general, others believe it has a net negative effect.
a. What positive effects do you believe the threat of litigation has on the auditors' work and/or on financial reporting? (Check as many boxes as are appropriate)
9 1. It forces the auditors to increase the quantity of auditing tests and procedures.
10 2. It forces the auditors to elevate the quality of their work.
Participant C-11: It should, anyway.
7 3. It forces companies to disclose more information about potential "downside" risks.
4 4. It forces companies to elevate the quality of their financial reports.
1 5. Other. Please describe:
Participant C-12: It encourages auditors to consider the bigger picture (or to do a simple "reality check") e.g. 1) how is the [name deleted] able to lend enormous amounts on developmental real estate (a known high risk asset) without reporting much loan loss expense? 2) To the extent that audited financial statements are used to sell high-risk securities (i.e., capital debt) to unsophisticated investors (i.e., branch customers), should the auditors apply stricter standards (or more aggressive business judgment about the client)?
Participant C-4: The threat of litigation is essential to keep external accountants accountable!
b. What negative effects do you believe the threat of litigation has on the auditors' work and/or on financial reporting? (Please check as many boxes as are appropriate)
3 1. It imposes unnecessary legal costs on companies and increases the costs of audits (costs which are ultimately borne by the users of financial reports).
6 2. It provides auditors with a disincentive to associate themselves with "riskier" clients (perhaps because of the nature of the client's industry or the client's financial condition at one point in time).
Participant C-5: Where audits needed.
4 3. It reduces companies' willingness to experiment with new disclosures that could be helpful to users of financial reports.
6 4. It leads to a detailed "cookbook" approach to accounting that emphasizes strict "legalistic" compliance with detailed rules rather than focusing on broad reporting objectives that better reflects the economic substance of a company's business activities.
4 5. It creates an attitude toward financial reporting that encourages "over- conservatism" to protect the preparer and auditor.
2 6. Other. Please describe:
Participant C-4: Although it raises costs, every industry is faced with higher costs because of the threat of legal action. Why should CPAs be exempt? If anything, our entire legal system needs modification, particularly in the area of TORTS!
c. On balance, do you believe that the current litigation environment has a net beneficial or detrimental effect on the quality and cost of external financial reporting?
7 BENEFICIAL 5 DETRIMENTAL
Participant C-4: Quality outweighs cost.
d. Do you believe that the current litigation environment has a net beneficial or detrimental effect on the quality and cost of audits of financial statements?
7 BENEFICIAL 5 DETRIMENTAL
Comments:
Participant C-8: It has not been all bad.
Participant C-15: Regular semi-annual meetings with Task Force or one on one discussions by AICPA board members and creditors.
Participant C-12: This is a societal problem, not just an accounting problem.
Participant C-11: So far I have not heard auditors say that they are taking steps to improve the quality of auditing.
Participant C-21: Sometimes a correct is necessary; however, litigation continuing at its current level is now having a negative impact.
[PMQC 3/11, p. 31-33]