I usually spend two class periods discussing auditors’ legal liability. On the first day, I explain through lecture and examples the auditor’s liability to clients and third parties under common law and statutory law. On the second day, we discuss a specific lawsuit against an auditor. For several years, I assigned my students to read Cottrell & Glover’s CPA Journal article describing the Phar-Mor suit because it provides the best analysis I have found of an actual jury trial. The article outlines the legal issues in dispute, the evidence offered by the shareholder plaintiffs, and the defenses attempted by Coopers & Lybrand. More recently, I have assigned the Heilig-Meyers case, which requires students to analyze a lawsuit filed by shareholders against Deloitte & Touche following Heilig-Meyers’ bankruptcy.
I like to spend the last 20 minutes of the second day discussing proposals to limit auditors’ legal liability. Stephen Taub’s CFO.com article describes one such proposal. Rob Lewis’s AccountingWeb.com article suggests that some sort of cap is necessary if the big accounting firms are to survive. Geiger et al.’s JAAP article warns that limiting auditors’ liability may hurt audit quality.
“Auditors Beware: Key Factors Can Lead to Lawsuits,” James H. Thompson and Earnestine S. Quinn, Business Forum (Summer/Fall 1996): 22-28. This article provides a good overview of auditor liability to clients and third parties under common law and statutory law.
“The Harder They Fall: Will the Big Four Survive the Credit Crunch?” Rob Lewis, AccountingWeb.com (October 1, 2008). The six largest accounting firms face 27 outstanding lawsuits seeking damages in excess of $1 billion, including 7 suits exceeding $10 billion.
“SEC’s Hewitt: Indemnify the Big Four,” Stephen Taub, CFO.com (January 26, 2007). SEC chief accountant Conrad Hewitt wants Congress to limit auditors’ liability to investors and creditors; fears losing one or more of the Big Four through litigation.
“Audit Engagement Provisions Raise Queries,” David Reilly, Wall Street Journal (March 6, 2006): C1+C3. Accounting firms ask clients to sign engagement contracts promising to forego punitive damages and settle disputes through arbitration rather than litigation. Some critics argue that such provisions impair auditor independence.
“Finding Auditors Liable for Fraud: What the Jury Heard in the Phar-Mor Case,” David Cottrell & Steven Glover, CPA Journal (July 1997): 14-21. Investors and creditors of failed retail giant Phar-Mor sued Coopers & Lybrand claiming the auditors violated Section 10(b) of the Securities Exchange Act of 1934. This article summarizes the plaintiffs’ allegations and the defendants’ defenses.
“The Rise and Fall of Heilig-Meyers,” Paul Clikeman, Journal of Accounting Education (December 2005): 215-231. The second part of this two-part case requires students to analyze a lawsuit filed by shareholders against Deloitte & Touche following Heilig-Meyers’ bankruptcy.
“Brodnax Minerals Company: A Case Study on Auditors’ Responsibilities,” John Reisch, Issues in Accounting Education (November 1999): 589-612. Students conduct a mock trial to resolve litigation between external auditors and shareholders who lost billions of dollars as a result of a massive fraud.
“Using Financial and Market Information to Identify Pre-Engagement Factors Associated With Lawsuits Against Auditors,” J.D. Stice, Accounting Review (July 1991): 516-533. Lawsuits against auditors are more frequent when: inventory and accounts receivable are high as percentage of total assets, the client’s financial condition is poor, the market value of the client’s stock is high, and the variance of the client’s abnormal stock returns is high.
“The Effects of Client Characteristics on Auditor Litigation Risk Judgments, Required Audit Evidence, and Recommended Audit Fees,” Jamie Pratt & J.D. Stice, Accounting Review (October 1994): 639-656. Auditors appear to gather more evidence when they perceive a high risk of litigation. And auditors appear to charge a “premium” for high-risk audits over and above the cost of performing additional audit procedures.
“Auditor Decision-Making in Different Litigation Environments,” Marshall Geiger, K. Raghunandan & D.V. Rama, Journal of Accounting and Public Policy (May/June 2006): 332-353. The legal protections provided by the Private Securities Litigation Reform Act of 1995 appear to have made Big Six auditors less conservative in their going concern reporting decisions.