BLG Accountants’ Professional Indemnity Issues and Liability Exposures By Simon Konsta

BLG Basic Insurance Requirements  ICAEW requires any member holding a practising certificate to take out professional indemnity insurance  Minimum levels of cover x gross fee income, minimum £50,000  PII must be obtained from a Participating Insurer  ICAEW requires any member holding a practising certificate to take out professional indemnity insurance  Minimum levels of cover x gross fee income, minimum £50,000  PII must be obtained from a Participating Insurer

BLG Basis of Cover  Civil liability incurred in conduct of professional business  Development in range of services provided an issue:  Investment advice  D&O  Management Consultancy  IT Consultancy  Corporate Finance  The need for adequate understanding of business services, nature of client base etc  Civil liability incurred in conduct of professional business  Development in range of services provided an issue:  Investment advice  D&O  Management Consultancy  IT Consultancy  Corporate Finance  The need for adequate understanding of business services, nature of client base etc

BLG The Nature of the Risk Sample  Claims or circumstances referred to this firm  Period - May 2000 to May 2001  Population - overseas claims excluded - sole practitioners to “Big 5” Assumption  Informed assessment of maximum potential exposures, net of costs Sample  Claims or circumstances referred to this firm  Period - May 2000 to May 2001  Population - overseas claims excluded - sole practitioners to “Big 5” Assumption  Informed assessment of maximum potential exposures, net of costs

BLG Source of Claims Activity% Tax33.3Corporate and personal Audit 29.0Private and public companies Transactional 16.6M & A, corporate finance/reporting and due diligence Insolvency 7.5Liquidations, receiverships and other insolvency functions Accountancy 5.5Valuations and general accounting Trusts 3.7Trustees and executors Consultancy and Others 4.4Predominantly IT Activity% Tax33.3Corporate and personal Audit 29.0Private and public companies Transactional 16.6M & A, corporate finance/reporting and due diligence Insolvency 7.5Liquidations, receiverships and other insolvency functions Accountancy 5.5Valuations and general accounting Trusts 3.7Trustees and executors Consultancy and Others 4.4Predominantly IT

BLG Degree of Exposure  Banding of claims or circumstances (a)Less then £50,000 (b) More than £50,000, less than £100,000 (c)More than £100,000, less than £500,000 (d) In excess of £500,000  Tax, consultancy and other categories - general spread amongst bands.  Audit - 50% in (d) category but otherwise evenly spread amongst (a) - (c).  Transactional - 88% in category (d) with a greater potential for catastrophic losses.  Banding of claims or circumstances (a)Less then £50,000 (b) More than £50,000, less than £100,000 (c)More than £100,000, less than £500,000 (d) In excess of £500,000  Tax, consultancy and other categories - general spread amongst bands.  Audit - 50% in (d) category but otherwise evenly spread amongst (a) - (c).  Transactional - 88% in category (d) with a greater potential for catastrophic losses.

BLG Other Features  Fraud  significant contributing factor in 20.3% of cases  significant contributing factor in 28% of audit claims  Insolvency: 27% of cases connected to insolvency or client failure  Institute or other regulatory involvement: 16%  Fraud  significant contributing factor in 20.3% of cases  significant contributing factor in 28% of audit claims  Insolvency: 27% of cases connected to insolvency or client failure  Institute or other regulatory involvement: 16%

BLG The statistics in context  Developments in the duty of care  The Caparo influence - restriction on statutory auditors’ duties of care  Invaluable tool for discouraging and disposing of third party audit-derived claims  But not an accountants’ charter + audited company suffering recoverable losses may still sue + statement of tortious principles applied to establish duties to third parties  Developments in the duty of care  The Caparo influence - restriction on statutory auditors’ duties of care  Invaluable tool for discouraging and disposing of third party audit-derived claims  But not an accountants’ charter + audited company suffering recoverable losses may still sue + statement of tortious principles applied to establish duties to third parties

BLG Risk Assessment Post Caparo  Transactional Work  Myriad of duties and potential duties  ADT v. Binder Hamlyn  Audit derived but multiplied exposure  Negligent misstatement  Rigorous risk management procedures  Transactional Work  Myriad of duties and potential duties  ADT v. Binder Hamlyn  Audit derived but multiplied exposure  Negligent misstatement  Rigorous risk management procedures

BLG Risk Areas Post Caparo (2)  Killick & Arthur v. PricewaterhouseCoopers  Benfield Greig Group Plc  Buy-back valuation  Alleged duty owed to shareholders  HELD: duty owed on Caparo grounds.  Regulatory Work  CAA v. Kounis Freeman  Law Society v. KPMG  Conclusion?  Enhanced risk associated with regulated clients  Killick & Arthur v. PricewaterhouseCoopers  Benfield Greig Group Plc  Buy-back valuation  Alleged duty owed to shareholders  HELD: duty owed on Caparo grounds.  Regulatory Work  CAA v. Kounis Freeman  Law Society v. KPMG  Conclusion?  Enhanced risk associated with regulated clients

BLG Causation and Loss  Recent decisions reflect judicial reluctance to make professional advisers warrantors that (a)a company or business will be profitable; or (b)a transaction will be successful  The Courts will not contemplate an outcome by which the professional is deemed to underwrite a transaction or a company’s business fortunes  Recent decisions reflect judicial reluctance to make professional advisers warrantors that (a)a company or business will be profitable; or (b)a transaction will be successful  The Courts will not contemplate an outcome by which the professional is deemed to underwrite a transaction or a company’s business fortunes

BLG Causation and Loss (2)  Scope of Duty  South Australian Asset Management Corporation -v- York Montague Limited [1997] AC “But for” test not sufficient in itself + what consequences are attributable to the wrongful act of the accountant?  Causing loss vs occasioning the opportunity for losses to arise  Galoo Limited -v- Bright Grahame Murray [1994] 1 WRL Was the loss, as a matter of law, caused by the breach of duty? + Trading losses held to be irrecoverable  Scope of Duty  South Australian Asset Management Corporation -v- York Montague Limited [1997] AC “But for” test not sufficient in itself + what consequences are attributable to the wrongful act of the accountant?  Causing loss vs occasioning the opportunity for losses to arise  Galoo Limited -v- Bright Grahame Murray [1994] 1 WRL Was the loss, as a matter of law, caused by the breach of duty? + Trading losses held to be irrecoverable

BLG Causation and Loss - What will be recoverable?  Overpayments  Money wrongly paid out  Audit - dividends paid out of capital due to overstatements of profit  Galoo tempered by Sasea Finance -v- KPMG (trading losses occasioned by fraud)  Defalcations by director or employee  Overpayment of tax and penalties  Wasted accountancy costs and management time  Plant & Planters (London) Ltd v. K J Fisher  Overpayments  Money wrongly paid out  Audit - dividends paid out of capital due to overstatements of profit  Galoo tempered by Sasea Finance -v- KPMG (trading losses occasioned by fraud)  Defalcations by director or employee  Overpayment of tax and penalties  Wasted accountancy costs and management time  Plant & Planters (London) Ltd v. K J Fisher

BLG Company Law Review - Key Proposals  Status of Caparo “For some time, the basis of this ruling [Caparo] has been regarded as outdated and in need of reform to accord with the demands of a modern economy, where those who attach importance to the audit of financial statements include future investors/shareholders, suppliers, employees and creditors (including banks) to name but a few” - Developing the Framework - March 2000  Auditors’ duty of care to be extended to creditors and potential creditors and investors in their capacity as such if legislation capable of being drafted  Status of Caparo “For some time, the basis of this ruling [Caparo] has been regarded as outdated and in need of reform to accord with the demands of a modern economy, where those who attach importance to the audit of financial statements include future investors/shareholders, suppliers, employees and creditors (including banks) to name but a few” - Developing the Framework - March 2000  Auditors’ duty of care to be extended to creditors and potential creditors and investors in their capacity as such if legislation capable of being drafted

BLG Company Law Review - The Volte-Face “In view of the weight of these responses and the arguments raised we do not believe that the case has been made out for statutory extension of the duty of care of auditors in the way suggested in Completing the structure.” “It is widely recognised that auditors’ so called “deep pockets” have ensured that, of the possible targets of professional negligence claims for financial loss caused by mis-statement in accounts, they are the favourites. This field of litigation has expanded hugely over the the last 35 years. Auditors’ exposure is now very great. It would be exacerbated by our recommendations widening their functions”. - Final Report - June  In short, development of the law of auditors negligence to be left to case law. “In view of the weight of these responses and the arguments raised we do not believe that the case has been made out for statutory extension of the duty of care of auditors in the way suggested in Completing the structure.” “It is widely recognised that auditors’ so called “deep pockets” have ensured that, of the possible targets of professional negligence claims for financial loss caused by mis-statement in accounts, they are the favourites. This field of litigation has expanded hugely over the the last 35 years. Auditors’ exposure is now very great. It would be exacerbated by our recommendations widening their functions”. - Final Report - June  In short, development of the law of auditors negligence to be left to case law.

BLG Company Law Review - Additional Protection from Abuse  Limiting liability  Repeal of Section 310 Companies Act  Ability for auditors contractually to limit their liability subject to shareholder approval in general meeting and disclosure in audit report  Attribution  Fraud and breach of duty of directors and employees  Enhanced obligation of disclosure on directors in audit context  Limiting liability  Repeal of Section 310 Companies Act  Ability for auditors contractually to limit their liability subject to shareholder approval in general meeting and disclosure in audit report  Attribution  Fraud and breach of duty of directors and employees  Enhanced obligation of disclosure on directors in audit context

BLG Risk Management - What is the profession doing?  Enhanced focus on risk management meeting:  Client expectation  Readiness to litigate  Departure from core auditing and accounting and auditing functions  ICAEW roadshows  Education, Guidance and Direction  Enhanced focus on risk management meeting:  Client expectation  Readiness to litigate  Departure from core auditing and accounting and auditing functions  ICAEW roadshows  Education, Guidance and Direction