Professional negligence claims against auditors and accountants/tax advisers
3rd September 2014 by Fiona Hotston Moore
In the past negligence claims against professional advisers were rare. However, in recent years, clients and other third parties have become more willing to pursue claims against professional advisers and a number of substantial claims have been filed.
The issues surrounding ‘auditor negligence’ differ from the wider issues of negligence by accountants and tax advisers.
When is an auditor negligent?
The duties of an auditor are found within the Companies Act, the profession's Auditing Standards and the client’s engagement letter.
In giving a clean audit opinion the auditor is representing to the company that the financial statements contain no "material misstatement" and that they give a true and fair view of the state of the company's affairs.
Professional negligence claims against auditors can be brought by the company or, in restricted circumstances, by third parties to whom the auditors vouched the accuracy of the financial statements. For example prospective purchasers of a company.
Claims can be for negligence leading to failure to uncover fraud or negligence leading to a failure to discover a material error in the financial statements resulting in the auditor giving an incorrect audit opinion.
The case of Stone & Rolls v Moore Stephens established that the company cannot bring a claim for auditor negligence in cases of fraud unless there is an innocent shareholder. In Stone & Rolls there was only one shareholder and that individual was the perpetrator of the fraud.
Furthermore auditors are not automatically responsible for detecting fraud. However auditors are required under Auditing Standards to consider the risk of fraud and plan and conduct their audit accordingly.
An auditor is judged against the standards of a reasonably competent auditor and Auditing Standards tend not to be prescriptive, allowing the auditor to exercise professional judgement. An expert witness will give an opinion on what work a reasonably competent auditor should have undertaken and the conclusions they would have reached.
The UK Financial Reporting Council (FRC) noted in 2013 that some auditors were failing to adhere to ethical standards and/or to demonstrate sufficient professional scepticism. The FRC reported an increase in audits needing significant improvement from 10% to 15%.
The FRC also noted particular concerns about the auditing of loan book provisions which is an area of weakness the author has also noted.
In the US a recent study again reported a failure by auditors to demonstrate professional scepticism as well as a failure to assess fraud risk and to make basic mistakes in audit process. The authors suggested auditors made errors due to fee constraints or a concern that by pressing clients for answers they would alienate the client.
In my professional experience the commonest failures by auditors include:
- A failure to demonstrate appropriate professional scepticism, which is particularly dangerous when exhibited by the senior members of the audit team;
- A failure to set and use an appropriate materiality level which then undermines the whole audit process;
- A failure to follow the firm's audit guidelines and manual;
- A failure to investigate errors arising in the sample during audit testing;
- A failure by the audit partner to investigate questions or review points raised by audit team members; and
- A failure to adequately audit the going concern assumption upon which financial statements are normally based.
Our work as an expert witness will involve a detailed review of the auditor's working papers, any related correspondence and potentially re-performing audit work.
Aside from claims against auditors, claims against accountants for negligence typically arise from defective tax advise including the promotion of tax schemes, corporate finance work or business valuations. However I have seen a variety of other claims including one arising out of a referral to another firm where the claimant felt the referral had been given without sufficient care. The claimant will need to show that, due to an act or omission by the firm (or its employees and associates), the claimant suffered a loss and that the claimant was owed a duty of care.
An expert witness can give an opinion on whether the adviser was negligent and whether their conduct fell short of the standards of a reasonably competent professional as well as potentially giving an opinion on the quantification of the loss.
For further information on our forensic accountancy services please contact our Forensic Team
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