The betting is that the vendor outsourcing a company's internal auditing function will be a chartered accountant. Therefore, to complete the discussion in the previous section about possible liabilities on the institution's side because of outsourcing one of its core functions, we should look at auditing liabilities issues which affect the CPAs. In the United States, such liabilities became a huge subject after the S&Ls (thrifts) meltdown of the late 1980s.
The big CPAs presently take very seriously the possible financial consequences of litigation regarding their external audits, let alone the added responsibility of outsourced internal auditing services. In England and in Luxembourg, the liquidators of BCCI claimed $8 billion from Price Waterhouse and Ernst & Young. This money was demanded because of the 1985 audit of the collapsed bank. Additional claims were filed in connection with the 1986 and 1987 audits.
In 1990, in Canada, Ernst & Young, and a predecessor of Peat Marwick Thorne, paid a major portion of a C$125 million settlement in connection with the failure of two Canadian banks. Price Waterhouse was sued in Hong Kong with regard to the bankruptcy of Peregrine Investments in early 1998, in the aftermath of the East Asia meltdown.
In the early 1990s, in Australia, KPMG settled for A$100 million in a A$ 1.1 billion suit resulting from the audit of Tricontinental Corporation, a government-owned merchant bank. Ernst & Young was sued for A$175 million by the liquidator of the investment bank Duke Group; this case was settled for A$35 million.
In London, a High Court judge found an accounting firm liable for negligence in permitting a loss-making Lloyd's of London syndicate to close its accounts. By implicating the syndicate's auditors, Ernst &
Whinney (now part of Ernst & Young), this ruling made it easier to extract cash to finance a settlement offer to the insurance market's litigating names.
Coopers & Lybrand in the United Kingdom and in Singapore and Deloitte & Touche in Singapore have put up to £33 million ($54 million) as a 'contribution from auditors' because of alleged negligence in the Barings case. This is part of £91 million ($151 million) available to the liquidators,
The Contribution of External Auditors 335 the next biggest sum to that of the auditors has come from a 'contribution from certain other covenants'.
Big as they may seem in absolute terms, these sums are a bargain since claims for damages in the English auditors' action have been estimated before interest, as being at least £1 billion ($1.65 billion) including goodwill; or £560 million ($930 billion) excluding goodwill. The liquidators reached this figure by considering the claim as in essence monies which went out of Barings Futures Singapore on unauthorized trades after the date at which Nick Leeson's activities should have ceased - if the audit had not been carried out in an allegedly negligent manner.
On paper, the difference between £33 million and £1 billion is tremendous, but in the world of auditor liability nothing is as cut and dried, and at that time (mid-1988) precedents were thin. It fact, executives from chartered accountants' firms suggested that the external auditor relies, in part at least, on the assurances provided by the company's management.
Therefore, even if there was some misinterpretation and misrepresentation it was not all the external auditors' fault.
In the Barings case, the external auditors asserted that at the time of the collapse their firm had not signed its audit opinion and had not completed its audit work. Coopers & Lybrand maintained that it had not exhausted the audit work which could have led to the identification of Nick Leeson's alleged frauds. Hence the chartered accountants' argument concerned contributory negligence by various members of the senior management team at Barings.
There is also a matter of coverage by insurance. Coopers' insurance cover was shown to be £47.06 million ($78 million) subject to an excess which had already been exhausted. Deloitte & Touche Singapore's cover did not exceed £55 million. At the bottom line this means that whatever is not covered by insurance should be paid by the partners. In terms of capital reserves, however, accountants are not banks with minimum capital requirement established by regulators.
• CPAs do not accumulate capital reserves beyond those necessary to meet their day-to-day, operating requirements
• This carefully crafted argument is upset if a court decides that the partners are personally responsible.
All this is food for thought in terms of giving the external auditors more assignments, like the responsibility for auditing internal control and indeed for substituting themselves for a company's internal auditors. As the Barings bankruptcy case demonstrates, the normal hazards of litigation
336 Case Studies on Implementation
increases greatly in the case of global operations. They would grow further if internal controls were audited.
Besides this, the complexities of global internal controls and personal accountability are such that legal cases would drag on for years, with discovery after discovery being inconclusive if not outright controversial.
Nor are common sense and logical thinking good guides in the sea of litigation. The life of the law is not logic but experience, as Justice Oliver Wendell Holmes once said.
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Appendix of Participating Organizations
The following organizations, through their senior executives and system specialists participated in the recent research projects that led to the contents of this book and its documentation.