I’ve been mulling over the Moore Stephens case reported in the FT and subsequently AccountancyAge. The background: Moore Stephens audited Stone & Rolls but S&R defrauded its banks. S&R was sued for $94 million in 2002 which led to its collapse. In turn, the company sued Moore Stephens via a third party in the hope of claiming damages. First the FT:
Britain’s highest court ruled that Stone & Rolls’ liquidators, who were pursuing the case on behalf of the creditors, could not bring a claim for damages when the company itself was responsible for the fraud.
Legal experts said the judgment would block creditors from pursuing lawsuits against accountancy firms when a powerful executive masterminded a criminal scheme.
Stone & Rolls’ liquidators had argued that the company’s auditors, Moore Stephens, should have spotted the fraud because that was what they had been hired to do. But the law lords refused to depart from an ancient legal maxim – known in Latin as “ex turpi causa non oritur actio” – that nobody can bring a cause of action based on his own criminal conduct.
Tim Strong of Barlow Lyde & Gilbert believed the ruling did not apply to the largest businesses, usually audited by the Big Four, and not controlled by individual or families, so the leading firms could still find themselves dragged through the courts.
‘[The ruling]is quite narrow in principle. It’s relevant for the mid-tier which deal with a lot of “one man companies” and smaller businesses run by families, but it’s unlikely to have an impact on the biggest cases,’ said Strong.
What’s interesting here is that two of the judges dissented. Back to the FT:
In a sharply worded dissenting opinion to the judgment, Lord Mance warned that it was contrary to public policy to insulate auditors from the consequences of failing to scrutinise the activities of “one-man” fraudsters.
“In my opinion, English law does not require it,” Lord Mance said.
Rather than clarify the situation, I am wondering whether the law lords have muddied the waters. It is clear that litigants in fraud cases now believe they have an open door through which to attack accountants in the belief they will likely have the deepest pockets. The public policy of applying ex turpi goes some way towards moderating that but the dissent suggests the mood has changed – at least in the minds of some law lords.
I was not familiar with the practice of third party funding to pursue such cases in the expectation of taking a piece of the action. In my opinion, that should be constrained to very specific types of case because it is too easy to abuse. Mid-tier firms are particularly vulnerable because as Francine McKenna explained to me, they have no choice but to resist claims to the bitter end. This contrasts sharply with the Big Four who will usually settle before a case comes to court. That allows them to preserve their perceived reputation, keep facts out of the public domain and mitigate costs and damages at an early stage.That may change with Parmalat, Madoff and Satyam, all of which implicate and expose the Big Four to varying degrees.
The bigger issue that has yet to be clarified centres around audit duty. It now seems that despite the well known notion that audit is not designed to detect fraud, litigants believe otherwise. There is a welter of cases in the pipeline. The profession needs to know where the line is positioned. In my view that’s not something that can be settled in court because as we know, court decisions are subject to all manner of variables – not least the ‘mood’ at the time. Moore Stephens is a great case with which to demonstrate the problem. It seems to me the time has come for legislators to reconsider this issue. I am not hopeful.
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