I’m not a lawyer though I’ve done my share of arguing in front of HM Revenue and Customs General Commissioners and briefing counsel on litigious matters. It can be tough yet rewarding work.
Over the weekend Francine McKenna sent me the amicus brief submitted on behalf of AICPA and NYSSCPA in the case of Teachers’ Retirement System of Louisiana and City of New Orleans Employees’ Retirement System v PwC and others. For those that don’t know, an amicus brief is defined at Wikipedia as:
An amicus curiae (also spelled amicus curiæ; plural amici curiae) is someone, not a party to a case, who volunteers to offer information to assist a court in deciding a matter before it. The information provided may be a legal opinion in the form of a brief (which is called anamicus brief when offered by an amicus curiae), a testimony that has not been solicited by any of the parties, or a learned treatise on a matter that bears on the case. The decision on whether to admit the information lies at the discretion of the court.
That’s good enough for our purposes. At this point I’ll add that it is increasingly rare for me to comment on these matters since Francine does such a good job. However, there are principles at stake which are worth the airing.
The great thing I find about US legal documents is that they are remarkably easy to understand compared to UK briefs. The language used is often straightforward and the precedents easily referenced. In this case though, the brief reads like an alarm bell. The choice of language is alarmist and repetitive:
The potential implications of these cases are vast. The Appellants in both cases seek to eviscerate related defense of in pari delicto, long available to auditors and other professionals in connection with claims asserted by or on behalf of companies whose senior managers defrauded their auditors, the market, and the investing public. Gutting those doctrines, even if only at the motion to dismiss stage, would expand auditor liability well beyond the boundaries of established precedent and out of proportion to an auditor’s ability to detect and prevent management fraud. The expenses of litigation and discovery in accounting fraud cases can be so significant as to virtually compel accounting firms to settle even the least meritorious claims, the costs of which may be passed on to clients in the form of higher fees.
Among the AICPA’s purposes are the promotion and maintenance of high professional standards of practice. Because of its historical role in formulating standards relating to audits, reviews, compilations, and attest engagements, and the reports issued thereon, the AICPA maintains a strong interest in the scope and bases of civil liability sought to be imposed on accountants pursuant to those standards……Over the past twenty years, the NYSSCPA has submitted numerous briefs to the Court as amicus curiae so that the Court’s rulings that affect the accounting profession can take into consideration professional standards and policy matters that might otherwise not be brought to the Court’s attention. The NYSSCPA believes that its perspective, which is based on a broad, historical understanding of the accounting profession as the oldest and one of the largest statewide accounting organizations in the country, will assist the Court in considering the issues presented in this appeal.
“[A]udits are performed in a client-controlled environment,” and “the client necessarily furnishes the information base for the audit.” Auditors, therefore, must rely on management to provide them with financial information relevant to the audit.Moreover, deceptive conduct by company personnel can interfere with the auditor’s detection of misstatements, because management typically has the ability to manipulate accounting records and override internal controls. For this reason, management is required to provide specific representations to an auditor relating to, among other things, management’s responsibility for the fair presentation of financial position, results of operations and cash flow, and management’s belief that the financial statements are fairly presented in accordance with Generally Accepted Accounting Principles (“GAAP”). GAAS also specifically recognize that even a properly planned and performed audit cannot guarantee prevention or discovery of all material misstatements, particularly those resulting from management fraud.”[my emphasis added.]
When a company is meeting or exceeding expectations and returning value to its shareholders, there is a natural inclination to not ask too many questions about how management is achieving those results – in fact, there may be a strong temptation for directors and shareholders to look the other way even if things don’t seem quite right. This is because the shareholders and directors may themselves be benefiting from the fraud, even if they don’t exactly know (or don’t want to know) of its existence. Therefore, in those cases, courts use mechanisms such as imputation and in pan delicto to realign the shareholders’ and directors’ interests with those of potential investors, by preventing them from shifling responsibility for management fraud onto third parties.
If we accept that the relationship that exists is: 1. management owes a fiduciary responsibility to shareholders and that 2. the purpose of the audit is to protect the interests of the shareholders then how is it logically possible to assign a kind of joint responsibility to shareholders for the actions of management and thereby limit audit responsibility. It does not make logical sense unless you think that shareholders and management are one and the same. If you accept that then the whole premise of any audit crumbles to dust. And, in the context of this brief, how is it possible to somehow invoke the ‘nod and wink’ defense with any plausibility without accepting that the very purpose of audit is to counter the ‘natural inclination?’ It is nonsensical at best.
To make matters just that bit more interesting, the brief acknowledges that:
The courts have acknowledged that nearly every corporate officer who engages in fraud may benefit personally through performance-based bonuses or increased stock price. Indeed, to suggest that a manager who fraudulently inflates his company’s results in order to increase his own compensation or the value of his shares has “totally abandoned” the company’s interests ignores the very purpose of incentive- or stock-based compensation, which is to align the interests of the company and management.
It seems under this finding, the auditors gets a pass. But if that is known to be the case (see my emphasis added) then surely the auditor should be held accountable for missing something that everyone else seems to know is likely to occur? Apparently not. The expression: ‘Let the good times roll and damn the rest’ springs to mind. Yet in my experience it is when things seem to be going exceptionally well that auditors should be at their most vigilant.
Finally, the brief tries to cement its position by arguing the principles that protect auditors are well established and that to set them aside would mean huge implications for policy. Why should this be an issue? In the 19th century we used to hang people for stealing sheep until we realized that was inhuman and harsh. We used to think slavery was perfectly acceptable. Yet here we have a form of slavery that keep corporations coming back for more audit of a kind that is apparently no longer attempting to undertake the basics of shareholder protection yet sucks money out of the business. How is that right while at the same time providing protection to the very people who are supposed to protect shareholder interests? Again, it doesn’t make sense.
Shame on you AICPA and NYSSCPA for thinking that 21st century commerce can be conducted on this antiquated and outmoded system of avoiding responsibility. It is time for change because quite frankly this constant game of cat and mouse is in nobody’s interests.
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