The Club to Resolve Auditor Quarrels (CAQ)

Well, here we go again.

It’s a good thing too, since they’re not all on the same page with everything and may need to discuss other alternatives soon. (Maybe the Department of Justice should move its listening devices from the black tie events on Long Island and put some in the new HQ of the CAQ…)

With an election coming in the US in 2008, the largest audit firms are forming a not-for-profit “advocacy” group, the Center for Audit Quality, “a place where the groups can discuss audit quality and issues such as the competitiveness of the capital markets with pension and mutual funds, lawmakers and publicly listed companies.”

Two former SEC officials (actually women, the better to show a softer side…) have been hired as Directors. The last time the auditors put on a big lobbying push, it was to squelch the push by former SEC Commissioner Arthur Levitt, pre-Enron, to eliminate the conflicts of interest inherent in the firms performing audits and consulting engagements for the same clients. They were so good at it, they even had Senator Paul Sarbanes of Sarbanes-Oxley fame as a supporter.

This time the big burr under their saddle is auditor liability. The number and size of settlements is growing and seems never ending. In future posts, we’ll look at the true financial position of the firms (at least as much as their limited public financials can tell us) and whether it’s really true, as the FT stated recently in relation to the Deloitte Parmalat settlement that , “…audit firms have limited resources and have rarely settled lawsuits for more than $200m.”

In the meantime, let’s take a look at what Deloitte says about the issue in their Worldwide 2006 Member Firms Annual Review: (I think you’re going to be seeing some of this language more and more.)

“The increasingly litigious environment in certain parts of the world is raising the legal costs and professional insurance costs—and the risk profile—of all global professional services organizations, particularly with respect to their audit functions.

Professionally related litigation is a problem for all professional services providers. With respect to management fraud, auditors are increasingly subject to immediate regulatory action and civil litigation whenever fraud is exposed in public companies—including systemic collusive fraud by management —a phenomenon that the audit was never designed to guarantee against. That effectively places audit firms in the position of insurers of the capital markets, which is an unsustainable position. This is not to say that auditors should not be subject to legal action if they are involved in collusive fraud (although this is rarely the case) or where there has been some other significant failure to perform in accordance with professional standards.

Deloitte member firms maintain professional liability insurance coverage; but in the profession as a whole, insurance has become increasingly difficult to obtain in the commercial market. Each Deloitte member firm is required to purchase professional liability insurance to the extent it is available, customary according to the laws under which it operates and at a level that is believed to be appropriate for the risks associated with the services it provides. Notwithstanding, such insurance protection is far less than the potential exposure to claims against the profession.

While Deloitte member firms have been able to effectively manage around these risks (???), this environment—particularly as it continues to develop—is a significant challenge to Deloitte member firms and other professional services organizations. Deloitte member firms, like the others, are private partnerships, which is the legal requirement in many markets. This is creating negative ramifications for operating the business and increases the personal liability for the owners. This, in turn, may also negatively affect the ability of member firms to attract and retain talented people; and the cost of services, and, if not rationalized, may inevitably have an impact on the long-term viability of professional services.