Case B –Auditor Liability
Do you agree with the ruling in the Hercules Management case?
Yes I agree with Supreme Court decision and the view that the essence of audit reports is for shareholders to assess the performance of management. Yet the distinction drawn by the court with respect to the purposes for which financial statements are prepared is tenable. This is because one’s investment cannot be used as one’s oversight and evaluation of management’s performance. Nevertheless, Hercules provides authoritative precedent for future courts to negate a prima facie duty of care once established on the basis of policy. Hercules has however rendered future litigation useless and difficult to win by so doing. The financial statement of a company is such a technical document which may be difficult to be understood by the unprofessional shareholder and can only be understood by minority shareholders who may therefore have upper hand over the other investors.
Also individual investor do not have all the time as to analyze this corporate disclosure documents including the financial statements which the Hercules had erred by using it as a standard for making their investment decision. Financial statement is such a complicated and hard to comprehend document which in most cases is
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How hard is it for a shareholder to obtain a remedy in Canada?
With a common-law action?
Generally speaking it is harder for a shareholder to obtain a remedy in Canada under the common law as in the case of Hercules than under the securities act in Ontario as shareholders have limited remedies against auditors. Under common law, shareholders’ main right to demand payment is to bring an action on the basis of fraudulent or negligent misrepresentation. However in fraudulent misrepresentation suits, shareholders will be confronted with obstacles in gathering evidence in order to proof the fraud itself; in negligence cases, plaintiffs will need to proof that all of the fulfillments of the duty of care litmus test for negligent misrepresentation have been met including the establishment of a special relationship and dependability. They also required to proof that the existing policy rationales for limiting the extent of ability for strict economic loss cannot be applied to the case. Irrespective of whether the claim is one of fraudulent or of negligent misrepresentation, getting the mandatory certification in cases of class action will be associated with a lot of procedural limitations and obstacles.
How hard is it for a shareholder to obtain a remedy in Canada?
Under the Securities act in Ontario?
Under the securities act in Ontario, the requirement that the plaintiffs must proof reliance that exist under the common law is excluded.Therefore,the legislation will assist the transparency and accountability of auditors to the investors who largely depend on the reports of the audit including the financial statement.
The act 198 offers investors in the secondary market the opportunity to file a suit against issuers, executive directors, professionals like auditors,barristers,engineers medical doctors in the case of making a misrepresentations of any public document whether in the written form in speaking terms about the organization or for lack of compliance with the perpetual disclosure obligations. The typical example of liability will be whether the misrepresentations are made deliberately or not and not that whether or not investors ‘relied’ on the misrepresentation. For unconsciously made misrepresentations, liability is capped and is proportionate. For those made knowingly, liability is not capped and is joint and several.
Which jurisdiction do you believe has the most appropriate standard?
The Securities act of Canada has a better standard compared to the Common law regime as it removes the seeming “protection clause” on the auditors. The common law relying on facts and figures of previous judgments may not in reality be the appropriate solution to the shareholder-auditor suits. The Securities act of Ontario is however fair enough though not also without its lapses but the overall effect leaves the corporation, the auditor, investors, members of the public and the government a fair share and treatment in the issue. Under the Securities act jurisdiction, by using ‘knowledge’ as opposed to reliance as the premise of liability is beneficial for shareholders as it allows recovery by investors who may have suffered damage indirectly due to the effect of the misrepresentation on the security’s market price.
What changes would you make to the Canadian system?
Under the current Canadian regime, shareholders’ rights against auditors are limited. The precise and exact duty owed by auditors to shareholders is not defined either under statute or at common law. The corporate statute allows shareholders to appoint auditors but does not provide them with the ability and opportunity to select the corporation’s auditors through a true election. Furthermore, the common law regime provides few rights to shareholders. Hercules effectively objects claims of negligent misrepresentation by shareholders to auditors and class action lawsuits are in terms of procedure, difficult to bring forward. The proposed implementation of statutory liability for secondary market disclosures may enhance shareholder rights, but this remains to be seen. The changes will concentrate on the rights of shareholders vis-à-vis auditors and on the efficacy of these rights. These changes will specify the nature of the duty owed by auditors to shareholders. It will also attempt to strengthen existing shareholder rights by enabling shareholders to participate directly in the election and monitoring of the corporation’s auditors rather than mere rubberstamping by the shareholders, an already selected auditor by the management. The changes will prescribe all the aforementioned as important not just to invigorate shareholders’ rights as an end in it but also to improve company’s governance by improving management accountability and transparency by making auditors more independent.
Would audit quality improve in any jurisdiction in which auditors are exposed to greater liability and what are the cost and consequences of increased auditors’ liability?
From an economic perspective, a stringent and greater audit liability regime has several ramifications and complicated results. In the first instance, it may create incentive to auditors to increase their hard work and carry out more thorough and reliable transparent audits to the extent that this decreases their expected liabilities. Similarly, as a defensive mechanism, auditors may switch the pattern of the audit they perform and try as much as possible to avoid revealing an opinion on issues that has the potential of unmasking them to a potential liability, thereby decreasing the information content of the audit report. A related consequence is that auditors may attempt to minimize liability by selecting their clients carefully. In addition, the encouragements of shareholders and creditors may be decreased making them not being able to carry out their corporate control rights as a result of being absolutely insured by the audit liability regime. Other consequences include skyrocketed insurance premiums, accountants are confronted with higher cost, the opportunity cost in the time invested in litigation rather than in creating accounting revenue, decreased accounting services availability as corporations are driven to the wall and also can lead to a raised cost of the consumers.
Summarily, while the presence of audit liability is a pivotal motivating factor, some aspects of a severe liability system may motivate suboptimal behaviour, and potentially result in adverse effects on corporate governance and capital market efficiency; problems of command and control regulation. The cost of an improved liability of the auditors are also many as a widely cast duty of care will lead to the evolution of excessive negligence suits and this will further impose costs on the auditors who will now transfer this to the public investors. The total dollars that will be charged by the employed barristers will increase out of proportion as auditors will have to employ their services more frequently. Part of the increased costs that is borne by and imposed on the auditors will also be transferred to the clients and by way of extension to the corporation.Futhermore; the customers would subsequently pass on the increased costs to their shareholders or consumers.