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Master's Thesis, 2013
CHAPTER 1 - INTRODUCTION
2. THE CASE FOR REFORM
2.1. Project 70 - Limitation of Professional Liability
2.2. Further Information
2.3. Financial Crises
2.4. Inherent Limitations of an Audit
2.5. Importance of auditor liability
3. RESEARCH PROBLEM AND RESEARCH QUESTION
4. CONTRIBUTION TO KNOWLEDGE IN THE AREA OF RESEARCH
5. AIMS AND OBJECTIVES
6. RESEARCH METHODOLOGY
7. ASSUMPTIONS OF THE STUDY
8. LIMITATIONS OF STUDY
9. INTERNATIONAL JURISDICTIONS
9.3. United Kingdom
9.4. United States of America
10. STRUCTURE OF DISSERTATION
10.1.Chapter Two: Context and Policy Analysis
10.2.Chapter Three: Regulatory Framework: South Africa
10.3.Chapter Four: The Legal Liability of Auditors in South Africa
10.4.Chapter Five: Regulatory Framework: International Jurisdictions
10.5.Chapter Six: The Legal Liability of Auditors in International Jurisdictions
10.6.Chapter Seven: Comparative Analysis
10.7.Chapter Eight: Analysis of Proposals
10.8.Chapter Nine: Conclusions and Recommendations
CHAPTER 2 - CONTEXT AND POLICY ANALYSIS
2. THE AUDIT PROCESS
3. AUDITOR LIABILITY IN CONTEXT
4. POLICY ANALYSIS
CHAPTER 3 - REGULATORY FRAMEWORK: SOUTH AFRICA
2. THE COMPANIES ACT, 2008
2.1. Appointment of Auditor
2.2. Rights and Restricted Functions of Auditors
2.3. Collective Actions
2.4. Annual General Meeting
2.5. Civil Action
3. THE AUDITING PROFESSION ACT, 2005
3.1. Registration of Individual Auditors
3.2. Registration of Firms as Registered Auditors
3.3. Termination of registration
3.4. Conduct by and Liability of Registered Auditors
3.4.2.Duties in Relation to Audit
3.4.3.Duty to report on irregularities
3.5. Limitation of Liability
3.6. Accountability of Registered Auditors
3.6.2.Investigation of Charge of Improper Conduct
3.6.3.Disclaimer of Liability by an Auditor
CHAPTER 4 - THE LEGAL LIABILITY OF AUDITORS IN SOUTH AFRICA
2. SOURCES OF THE AUDITOR’S DUTIES
3. CIVIL LIABILITY TOWARDS THE COMPANY
3.1. Performance Standard in Execution of Duties
3.2. Concept of Reasonable Care and Skill
3.3. What Constitutes Reasonable Care and Skill
4. RESPONSIBILITY FOR WORK OF TRAINEES
5. CLIENT COMPANY’S CIVIL REMEDIES AGAINST ITS AUDITOR
5.1.2.Breach of Contract
18.104.22.168.Common Law Delictual Action
5.2. Breach of a Statutory Duty
5.3. Relevant Statutory Provisions
6. CIVIL LIABILITY TOWARDS THIRD PARTIES
6.1. General Principles For Common Law Delictual Liability
7. STATUTORY DISPENSATION
7.1. When Liable and What Must be Established
8. AXIAM HOLDINGS LTD V DELOITTE & TOUCHE
9. CRIMINAL LIABILITY
9.1. Criminal Offence: Companies Act, 2008
9.2. Offences: Auditing Profession Act, 2005
CHAPTER 5 - REGULATORY FRAMEWORK: INTERNATIONAL JURISDICTIONS
2.1. Function of Auditors
2.2. Statutory Requirements
2.3. Who May Be an Auditor
2.4. Registration Requirements
2.5. Forms of Practice
2.6. Cancellation and Suspension of Registration
2.7. Auditor Independence
2.8. Auditing Standards
2.9. Annual General Meeting
2.10.The Duty to Detect and Report Fraud and Irregularities
3.1. Function of Auditors
3.2. Statutory Requirements
3.3. Appointment of Auditors
3.4. Registration Requirements
3.5. Forms of Practice
3.6. Cancellation and Suspension of Registration
3.7. Auditor Independence
3.8. Auditing Standards
3.9. Annual General Meeting
3.10.The Duty to Detect and Report Fraud and Irregularities
4. UNITED KINGDOM
4.1. Function of Auditors
4.2. Statutory Requirements
4.3. Appointment of Auditors
4.4. Registration Requirements
4.5. Forms of Practice
4.6. Cancellation and Suspension of Registration
4.7. Auditor Independence
4.8. Auditing Standards
4.9. Annual General Meeting
4.10.The Duty to Detect and Report Fraud and Irregularities
5. UNITED STATES OF AMERICA
5.1. Function of Auditors
5.2. Statutory Requirements
5.3. Appointment of Auditors
5.4. Registration Requirements
5.5. Forms of Practice
5.6. Cancellation and Suspension of Registration
5.7. Auditor Independence
5.8. Auditing Standards
5.9. Annual General Meeting
5.10.The Duty to Detect and Report Fraud and Irregularities
CHAPTER 6 - THE LEGAL LIABILITY OF AUDITORS: INTERNATIONAL JURISDICTIONS
2.1. Contractual Liability
2.2. Delictual Liability
2.3. Proportionate Liability of Auditors
2.4. Limiting The Quantum of Damages
2.5. Vicarious Liability
3.1. Contractual Liability
3.2. Delictual Liability
3.3. Proportionate Liability of Auditors
3.4. Limiting The Quantum of Damages
3.5. Vicarious Liability
4. UNITED KINGDOM
4.1. Contractual Liability
4.2. Delictual Liability
4.3. Proportionate Liability of Auditors
4.4. Limiting The Quantum of Damages
4.5. Vicarious Liability
5. UNITED STATES OF AMERICA
5.1. Contractual Liability
5.2. Delictual Liability
5.3. Proportionate Liability of Auditors
5.4. Limiting The Quantum of Damages
5.5. Vicarious Liability
CHAPTER 7 - COMPARATIVE ANALYSIS
2. AUDITOR LIABILITY REFORM IN THE EUROPEAN UNION
2.1. Issues in the International Audit Market
2.2. Why the European Commission study is relevant to South Africa
2.3. Compulsory Insurance for all Auditor Liability Risks
2.4. Limiting Auditors' Liability
2.4.2.Auditor liability caps on the quantum of damages
22.214.171.124.One single monetary cap
126.96.36.199.Cap depending on the company’s size
188.8.131.52.Cap depending on the audit fees charged to the company
3. COMPARATIVE ANALYSIS
CHAPTER 8 - CRITICAL ANALYSIS OF PROPOSALS
2. CRITICAL ANALYSIS OF PROPOSALS
2.1. Models for Limiting Auditors’ Statutory Audit Liability
2.1.1.Model 1 - An Absolute Cap Set at x million Rands (Single Monetary Cap)
2.1.2.Model 2 - A Variable Cap: Level a Function of the Size of the Auditee
2.1.3.Model 3 - A Variable Cap: Level a Function of the Size of Audit Fees
2.2. Proportionate Liability
2.3. Limited Liability Agreements
2.3.1.Impact of Director’s Liability
2.3.3.Main Features of the Limited Liability Agreement
2.4. Limited Liability Partnerships
2.4.2.Main Features of the Limited Liability Partnership
2.5. Compulsory Professional Indemnity Insurance
CHAPTER 9 - RECOMMENDATIONS AND CONCLUSIONS
2. REVIEW OF AIMS AND OBJECTIVES
3. SIGNIFICANT CONCLUSIONS
4.2. Practice Structure
4.3. Limited Liability Agreements
4.4. Monetary Caps
5. GENERAL OBSERVATIONS
2. JOURNAL ARTICLES
4. COURT CASES
4.1.3.United States of America
4.2. South Africa
5.1.4.United States of America
5.2. South Africa
6. INTERNET REFERENCES
7. AUDITING STANDARDS
8. GOVERNMENT AND PROFESSIONAL BODIES COMMISSIONED PAPERS
8.2. South Africa
9. UNPUBLISHED THESES
10. PRESS ARTICLES
I, Steven Ronald Firer (ID - ) declare that this dissertation is my own unaided
work. It is submitted in fulfilment of the requirements for the degree of Masters of Law by dissertation at the University of the Witwatersrand, Johannesburg. It has not been submitted before for any degree or examination in this or any other university.
Initial Submission Date - 15 March 2013
Acceptance Date by Examiners - December 2013
Final Submission (subsequent to amendments) - 9 May 2014
1. Thanks to hashem almighty who gave me the strength and tenacity to complete this dissertation.
2. I dedicate this dissertation to my ever so tolerant Wife (Desiree) and my four children (Ma’ayan, Yakira, Livya and Raphael). I love you all more than anything in this world.
3. I would like pay tribute to all those Professors within the University of Witwatersrand’s School of Law who for three hours interviewed and grilled me and eventually allowed me to continue with my dream. Thank you all so much.
4. I must acknowledge the roles played by Professor Cathy Albertyn and Professor Pamela Andanda who in my opinion went beyond the call of duty to ensure that I succeeded. You are both amazing and a credit to the University of Witwatersrand’s School of Law.
5. Special blessings are due to my supervisor - Professor Constantine Theophilopoulos - whose contribution to the success of this project was priceless. His leadership and patience was invaluable and he is an asset to the University of Witwatersrand’s School of Law. He gave me the space to do my thing and whose counsel took me from a dazed cacophony of thoughts in respect of the law of professional liability to someone who is now very aware and adept in understanding this specific area of the law. G-d bless you and thank you Prof.
6. I would like to pay very special tribute to Judge Ezra Goldstein who had the courage of his convictions to do what was right in terms of the bone mores of society in his judicial decision in Thoroughbred Breeders Association of South Africa v Price Waterhouse. His Lordship never once lost patience with me and my questions day after day. Thank you and G-d bless you ‘My Lord’.
7. I must thank the following lawyers who tolerated my questions about the law throughout our many rounds of golf. You guys also made this possible: Adv. Stephen Joseph, Harvey Chait, and Adv. Bobby Levin.
8. I am at a loss for words on how to thank Steven Louw a senior partner at KPMG for his role in my success. I was allowed to take into my interview with the law professors anyone whom I chose. Steven had no hesitation in defending my dream. You are a man of honour. Thank you.
9. A final thank you to the two external examiners of my thesis. I am privileged and thankful your saw it my way.
This dissertation recommends that the laws governing the liability of the auditor in South Africa be amended to ensure a sustainable audit function and accordingly a competitive market for audit firms. These amendments must take the form of (a) introducing a monetary cap or ceiling on the quantum of damages that may be claimed by a plaintiff in the event that an auditor is found guilty of a breach of his or her legal duties and obligations in contract and in delict, (b) the provision for auditors to enter into contracts with their clients to limit the quantum of damages that may be suffered by the client as a result of the auditor’s breach of the contract with his or her client, and (c) introducing legislation which, will protect audit partners from personal liability if they did not participate directly in another partner's misdeed or fraud. It is submitted that this dissertation should be viewed as a Revised Project 70 where the South African Law Commission in 1988 investigated the desirability of the limitation of professional persons and the possible regulation thereof by legislation [the conclusion was that there was no justification to limit the liability of any category of professionals by legislation]; which is updated with and including the fundamental and paradigm shifting changes that have taken place in the global markets since then regulators in Australia, United States of America, United Kingdom, Austria, Germany, Greece, Belgium, Slovenia and Australia have removed the prohibition on auditors limiting their liability in relation to work conducted within the statutory audit function. This dissertation explores and analyses whether these significant changes to the legal systems in the United States of America, European Union and Australia would be considered appropriate for implementation in South Africa. The main component of this dissertation is constituted by a comparative analysis of the different civil liability systems for auditors which currently exist in Australia, Germany, South Africa, the United Kingdom and the United States of America. The objective of the comparative analysis was to determine to what extent the different systems of civil liability of auditors which exist in Australia, Germany, United Kingdom and United States of America could be implemented in South Africa.
It is clear from the comparative analysis that the laws that govern the auditor in South Africa are very similar and not significantly different to the laws that govern the auditor in Australia, Germany, United Kingdom and United States of America. This finding was to be expected as Australia, Germany, South Africa and United Kingdom have all modelled their auditor liability regimes on the Sarbanes-Oxley Act, 2002 which is a United States of America federal law that set new and enhanced standards for all United States of America public company boards, management and auditing firms.Since the introduction of the audit, the need for certain companies’ financial statements to be audited by an independent external auditor has been a cornerstone of confidence in the world’s financial systems. The manner of appointment, the qualifications and the format of reporting by the auditor is defined by statute in all jurisdictions and does not vary significantly for the jurisdictions examined. For each of the jurisdictions examined auditors must be a member of a recognised professional accountancy bodies. External auditors in all jurisdictions address their reports to the shareholders of a corporation. The jurisdictions examined have all followed similar paths in developing local Codes of Ethics based on the IFAC Code and in establishing education, training, disciplinary and quality control procedures to support auditor behaviour and independence.
Consequently there is no reason for South Africa not to implement similar changes [in respect to auditor liability]. This dissertation submits that South Africa’s current auditor liability framework no longer fits the nature of the work expected of auditors in South Africa. South Africa urgently needs the liability reforms outlined in this paper to stay alive as a major global financial centre.
This first chapter outlines the reasons why there is a crucial need to reform the current liability regime that face auditors in South Africa. The case for reform is made against the backdrop of the investigation undertaken in 1988 by the South African Law Commission (‘SALC’) and the changes that have already taken place in Australia, Europe and the United States of America who have recently introduced legislation that provides for the statutory limitation of an auditor’s liability. This dissertation adopts a comparative research methodology to determine to what extent the limitation of liability aspects within the systems of the civil liability of auditors, which exist in Australia, Germany, United Kingdom, and United States of America may be implemented in South Africa.
On 26 October 1988, the Minister of Justice requested the SALC to undertake an investigation into the civil liability of professionals as a result of professional negligence or breach of contract.1 The SALC commission, in their conclusions, made the following statement: ‘ With the information at its disposal, the Commission is not persuaded that there is justification at this stage to limit the delictual liability of any category of professionals by legislation. ’ 2
The words ‘ information at its disposal ’ and ‘ at this stage ’ clearly indicate that had the SALC further information at its disposal, a probability existed that it might have arrived at different recommendations3 and that there may be a time in the future where the laws that govern auditor liability may well be amended.4 It is submitted that this dissertation may be viewed as a revised Project 70,5 updated with and including the further information that was not available during the seven years that the SALC investigation remained open.
When the SALC study began in 1988, South Africa was not part of the international business community.6 Since returning from virtual obscurity following the demise of Apartheid in 1994, South Africa has endured 18 years of aggressive transition across nearly all aspects of its legal, social, political and economic infrastructure.7 Sweeping economic reforms in South Africa over the last 18 years have turned the world's attention towards South Africa as conditions have become more conducive to business development. Positive moves and policies adopted by the South African Government have played a significant role in promoting South Africa as a viable business partner in the global market.
Although South Africa has adopted regulatory reforms,8 the laws governing the legal liability of professionals have not been addressed in a similar fashion and lag behind the rest of the world. It is submitted that there is a critical need to modernise and strengthen professional liability legislation in South Africa by aligning the litigation-based enforcement regime that governs the liability of professionals in South Africa with international best practice.
Globalisation9 of professional services is now a fact of business and professional life. Competition for highly skilled and educated professionals is a global phenomenon. With globalisation came the need to encourage the development of a sophisticated business environment in South Africa. In its policy document South African Company Law for the 21st Century: Guidelines for Corporate Law Reform 10 it was posited that: ‘ The mobility of international capital has highlighted the need for domestic laws to be investor friendly and competitive with international trends.’ The 1988 SALC report11 stated: ‘ In general terms, the position in South Africa is far more favourable than that of most overseas legal systems. ’ It is submitted that currently this is not the case. There have been fundamental changes to the auditor liability regimes in major international legal systems. Bush et al state that:12
‘ The past decade has seen many changes in audit liability regimes of the US and the UK, and more may be on the way. These include LLP status for audit firms, proportional liability, and the introduction of various forms of liability caps through contract in engagement letters. ’
The changes have taken the form of monetary caps on the quantum of damages that may be claimed from negligent auditors,13 permitting liability limitation agreements between a company and its auditors14 and introducing legislation which, among other things, protects partners from personal liability if they did not participate directly in another partner's misdeed or fraud.15 It is perhaps rather trite to comment on the following statement made by the SALC: ‘ Limiting the quantum of damages is an exceptional measure, and one that is unacceptable (outside) the USA. ’ 16 Another indicator that the time is ripe for an updated Project 70 can be found in the following opinion of the SALC: ‘ Moreover, in the USA, such a ceiling is regarded as justified only if there has been a (crisis) and the ( ‘ societal quid pro quo ’ ) established by the ceiling in fact benefits the community. ’ 17
The crisis arrived in the form of international accounting scandals,18 which marked the beginnings of the idea of the ‘societal quid pro quo’ where the European Union and countries such as Australia established ceilings limiting the liability of auditors. Two names synonymous with financial crises are Enron and Arthur Anderson.
The accounting scandals that involved these entities brought bubbling to the surface the issue of auditor liability and the heated debate whether an auditor should be held accountable for the misdeeds of its clients. The Enron/Arthur Anderson incident was not in itself the catalyst for the push towards auditor liability limitation, as debate had been taking place for a number of years beforehand as to the potential benefits of liability limitations. The global financial crisis of 2007 19 also intensified critical analysis in the professional accounting and related financial press over the equitable nature of auditor liability, and the potential risk that a successful lawsuit against the auditors of a collapsed bank or financial services institution might have, which could serve to bring down one of the four largest audit firms.20 Good examples of these publicised concerns are some recent instances of legal action against the Big Four21 audit firms, including the $1 billion lawsuit against KPMG for its audit of the failed United States of America subprime lender,22 New Century,23 and the currently unfolding case against Ernst & Young following the largest in the United States of America’s history of bankruptcy to date, that of Lehman Brothers.24
Similarly, the 2008 claim for R7 billion against one of the Big Four audit firms25 for alleged audit failure is a stark reminder in South Africa of the problems facing the auditing profession in the absence of some protection offered by an equitable apportionment of liability regime. Recently as March 2014 PricewaterhouseCoopers have been sued by MF Global Holdings Limited for $1 billion.26
The SALC27 inter alia also based their recommendations on a statement made by Roy Anderson28 in 1989, where he suggested that the legal environment is different in South Africa from that of the United States of America. Anderson explained that lawyers in the United States of America are permitted to take lawsuits on a contingency basis whereas lawyers in South Africa were not and that made South African society less litigious. He argued that it was unlikely that claims against auditors in South Africa will escalate as rapidly as they have in the United States of America. Anderson understandably was unable to anticipate the passing of the Contingency Fee Act, 1997. The Contingency Fee Act, 1997, provides that legal practitioners, both attorneys and advocates, are permitted to accept litigation work on the basis that no fee will be charged if the litigation is unsuccessful, but that they will be entitled to a greater fee (up to 100% more than their normal or usual rate) if the litigation succeeds.29
The principle theme of this dissertation is to advance the notion that the position of auditors is unique-in contrast to other professions. The reason for this opinion is based on the Sui Generis 30 nature of an audit, and the inability of auditors to control the risk in respect of the types of claims usually brought against them. The extent of exposure of auditors to unlimited liability in respect of a wide range of potential claimants far exceeds that of any other profession.31 The nature and type of risk and the amounts involved distinguish the auditors’ liability position from that of the other professions.32 The International Federation of Accountants (‘IFAC’) by its own admission, acknowledge this as a fundamental problem. The IFAC33 issued International Standard on Auditing (ISA) 240, ‘ The Auditor ’ s Responsibilities Relating to Fraud in an Audit of Financial Statements ’ in which para 5 reads as follows:
‘ Owing to the inherent limitations of an audit, there is an unavoidable risk that some material misstatements of the financial statements may not be detected, even though the audit is properly planned and performed. ’
In an article published in April 2003;34 The Economist described current models of financial reporting as producing little more than a ‘ brittle illusion of accounting exactitude. ’
The reality is that producing and auditing a complete set of annual financial statements in the increasingly complex global economy is now more of an art than a science, and one that must be, by definition, reliant on judgments that flow from experience and a sophisticated understanding of business and accounting.35 This, however, goes unrecognised all too often.36 Rather, investors and others who continue to rely on audited financial statements to give them a degree of certainty have been disappointed - and have demanded redress.37 It is argued in this dissertation that too much may be demanded of the auditing process. Auditing financial statements, by definition, requires more judgment and more subjectivity than has hitherto been recognised.38 The complexity of financial reporting standards demands a greater use of judgment by auditors and it is this increase in the use of judgement that will expose the auditing profession to more litigation.39
Auditor liability matters to shareholders 40 and others relying upon audited financial statements because it affects the extent to which they may be able to seek damages from negligent auditors. As company audits are carried out by commercial organisations, the extent of auditor liability matters to audit firms because it affects the extent of audit effort and their current and future profitability. A low liability threshold to a range of indeterminate parties may persuade auditors to abandon company audits. Conversely, a restrictive scope of liability may dilute auditor incentives to deliver good audits and can, in the process, undermine confidence in corporate governance.
Issues about auditor liability matter to the state because, as the ultimate sponsor of capitalism it is keen to secure a particular kind of social order and to persuade people to believe that capitalism, is not corrupt and that there are independent watchdogs to ensure that companies provide honest and trustworthy accounts. Such a system assumes that auditors have incentives to be vigilant and effective because failure to do so would leave them open to lawsuits and claims from injured stakeholders.
This dissertation is critical to the future of the auditing profession in South Africa as illustrated by the concern expressed by the South African Institute of Chartered Accountants (‘SAICA’):
‘ The current situation 41 is not in the best interests of all the parties concerned, and some legislative reform is required to address the glaring inequitable risk/return situation that faces auditors. ’ 42
The reasons which compel the above conclusions include the following:43 The annual audit plays an essential part in ensuring the integrity of corporate reporting, which is in the interests of the business community in South Africa and its international competitiveness; Corporate fraud is increasing, and while detection of fraud is not the primary responsibility of the auditor, there is little doubt that the auditor has an important role to play in the detection of such fraud; The audit provides a reliable basis for the assessment of corporate taxation, to the benefit of the fiscus and taxpayers generally; Competition among the major firms has reduced the real cost of the audit, to the benefit of their clients, but concerns over liability could lead to defensive increases in the amount of audit work, resulting in increased costs. The drive for reform was taken up by the SAICA who published an informal discussion paper on auditor’s liability reform in South Africa. SAICA holds the view that the causes of expanded liability internationally echo the causes of liability in South Africa.44 The concern is expressed that a continuation of the current situation may well lead to the collapse of one of the medium to large firms in South Africa, a fear already expressed in the United Kingdom and the European Union, and experienced in the United States of America.45 The response to the problems facing the auditing profession46 has been rapid and innovative.47
Regulators in the United Kingdom, Austria, Germany, Greece, Belgium, Slovenia and Australia have removed the prohibition on auditors, limiting48 their liability in relation to work conducted49 within the statutory audit function. A number of these countries have introduced legislation imposing auditor liability caps.50 In respect of the United Kingdom, Austria, Germany, Greece, Belgium and Slovenia, the introduction of legislation limiting the liability of the auditor placed these countries in conformity with the recently finalised European Commission Recommendation on the civil liability of statutory auditors.51 Australia introduced the Corporate Law Economic Reform Program (Audit Reform and Corporate Disclosure) Act, 2004 (‘CLERP 9’), which expanded the duties imposed on auditors and thereby increased auditors’ potential exposure to greater claims of negligence by third parties. CLERP 9 became effective in July 2004. The Australian government introduced two measures in CLERP 9 to mitigate auditor liability: the first measure introduced the principle of the apportionment of damages and the second measure allowed for a statutory cap for auditor liability through the Treasury Legislation Amendment (Professional Standards) Act, 2004.52
The absolute maximum cap on liability is $75 million AUD.53 The question arises as to whether these significant changes to the legal systems in the European Union and Australia would be considered appropriate for implementation in South Africa? These jurisdictions have deemed it necessary to make certain that they have legislation in place that ensures the future viability of the auditing profession. From this it can be inferred that these jurisdictions have determined that the independent external auditor’s role in society is of such importance that there is a need to provide the independent external auditor with sufficient protection from liability to ensure that he/she play the role that society demands of him or her and that these changes echoed the legal convictions of the community and the bone mores of society within these jurisdictions.
Whether one is for or against the reform of the auditor liability regime in South Africa, there can be no dispute that there is a need to conduct a critical evaluation of the auditor liability regime in South Africa. This critical evaluation as conducted in this dissertation will enable regulators and policymakers in South Africa to determine the way forward in establishing an optimal design for an auditor liability regime in South Africa. In addition to the vigorous campaign that is currently being conducted by the auditing profession, there are extremely important and compelling reasons, which will become apparent for revisiting the fairness of the auditor liability regime in South Africa. This dissertation has identified a number of concerns that have the effect of potentially increasing the liability that auditors may face in the future. The concerns that are identified in this dissertation firstly support the motivation for a critical evaluation of the auditor liability regime in South Africa and secondly the concerns identify the critical areas where new or amended legislation may be considered necessary to resolve the concerns identified.
The first concern involves the question of insurance.54 The level of auditor liability insurance available for ‘higher limits’55 from the commercial market has fallen sharply in recent years in terms of both the level and amount of insurance, and the conditions under which the insurance cover is effective.56 Louw submits in the case for reform in South Africa:57
‘ From time to time we hear of a multibillion Rand claim against an audit firm. In what other industry does an entity face potential exposures, in some cases, of up to hundreds of times the fee earned for performing that service, and being held jointly liable with the actual perpetrator of the crime? It's no wonder that professional indemnity capacity does not exist in the local market for the bigger audit firms. Large premiums are paid offshore each year to buy some protection against potential lawsuits, money that could be retained in South Africa to purchase cover locally if the full claims-potential was more certain. Few statistics exist for claims actually paid as these, if paid, are usually settled out of court after many years of legal wrangling and usually at a fraction of the original amount claimed. So why not bring certainty to the market by capping the liability for auditors when conducting an audit? Many other legal jurisdictions either have incorporated, or are in the process of incorporating, a limitation of liability into their national liability regimes. This would allow local insurers to quantify potential risk exposure and to offer liability protection locally. In addition, aggrieved parties could institute more realistic claims. Auditors may be inclined to settle more quickly thereby avoiding valuable court time. ’
As far back as 1989, Roy Anderson declared:58
‘ What concerns me is that our insurance cover costs are becoming almost prohibitive. They are, in the main, dollar based. The cost of getting cover is rising, the level of cover is declining and the net result is that all this foreign exchange is flowing out of the country. ’
CLERP 9 stated in Australia’s case for reform:59
‘ The recent submissions by the two professional accounting bodies indicate that the position in relation to the availability and cost of professional indemnity insurance has deteriorated in the current hard insurance market ’
In a study on auditors' liability and its impact on the European capital markets60 in the case for reform in the European Union, it was suggested that:61
‘ The increased market capitalisation of companies during the last decade has produced a corresponding increase in the risks of auditing such companies. At the same time, access to insurance for auditors has fallen sharply, especially for firms auditing international and listed companies, thus leaving partners in audit firms with the unattractive prospect of entirely supporting the liability risks themselves ’ .
The impact assessment-accompanying document to the Commission Recommendation concerning the limitation of the civil liability of statutory auditors and audit firms62 concludes that insufficient insurance cover may deter auditors from providing audit services for listed companies. SAICA argues that a liability cap would make liability risk exposure more predictable.63 A cap would also improve the insurance coverage for auditors, as the magnitude of potential claims would be limited, facilitating better pricing of risks by insurers.64 The challenge is that professional indemnity insurance for auditors is not compulsory in South Africa. SAICA also argue that if professional indemnity insurance were to be made compulsory, it would probably result in premiums being lower, as a greater number of participants would be contributing to the insurance pool.65 However, this is not the only solution to the problem of auditor liability, and compulsory insurance would have to go hand in hand with other reforms, such as the capping of liability and the reform of the apportionment of damages.66 Consideration should also be given to making indemnity insurance compulsory for company directors, particularly if the apportionment of damages is to play its rightful role in the matter of professional liability.67 SAICA suggests that any impact that large claims would have on the insurance market in Europe would similarly be experienced here, and the decrease in capacity would exacerbate the situation. Examples of this already exist; for example: the natural disaster of Hurricane Katrina was used by local short-term insurers in the United States of America as a reason for the increase in premiums in South Africa.68
The SALC69 study concluded that as no evidence was submitted that insurance premiums were disproportionately high in relation to income there was no need to consider the adaptation of a professional liability regime in South Africa.
Liebenberg, in an evaluation of the South African professional indemnity insurance industry in light of the insurance crisis of 1985 - 86; stated in his conclusion:70
‘ It is clear from the preceding section that the South African PI market is not in a particularly healthy state. The increased exposure of professionals to legal liability claims has led to an escalation in the number of claims made by professionals against their PI policies in recent years. Premium growth for the overall market has been substantial, but it has been driven by the rapid growth in claims. This is indicative of a more litigious society resulting in an increasing scope of the professional's liability exposure. ’
In Liebenberg’s analysis of the accounting profession in this context, he found the following:71
‘ It can be seen that the level of claims over the years 1985 to 1990 was consistently low in comparison to the claims experience in subsequent years. 1991 signalled the beginning of much larger claims against these professionals. It indicates the increased exposure of the accounting and auditing professions to legal liability claims alluded to in Section 8 [Auditors and Accountants world-wide, but particularly in the UK and United States of America, have been the target of a dramatic increase in liability claims] of this paper. These professionals are responsible for 23% of the total losses incurred for the PI market over the period 1985 to 1993 but contributed only 17% of the premium as reported above. ’
The second concern involves the matter of market concentration.72 Although there are several thousand-audit firms existing in South Africa, only a few audit firms are appointed to audit listed companies.73 Moreover, these companies rarely switch from one audit firm to another so that audit firms have few opportunities to gain clients. Due to the organisational structure and the international reach of the Big Four,74 capital markets are effectively dependent on them to supply the required statutory audits for multinational companies with subsidiaries. The market has become significantly more concentrated over the last ten years. Specifically, the merger between the second-largest audit firm (Coopers & Lybrand) and the fourth largest audit firm (Price Waterhouse) in 1998 reduced the then Big Six75 audit firms to the Big Five.76 Subsequently, the demise of Arthur Andersen in 2002 (following bankruptcy of the energy company Enron in the United States of America) reduced the number of global networks to the current Big Four.77
According to the impact assessment accompanying document to the Commission Recommendation concerning the limitation of the civil liability of statutory auditors and audit firms78 the limited number of players might shrink further for different reasons. The Big Four assert that a catastrophic claim79 could lead to the collapse of one of them. Another risk might be that major audit firms could implode due to an immediate loss of confidence and reputation by client companies who become aware of a major audit failure by an individual audit partner inside the international network, as is commonly held to be the reason for the collapse of Arthur Andersen in 2002. A further risk might be an indictment or removal from a register in a major country harming the brand of the entire network. John Fingleton, Chief Executive of the Office of Fair Trading in the United Kingdom stated:80
‘ The market for large company audits lacks sufficient competition and does not work well for customers. It is highly concentrated, largely supplied by four big firms, with clients rarely switching between auditors. The barriers to entry for new and smaller competitors were too high. These are not the indicators of a competitive market. ’
London Economics81 also found that liability risks, combined with the very limited insurance capacity, are barriers for major mid-tier firms seeking to enter the statutory audit market for large companies listed on capital markets.82 As a consequence, there is a fear that the international audit market for listed companies might not be sustainable over time.83
The United Kingdom has recently extended its accounting competition probe.84 The probe focuses on whether the world's Big Four accounting firms - KPMG, Deloitte, PricewaterhouseCoopers and Ernst & Young - are restricting competition in Britain's audit market for the top 350 listed companies. The Competition Commission faces pressure from politicians who believe that auditors let down taxpayers by not spotting problems at banks that had to be rescued in the financial crisis. The question arises as to how soon will the competition authorities in South Africa conduct such a probe?
The World Bank conducted the second report on the observance of standards and codes - accounting and auditing review in South Africa at the request of the Minister of Finance.85 In this report it was suggested that there might not be a future for the small to medium size auditing firm which includes the network firms.86 The report states:87
‘ The SMPs that want to be competitive in the market place need to raise their professional capabilities through expansion. It is worth noting that if an accounting firm is not a viable size, it is difficult for that firm to continuously support enhancement of professional capabilities. Merger of a number of SMPs and/or networking with a regional/international network of accounting firms may be the most effective vehicle for SMP expansion in South Africa. ’
This report it is submitted supports the view that auditing firms in South Africa are under extreme threat of extinction and the reasons for this can be attributed to an overburdensome regulatory regime which includes an inequitable allocation of the liabilities faced by auditors.
A third concern that is identified within the auditor liability regime in South Africa can be found in the manner in which external auditors are allowed to practice. In the United Kingdom, Australia and the United States of America, audit firms are able to incorporate to protect the personal assets of the partners not directly involved in a defective audit against claims.88 In South Africa, external auditors may only practice as sole proprietors, in partnerships, and incorporated entities, which are known as personal liability companies.
Section 38 (3) (a) of the Auditing Profession Act, 2005 reads as follows:
‘ The Regulatory Board must register a company as a registered auditor on the payment of the prescribed fee if the company is incorporated and registered as a company under the Companies Act, 2008, 89 with a share capital and its memorandum of association provides that its directors and past directors shall be liable jointly and severally, together with the company, for its debts and liabilities contracted during their periods of office. ’
Section 38 (3) (a) of the Auditing Profession Act, 2005 has the impact of ensuring that audit firms and auditors in South Africa operate as unlimited liability partnerships/sole proprietorships in which all assets of the firm, as well as personal assets of the partners/ proprietor, are at risk if the firm were found to be liable in a court of law.
In respect of a partnership, this has the effect that a ‘rogue’ auditor can bring down not only an entire firm but also an entire firm network90 as innocent partners are held accountable for the actions of guilty colleagues.91 There is no valid reason to ignore this fact and it requires auditors to practice in a form mandating unlimited liability.92 The denial of limited liability for auditors puts them at a competitive disadvantage against other sectors in the business world by inhibiting their ability to raise capital and protect their assets. Furthermore by denying a liability cap, auditors are required to answer for the sins of their peers and to accept the business risks of their clients. Company directors and shareholders are not personally liable for the negligence of their employees. Shareholders of a company that is not a personal liability company have limited liability. The question arises as to why are auditors singled out merely because they provide a service rather than a product?93 This question cuts to the essence of the issue of unlimited joint and several liability. 94 The personal nature of offering services should not prevent professionals from limiting their liability for negligent acts.95 In order to achieve the fairest situation, a balance must be struck. This balance is between the protection of the public from negligent professionals and protection of innocent and uninvolved professionals from the loss of their homes and life savings.96
The fourth concern that suggests that the auditor liability regime be reviewed concerns the introduction and enactment of the Companies Act, 2008.
The Companies Act, 2008 introduces several new provisions that were not part of its predecessor, the Companies Act, 1973 and will be certain to have an impact of adding to the potential liabilities that an auditor faces.97 The first of these provisions is the concept and notion of the class action lawsuit.98 Section 157 (1) of the Companies Act, 2008 has paved the way for a new era in multi-party litigation and has created the framework for the institution of collective redress lawsuits.99 The class action became the main justification for auditor liability reform in the United States of America100. litigation explosion that followed the Savings and Loans 101
In 1991, in response to the America, the Private Securities Litigation Reform Act, 2008 (‘PSLRA’) of 1995 was enacted, thereby protecting auditors from class action litigation. 102 This was followed in 1998 by the Securities Litigation Uniform Standard Act, 2008 (‘SLUSA’).103 against auditors at the federal as well as the state level.104 an impact on increasing the potential liability of an auditor is s 218 (2) of the Companies Act, 2008. This provision extends the already wide scope to whom the auditor may be liable. The impact of s 218 (2) allows an auditor to be potentially liable for something that could possibly have nothing to do with the statutory duties of the auditor, which are not governed by the Companies Act, 2008. Since the SALC 105 backing’ for accounting and auditing standards. The main purpose of this ‘legal backing’104 6 to increase the transparency of financial reporting by improving corporate disclosure and corporate governance practices and to encourage an ethical climate. The Auditing Profession Act, 2005 makes it obligatory for auditors to comply with International Standards on Auditing as issued by the Independent Regulatory Board for Auditors (‘IRBA’).
The Companies Act, 2008 makes it obligatory for companies to comply with International Financial Reporting Standards (‘IFRS’) and it is the auditors who have to ensure and monitor this compliance. The effect of giving legislative backing to auditing and financial reporting standards is to potentially increase an auditor’s exposure to liability under statute. Additionally, the Companies Act, 2008 makes provision for the voluntary attendance of auditors at the annual general meeting of their clients.107 significantly increase auditors’ accountability to third parties. It is submitted that these changes potentially expand the liability of auditors to third parties by widening the circumstances under which auditors owe a duty of care; this is arguably a significant development in the law relating to auditors’ liability to third parties in South Africa.
It is argued in this dissertation that the case for reform has been clearly made or at the very least the South African government needs to place these issues at the very top of its agenda for due consideration. The case for reform must be viewed in the context of fundamental changes that have already been made to auditor liability regimes internationally and the minor change to the liability regime in South Africa. This dissertation questions the efficacy of the legislative enactments that govern the auditor liability regime in South Africa and explores the issues that need to be addressed on whether the auditing profession in South Africa needs further protection from litigation or whether it is currently afforded excessive protection from litigation.
The relevance and contribution of this dissertation must be viewed in the context of the importance that auditing has within society and the impact it has upon the confidence in the capital markets. In this respect, the recommendations to limit auditor liability present a significant change, the impact of which still need to be determined.
Given the fact that auditing firms operate across national and geographic borders, and the drive towards legislating the limitation of auditor liability in many jurisdictions is on the increase examining the implications of the changes to auditor liability in South Africa appears to be particularly relevant. This dissertation makes a valuable contribution to the compilation and critical discussion of the regulatory developments in respect of corporate law reform currently taking place in South Africa. This dissertation makes a substantive start to what is a compelling agenda in South Africa - the need for auditor liability reform. Litigation has historically had a significant impact on the auditing profession and it seems reasonable to expect that it will continue to do so in the foreseeable future. Without doubt, the auditor liability debate raises many complex issues, not least the fact that the law was not designed with the current circumstances of auditing firms in mind.108 the auditor liability regime in South Africa were conceived long before the new Companies Act, 2008 was enacted. The Australian government was faced with a similar situation whereby CLERP 9 increased the potential liabilities of auditors and, as a result, had to introduce new legislation to mitigate this new 1 increased scope of auditor liability. The South African government faces a similar situation. It is the objective of this dissertation to provide recommendations and proposals on how to mitigate this new potential threat that auditors in South Africa may face. In the context of justifying the corporate law reform process that is currently taking place in South Africa, the Department of Trade and Industry made the following comment:109
We now live in a world of greater globalisation, increased electronic communication, greater sensitivity to social and ethical concerns, fast changing markets, greater competition for capital, goods and services. South Africa cannot afford to be left behind. ’
1 South African Law Commission Project 70 Limitation of Professional Liability (1989). The desirability of the limitation of the delictual liability of professional persons and the possible regulation thereof by legislation were investigated in this project. Working Paper 51 [an updated Project 70] was published in December 1993 for general information and comment. The conclusions reached remained the same as the original Project 70. On 17 December 1998, the Minister approved the request that the investigation into limitation of civil liability of professional persons be removed from the Commission’s program.
2 Ibid para 5.2.
3 That there was no justification at that stage to limit the delictual liability of any category of professionals by legislation.
4 It is important to note that the laws governing auditor liability were amended with the enactment of the Auditing Profession Act, 2005 (17 years later). This amendment consisted of a provision in the Auditing Profession Act, 2005 allowing auditors to mount a defence based on contributory negligence in contract despite the decision of the Supreme Court of Appeals in Price Waterhouse Meyernel v Thoroughbred Breeders' Association of South Africa (28/2002)ZASCA 137;4 All SA 723 (SCA) (15 November 2002) concluding that such a a defence is not allowed.
5 Op cit note 1.
6 The United States joined the international community in 1986 by imposing economic sanctions against South Africa. Available at http://countrystudies.us/south-africa/84.htm, accessed 10 February 2014.
7 Based on the comments made by Firer, S., & S. M. Williams ‘Intellectual capital and traditional measures of corporate performance’ (2003) 4(3) Journal of Intellectual Capital.
8 The new legislation that has had a profound impact in the manner in which business is conducted in South Africa since 1994 consists of: Companies Act, 2008; Broad-Based Black Economic Empowerment Act, 2003; Consumer Protection Act, 2008; Competition Act, 1998; Insider Trading Act, 1998; National Credit Act, 2005; Securities Services Act, 2004.
9 Globalisation is the process of international integration arising from the interchange of world-views, products, ideas, and other aspects of culture.
10 South African Company Law for the 21st Century: Guidelines for Corporate Law Reform (published in GG 26493 of 23 June 2004).
11 Op cit note 1.
12 Tim Bush, Stella Fearnley and Shyam Sunder ‘Auditor Liability Reforms in the UK and the US: A Comparative Review’ (2007), presented at the UK National Auditing Conference at 2.
13 The state of New South Wales in Australia adopted a cap on liability, and the principle has now been accepted throughout federal Australia.
14 Changes to the Companies Act, 2006 in the United Kingdom have meant that, as from 6 April 2006, the auditor will be able to agree a limit of liability, either in the form of a liability cap or by means of proportionate liability, with individual clients, which would be subject to shareholder approval.
15 The 1996 amendments to the provisions of the Reform Uniform Partnership Act in the United States of America included a new s 306 (c) providing for a corporate-styled liability shield which protects partners from vicarious personal liability for all partnership obligations incurred while a partnership is a limited liability partnership.
16 Op cit note 1.
18 The international accounting scandals were characterised by many large and well-respected companies in the United States of America admitting to manipulating their published financial statements. Hundreds of millions in reported profits were based on sham transactions with no economic substance. These scandals raised serious questions about the role of auditors as the main gatekeepers of modern financial markets. See John C. Coffee Jr Gatekeepers: The Professions and Corporate Governance (2006). Other accounting scandals included WorldCom, Barings, Waste Management, Xerox, AOL and Parmalat.
19 The financial crisis of 2007 to the present was triggered by a liquidity shortfall in the United States banking system. It resulted in the collapse of large financial institutions, the bailout of banks by national governments, and downturns in stock markets around the world. In many areas, the housing market has also suffered, resulting in numerous evictions, foreclosures and prolonged vacancies. It is considered by many economists to be the worst financial crisis since the Great Depression of the 1930s. Three top economists agreed that the 2009 financial crisis was the worst since the Great Depression (February 29, 2009), available at http:// www.reuters.com/article/2009/02/27/idUS193520+27-Feb-2009+BW20090227, accessed on 30 April 2011.
20 E L Talley, ‘Cataclysmic liability risk among Big 4 auditors’ (2006) 106 Columbia LR at 1641-1697.
21 A widely used reference to the four largest public accounting firms that perform most of the external audits in the United States of America for large publicly-owned corporations. The Big Four include PricewaterhouseCoopers, Deloitte Touche Tohmatsu, Ernst & Young, and KPMG. The group was long known as the Big Eight until it was reduced by mergers; it was called the Big Five until the Enron scandal led to the collapse of Arthur Andersen, available at http://financial-dictionary.thefreedictionary.com/Big+4, accessed on 1 November, 2010.
22 A sub-prime lender is one who made loans to borrowers who did not qualify for loans from mainstream lenders.
23 Yvette Essen, ‘KPMG faces $1bn suit over sub-prime lender New Century’ The Daily Telegraph April 2009.
24 P Inman, ‘Auditors’ role in Lehman’s collapse unites opposition in calls for reform’ Guardian 15 March 2010.
25 Barry Sergeant ‘PwC sued for R7,6bn’ MoneyWeb 08 May 2008. Randgold & Exploration issued a summons on PricewaterhouseCoopers, in respect of alleged damages suffered. Randgold & Exploration alleges in court papers that PwC ‘failed’ in no less than 31 specific areas (just one sample: ‘failed to exercise the professional care and skill of an auditor in public practice’). Randgold & Exploration essentially argues that had PwC done its job properly, it would have detected the ‘unlawful and wrongful misappropriation’ of 2m DRDGOLD shares during the 2000 financial year.
26 Available at http://guardianlv.com/2014/03/pwc-is-sued-for-1-billion-by-mf-global-holdings-limited/ accessed 2 April 2014. It is submitted that it may be difficult for PricewaterhouseCoopers to sustain itself subsequent to the settlement of the two billion dollar law suites that they currently face.
27 Op cit note 1.
28 The then Chief Executive Officer of Ernst & Young in South Africa.
29 In a search of the South African Law Reports since 1883 for cases that involved auditors the average number of cases prior to 1997 was one per year, while the average post 1996, were three per year.
30 Its own kind/genus or unique in its characteristics.
31 The Equitable Apportionment of Registered Auditors Professional Liability South African Institute of Chartered Accountants (2009) at 6.
32 Ibid at 31.
33 The International Federation of Accountants (IFAC) is the worldwide organisation for the accountancy profession.
34 The future of accounts: True and fair is not hard and fast The Economist April 24 2003. Page 20 of 212
40 This analysis is based on: Hanneby ‘what is auditor liability? Definition and Meaning’ Available at http:// hanneby.com/2011/08/what-is-auditor-liability-definition-and-meaning/ accessed 12 October 2012. Note - this website on 4 May 2014 was no longer available.
41 Op cit note 31 at 9.’ Unless something is done soon, the situation that currently exists where more and more experienced auditors are leaving the profession to escape the liability trap and the ‘ deep pocket ’ syndrome, will only get worse and there is a possibility that the provision of audit services may be withdrawn.’ The deep pocket syndrome is best explained by the words of Rogers, CJ: ‘ The scope for injustice occasioned by solitary liability is self-apparent. In brief, a well insured defendant, who may perhaps be responsible for only a minor fault, in comparison with the fault of other persons, may nonetheless be made liable, at least in the first instance, for the entirety of the damage suffered by the plaintiff. The defendant may indeed seek contribution from other persons responsible for the major damage. Why should the whole of the burden of a possibly insolvent wrongdoer fall entirely on a well-insured or “ deep pocket ” defendant ?’ Cambridge Credit Corporation Ltd and Anor v. Hutcheson & Ors (1985) ACLR 545.
44 Ibid at 12.
45 Ibid at 13. See also J Grant ‘Seidman case heightens calls for limited auditor liability’ (2007) Financial Times Friday 17 August 2007.
46 In the author’s view, whether the threats to the auditing profession are real or perceived is not the issue. Laws have been changed internationally to ensure that the fears as expressed within the auditing profession do not become a reality.
47 In the author’s view, the changes are innovative as the amendments to laws allowing for the limiting of an auditor’s liability are unusual and have never been done before in the context of an auditor’s liability. These amendments are forward-looking and represent an original approach to addressing the problems facing the auditing profession.
48 In simple terms placing a cap on the amount of damages and compensation that can be claimed by a plaintiff in a successful damages lawsuit against and auditor.
49 The work conducted in the context of this dissertation is limited to the required duties under a statutory audit conducted in terms of the Companies Act, 2008 and the Auditing Profession Act, 2005.
50 Countries with caps: Austria, Germany, Greece, Belgium, Slovenia and Australia. See study conducted by European Union; A study on systems of civil liability of statutory auditors in the context of a Single Market for auditing services in the European Union. The purpose of the study, as stated by the Commission, is to determine to what extent the different systems of civil liability of auditors which exist in the Member States could constitute an obstacle to the development of a single market in the field of auditing services in the European Union. Available at http://ec.europa.eu/internal_market/auditing/docs/liability/auditliability_en.pdf , accessed 10 December 2011. See also Ojo, Marianne, Limiting audit firms’ liability: A step in the right direction? (Proposals for a new audit liability regime in Europe revisited) (2008) available at http://mpra.ub.uni-muenchen.de/14878/ accessed 1 November 2011.
51 Commission Recommendation of 5 June 2008 concerning the limitation of the civil liability of statutory auditors and audit firms (notified under document number C (2008) (2274) (2008) Official Journal of the European Union June at 39 - 40.
52 The Treasury Legislation Amendment (Professional Standards) Act 2004 amends the Trade Practices Act 1974 to align it with State and Territory laws which aim to limit the civil liability of professionals and others while maintaining appropriate protection for consumers through measures such as risk management systems, compulsory insurance, codes of ethics and complaints and disciplinary procedures. This legislation was enacted on 13 July 2004 and is designed to complement Professional Standards Legislation across the States and Territories.
53 AUD - Australian Dollars. The legislation limits losses between $1 million and $20 million AUD based on the fee for the service. The absolute maximum cap on liability is $75 million AUD. The Australian government was presented with this problem to balance claims for greater auditor accountability against the threat of an exodus of auditors from the profession because of the threat of litigation and exposure to liability for the potentially high quantum of damages that may eventuate. In response to this challenge, the Australian government introduced two measures in CLERP 9, which mitigate auditor liability; namely, proportionate liability for pure economic loss arising from misleading or deceptive conduct, and a framework allowing for auditors to incorporate. Further to this, the Government also legislated to allow for a national approach to a statutory cap for auditor liability through the Treasury Legislation Amendment (Professional Standards) Act 2004.
54 Op cit note 31 at 14.
55 A policy limit is the maximum amount the insurance company will pay out per event.
56 Op cit note 31 at 14.
57 Steven Louw ‘The Auditors Liability and Risk’ (2011) Accountancy SA August. Steven Louw is the Managing Director in the Department of Professional Practice at KPMG.
58 Op cit note 1.
59 Commonwealth of Australia ‘ CLERP Paper No. 9: Proposals for Reform - Corporate Disclosure ’ (2002) at 89.
60 Directorate General for Internal Market and Services Commission Staff Working Paper: Consultation on Auditors' Liability and Its Impact on The European Capital Markets ‘ Consultation Report on auditors' liability and its impact on the European capital markets ’ (2007) at 3.
61 Ibid at 21. The study also stated: ‘ In the 1990s, the then Big 5 (including Arthur Andersen), facing such an insurance crisis, had to establish "captive" insurance companies to cover the second category (international audit mandates). Captives are mutual insurance entities owned by the member firms of an international network who share risk by pooling premiums to meet their individual claims over a long period of time. Each individual firm insured by the captive covers the lower levels of risks itself, through its own contribution in the captive. At higher levels all the participating firms share the liabilities for claims from other firms. Thus, significant claims adversely impact all the firms regardless of their individual claims record. However, those captives can no longer provide the levels of insurance cover needed in today's international audit market. ’
62 Commission of The European Communities Commission Staff Working Document accompanying document to the Commission Recommendation Concerning ‘ The Limitation of The Civil Liability of Statutory Auditors and Audit Firms Impact Assessment ’ (2008) at 4.
63 Op cit note 31 at 55.
64 Ibid at 26.
65 Ibid at 24.
67 Ibid at 25.
68 Ibid at 13.
69 Op cit note 1.
70 Andre Peter Liebenberg An Evaluation of The South African Professional Indemnity Insurance Industry in Light of the Insurance Crisis of 1985 - 86 (unpublished Honours in Business Economics thesis, University of the Witwatersrand, 1995).
72 In economics, market concentration is a function of the number of firms and their respective shares of the total production (alternatively, total capacity or total reserves) in a market.
73 Firer S & Swartz, G ‘An Empirical Analysis of the External Audit Fee in South Africa’ (2006) Southern African Journal of Accounting Research at 4.
74 Op cit note 21.
78 Op cit note 62.
79 An insurance claim as a result of a failure, which is a sudden and total failure, of some system from which recovery is impossible. The term is most commonly used for structural failures where total and irrecoverable loss occurs.
80 Big Four Auditors to Face Competition probe Daily Telegraph 31 August 2012.
81 Study on the Economic Impact of Auditors ’ Liability Regimes (MARKT/2005/24/F) Final Report to EC-DG Internal Market and Services by London Economics in association with Professor Ralf Ewert, Goethe University, and Frankfurt Main, Germany.
82 Ibid at 16.
83 Ibid at 33.
84 Britain extends accounting competition probe Reuters 16 October 2012.
85 Available at http://www.worldbank.org/ifa/South_Africa_rosc_Accounting_and_Auditing.pdf accessed 10 April 2014.
86 There is what is commonly called the ‘network’ audit firms. These are audit firms outside the Big Four who form associations with other firms. Such associations’ range from those created only to facilitate referral of work (where the firms would commonly be referred to as correspondent firms) to those where the firms operate under a common brand name and have common audit methodology and system of quality control, both of which are mandatory. Where a firm practices under the same firm name (or substantially the same firm name) as other firms in the larger structure to which it belongs, or includes within its name a significant element that is common to other firms in the larger structure (such as common initials or a common name), it would be considered to belong to a network firm. The Big Four also fit into the definition of a network firm however they are perceived to be brand names in their own right. The significant differences are that audit firms outside the Big Four form alliances as a result of the need to pool resources to compete with the Big Four. These large alliance audit firms do not all trade under the same name. They are mostly made up of affiliations of smaller audit firms who do not hold a large enough market share to make an impact on the market for audit services. The major alliances are 1. BDO; 2.RSM International; 3.Grant Thornton International; 4.Baker Tilly International; 5.Crowe Horwath International; 6.PKF International; 7.Moore Stephens International; and 8. Nexia International. Phillip Smith Top 35 Networks 2012: The Survey AccountancyAge 9 July 2012.
87 Op cit note 85 at 2. In this context PKF have merged with Grant Thornton and BDO have merged with Grant Thornton. Two of South Africa’s largest ‘black’ audit firms Sizwe and Gobodo have also merged. These mergers are a clear indication in South Africa of those firms with ability to audit listed companies.
88 Op cit note 12.
89 Section 19 (3) of the Companies Act, 2008: ‘If a company is a personal liability company, the directors and past directors are jointly and severally liable together with the company for any debts and liabilities of the company as are or were contracted during their periods of office.
90 Op cit note 86.
91 Op cit note 57.
92 Bryan Smith ‘The Professional Liability Crisis and the Need for Professional Limited Liability Companies: Washington's Model Approach’ (1995) 18 Seattle University LR at 557-592.
97 Companies Act, 61 of 1973.
98 In law, a class action or a representative action is a form of lawsuit in which a large group of people collectively bring a claim to court and/or in which a class of defendants is being sued. This form of lawsuit originated in the United States of America and is still predominantly a United States of America phenomenon. The South African common law does not allow for class actions, and prior to 1994 class actions were foreign to South African law. However, s 38 of the South African Constitution clearly contemplates the existence of class actions in matters involving the infringement of or threats to rights in the Bill of Rights. In giving effect to this section of the Constitution, the Supreme Court of Appeal held in Permanent Secretary, Department of Welfare, Eastern Cape v Ngxuza 2001 (4) SA 1184 (SCA) that s 38(c) of the Constitution authorised the use of an American-style class action.
99 In the author’s view the reason for the introduction of this type of lawsuit in South Africa could possibly be the ability of the class action to ensure that there is justice for all and not simply for those that can afford it. The possibility of group action would enable inexpensive legal action.
100 Paolo Giudici ‘Auditors Multi-Layered Liability Regime’ (2010) available at http://works.bepress.com/ paolo_giudici/1/ accessed on 9 May 2011.
101 The savings and loan crisis of the 1980s and 1990s (commonly referred to as the S&L crisis) was the failure of 747 out of the 3,234 savings and loan associations in the United States. A savings and loan or "thrift" is a financial institution that accepts savings deposits and makes mortgage, car and other personal loans to individual members—a cooperative venture known in the United Kingdom as a Building Society. ‘As of December 31, 1995, RTC estimated that the total cost for resolving the 747 failed institutions was $87.9 billion.’ The remainder of the bailout was paid for by charges on savings and loan accounts—which contributed to the large budget deficits of the early 1990s, available at http://en.wikipedia.org/wiki/Savings_and_loan_crisis accessed on 9 May 2011.
102 Op cit note 100 at 4.
103 Ibid at 4. The PSLRA was designed to limit frivolous securities lawsuits. Prior to the PSLRA, plaintiffs could proceed with minimal evidence of fraud, then use pretrial discovery to seek further proof. This set a very low barrier to initiate litigation, which encouraged the filing of suits which were either weak or entirely frivolous. Defending these suits could prove extremely costly, even where the charges were unfounded, and as a result, defendants often found it cheaper to settle than to fight and win. Under the PSLRA, however, plaintiffs need proof of fraud before they can initiate a suit. This makes it very difficult to file a frivolous suit, but it also makes it much harder to file legitimate ones, as plaintiffs are forced to present evidence of fraud before any pretrial discovery has taken place. The PSLRA imposes new rules on securities class action lawsuits. It allows judges to decide the most adequate plaintiff in class actions. It mandates full disclosure to investors of proposed settlements, including the amount of attorneys' fees. It bars bonus payments to favoured plaintiffs, and permits judges to scrutinise lawyer conflicts of interest. The Securities Litigation Uniform Standards Act of 1998 (SLUSA) is a federal legislative act in the United States regarding private class action lawsuits for securities fraud. SLUSA amended portions of the Securities Act of 1933 and the Securities Exchange Act of 1934 to preempt certain class actions that alleged fraud under state law in connection with the purchase or sale of securities. Such lawsuits cannot be filed in state or federal courts.
105 Op cit note 1.
106 Legal backing means obligatory compliance in terms of statute. Section 29 (6) of the Companies Act, 2008 states that a person is guilty of an offence if the person is a party to the preparation, approval, dissemination or publication of any financial statements, including any annual financial statements contemplated in s 30, knowing that those statements fail in a material way to comply with financial reporting standards. Section 44 (3) (a) of the Auditing Profession Act, 2005 prohibits an auditor from expressing an opinion to the effect that financial statements are a fair presentation of the financial position and results of an entity or are properly prepared in all material respects unless he is satisfied that he has carried out the audit free from any restrictions whatsoever. The Section goes on to provide legal backing to International Standards on Auditing by stating that an auditor must be satisfied that his audit is in compliance with official auditing pronouncements that are applicable to the conduct of the audit.
107 These issues will be discussed in detail in Chapter 2 onward. They are mentioned here to emphasise the need for a review of the auditor liability regime in South Africa.
108 Michael Power ‘Auditor liability in context’ (1998) 23 Accounting, Organizations and Society at 77-79.
109 Op cit note 10 at 13.
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