Liability for Mistakes Could Hit Global Accounting Firms

A raft of legal challengers are arguing that giant firms are responsible for their far-flung members' negligence

Investors have long been restricted in suing accountants for financial fraud. While global brands such as PriceWaterhouseCoopers, KPMG International, Deloitte Touche Tohmatsu, and Ernst & Young may have deep pockets, with combined revenue of $103 billion last year, they limit legal exposure by setting themselves up as a network of independent member firms linked by a central administrative office. That means heavy penalties in one market can't bring down the whole organization because assets are in the hands of each affiliate. Now two pending lawsuits threaten to make the global firms liable for botched audits in any part of their operations.

If successful, the suits could vastly expand the amount of money available for damages in lawsuits over audits. On Jan. 27, New York Federal District Judge Lewis A. Kaplan said he will allow a jury to consider whether Deloitte as a whole is liable for alleged accounting malpractice by its Italian operation in the 2003 collapse of milk producer Parmalat. And on Feb. 17, a state court jury in Miami is scheduled to consider whether Brussels-based BDO International should help pay a $521 million verdict against U.S.-based BDO Seidman for its audit of a now-defunct Miami company called E.S. Bankest.

The legal challenges come at a time when accounting giants face a wave of potentially massive liabilities in cases ranging from India's Satyam Computer Services (SAY) to the investment funds that funneled cash to Bernard L. Madoff's alleged Ponzi scheme. As Stanford law professor and former SEC Commissioner Joseph A. Grundfest points out: "The question is, will the dikes hold when you have this kind of a flood?"

Already, Satyam shareholders have filed suits against PwC International for failing to detect fraud. PwC spokesman Mike Davies argues that "there isn't such a thing as a global firm [because] we are a membership organization." Deloitte issued a similar statement after the New York federal court decision, while BDO International emphasized in a statement that it is "not a firm, but a network of independent member firms." (Arthur Andersen International, which collapsed in the wake of Enron, was also a membership organization.)

But claimants have had some success in arguing that the global businesses exert control over their far-flung network. In the Parmalat case, the judge noted that Deloitte's umbrella company required member firms to accept clients referred by other members, use specific methodologies, and submit work for a regular review of compliance. In deciding that the case could go forward against BDO International, a Florida appeals court pointed to the firm's stated mission "to manage and control" member operations.

Whether a jury agrees that such control is extensive enough to justify shared liability has yet to be decided. While the focus is on accounting, a handful of other professional-services firms such as legal giant Baker & McKenzie and consultancy Horwath International have a similar membership structure. Global auditors have so far managed to convince judges that they shouldn't be liable for the actions of member firms, but increased scrutiny over the links between offices gives them cause to worry.

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