Introduction :
The role of modern day accounting professionals has come a long way, from a core accounting function to that of being viewed as a corporate gatekeeper. Today’s professionals are not just auditors, certifying routine book of accounts, but also on the boards of companies as directors. This multi disciplinary role puts emphasis on “always taking the correct decisions and doing everything right”. While accountants look to successfully achieve the set standards, they are increasingly exposed to being targets for easy lawsuits, bought against them by third parties. A series of lawsuits filed against some of the reputed accounting firms and professionals is a beginning of the trend.
These third parties could be regulators, customers, shareholders and creditors, to name a few. Own employees cannot be excluded from the list. The list of reputed professionals, who have developed skill in what they do, over the years, but are yet, in the midst of proving their innocence in the court of law, will get longer. This will be fuelled by the arrival of the specialised litigation firms, who have been trained to gather claimants and win lawsuits in more litigious territories like Europe and US.
The Government is drafting regulations to ease Foreign Direct Investment and opening up of the Indian legal sector to overseas law firms. The local shops of the foreign firms will derive encouragement for local claimants to sue for miniscule failure by professionals to carry out diligence and care.
In most courts, the lawsuit may drag for long, cutting into the pockets and personal assets of professionals. The professionals may have acted in good faith and will have the best of the counsel defending them in the court of law, yet, the process may not only be expensive, but, time consuming, complex and lengthy. This adds to the agony.
A dent to reputation and financial condition with this situation is inevitable.
Recent cases in highlight involving accountants :
In the recent times, India has been a witness to a few incidents, where accounting professionals have been in the face of legal action.
Depositors in Nagarjuna Finance v. Mr. Nimesh Kampani & others
Source : Rediff business desk, 13-4-2009
The Supreme Court on Monday quashed a petition filed by financial industry magnate Nimesh Kampani to stop proceeding initiated against him in the Nagarjuna Finance Corp case, thus clearing the way for his arrest.
Nagarjuna Finance, the Hyderabad-based non-banking finance company has been charged with defaulting on repayment of deposits worth Rs.100 crore (Rs.1 billion).
Kampani was a director of Nagarjuna Finance when the alleged default took place. He had resigned as a non-executive director in 1999. He was, however, on the board when the NBFC raised deposits from the public.
Kampani, however, had earlier told APO police that he was in no way involved with the matter, having resigned as a non-executive director in 1999. The apex court had on April 2 stayed the arrest of investment banker Kampani.
Satyam ADR purchasers v. M/s. Pricewaterhouse Coopers
Source : Financial Express, 8-1-2009
The ADR purchasers of the Satyam Computers stock, represented by law firm Pomerantz Haudek Block Grossman & Gross LLP, have filed a lawsuit against the multinational audit firm Pricewater-house Coopers (PWC). The lawsuit alleges that PWC breached the duty towards shareholders, causing undue losses, by committing grossly negligent audits, overlooked internal control mechanisms. The lawsuit further alleges that PwC ignored red flags that should have alerted it to the fraud and that PWC failed to perform its audits in accordance with the requisite accounting principles.
The Indian unit of the global audit major, has been maintaining that it followed all the standard accounting principles while auditing the books of Satyam Computers. While two partners of the firm have been arrested for abetting the fraud, PWC also said that its auditing on Satyam could be construed invalid, if the statements made by promoter Raju, in his admission letter about the fraud were correct.
In the Satyam case, the audit firm is defending the allegations filed against it and incurring substantial legal expenses, while independent probe is under way by the Serious Fraud Investigation Office (SFIO).
Institute of Chartered Accountants of India v. Auditors of Global Trust Bank
Source : livemint.com
ICAI disciplinary committee has held two Global Trust Bank (GTB) auditors guilty of professional misconduct. In 2003, Global Trust Bank had collapsed. It was alleged that the GTB auditors had failed to adequately point out in its audit report about the high levels of NPA. Four partners at the firm had been made respondents in this case for their audit work spanning over three years. Reserve Bank of India had stepped in at that time and speedily restored normalcy for the bank’s customers, by approving its merger with Oriental Bank of Commerce.
As per the latest media reports, ICAI has conducted disciplinary proceedings and the case has been referred to the high level committee of the monitoring body. The partners of the audit firm have been hauled up and had to present themselves in front of the monitoring body to explain the alleged professional misconduct.
Liability under Indian Law :
In India, a civil liability for negligence can be attached when it is proved that an auditor’s client suffered a financial loss due to the auditor’s professional negligence. The basis of pointing the finger and establishment of the liability would be through two simple steps :
1. There was a professional negligence by the auditor in the performance of his duty
2. This professional negligence resulted in a loss or damage to the client
This process is simple and easy to allege. Professional negligence is generally held to imply “any action by an auditor that is careless or is not in consonance with the performance of his duty”.
Most accounting professionals are also directors on the boards of various listed and non listed companies. Error, omission or negligence on their part, can impact the performance of the company and erode its value. They could be sued for breach of their duty towards shareholders, even while the breach may not be willful. They would still have to defend themselves, in case a lawsuit is filed.
Once in court, the legal expense, may mount and end up being quite Significant. Subsequently, huge settlements may follow out of a court verdict or even a settlement may be negotiated out of court. All these are definitely likely to dent the bottom line of the audit firm held negligent, while there will also be a loss of reputation and goodwill of the firm, built over several years of hard work.
Risk mitigation through Insurance for Accountants:
Apart from relying on their own pocket to churn out expenses towards legal costs and litigation settlements, there are two specialised insurance policies which becomes a pertinent and reliable mechanism, for risk mitigation:
1. Accountants Professional Liability Insurance
2. Directors and Officers Liability Insurance
The insurance policies are carved to pay for defence expenses and settlements, broadly.
Accountants Professional Liability Insurance:
Sample policy coverage:
An Accountants Professional Liability insurance policy covers legal liability arising out of professional negligence and error or omission of the accounting/ audit firms. The key highlights of a typical insurance policy are:
- Provides protection against wrongful acts arising out of negligence, error or omission, of the insured firm, partners, employees.
- Responds towards defense costs and settlements, within the policy terms and conditions.
- Responds to acts taking place after the appended retroactive date in the policy. A retroactive date stands incorporated when a firm buys the insurance policy for the first time and usually remains constant over many years, thus giving continuity in the coverage of acts occurring after that date.
- Claims on the policy have to be made and reported within the policy period and covered within the retroactive date in the insurance policy.
- Every policy has a deductible, which is the minimum amount the insured has to bear on each claim. Depending on the firm, the deductible varies between 10% to 12% of the limit of liability opted for.
- Can be taken by firms into multiple professions like accounts preparation, book keeping, audit, tax compliance, liquidation, valuation, mergers and acquisition work etc. Usually, the insurance company would request for exhaustive information on the activities of the firm and extend policy coverage.
- Can be extended to include retroactive acts, provided they are unknown, when the policy is procured.
- Can be extended to include coverage for costs incurred towards documents destroyed, damaged, lost or mislaid, as a small portion of the liability limit of the insurance policy.
Directors and Officers Liability Insurance:
Sample policy coverage:
A Directors and Officers Liability insurance policy covers legal liability arising out of wrongful acts of the Directors and Officers of the company. The key highlights of a typical insurance policy are:
- Provides coverage for liability of :
- Directors and Officers who cannot be indemnified by the company
- Directors and Officers who can be indemnified by the company
- Responds towards defense costs and settlements, within the policy terms and conditions
- Responds to acts taking place after the appended retroactive date in the policy.
- Claims on the policy have to be made and reported within the policy period and covered within the retroactive date in the insurance policy.
- Every policy has a deductible, which is the minimum amount the insured has to bear on each claim. The deductible is smaller as compared to the Accountants Professional Liability insurance and usually has a fixed value.
- Coverage territory and jurisdiction is incorporated in the policy. Can be issued on a world-wide basis or only for India.
- Defense costs include attorney’s fees, reasonable expenses towards court attendance, administrative expenses, legal representation expenses and investigative costs.
- Policy has advancements on current basis, towards defense costs.
Premium computation and limits of liability :
The underwriters of this specialised nature of insurance policy, can structure and design coverage which could respond to individual firm’s business requirement. This involves an exchange of information with the underwriter, like profile of the firm, nature of services, partners’ profile. The size of the firm in terms of employees and revenue, financials, type of clients, contracts, geographical area of operation, incidents reported previously etc. are also studied.
This dialogue and information is processed to provide premium estimation to the firm seeking insurance. Depending on these parameters and the coverages opted for; the premium varies from firm to firm. Option is available with the insured, for volunteering for higher deductibles, which helps in bringing down the premium for the policies.
In conclusion:
In light of the increased emphasis on certifications to firms, whether it is in an audit or as a director on the board of listed and unlisted companies, it is recommended that all small, medium and large firms, purchase adequate level of insurance protection. In a dynamic economic and legal environment, the insurance policy will come handy as a risk mitigation tool.
Most of the leading underwriters of liability insurance offer these insurance policies. To get the best underwriter to be a part of one’s valued insurance program, the firm should ideally seek the assistance of an insurance broker. The insurance broker is licensed by the Insurance Regulatory and Development Authority (IRDA), to structure policy coverage, give informed advice and seek quotes from various insurers towards the finalisation of the best cover for their client.
