There can be no greater fear for one of the big accounting firms than the threat of a massive damages claim that could destroy theirits business.
As corporate scandals have piled up in recent years, plenty of aggrieved investors have attempted to breach the defences of the top firms. So far, though,, however, the accountants have managed to avoid wide-ranging negligence claims, relying to a large extent on their structures as networks of separate national partnerships to constrain liability.
But last week plaintiffs’ lawyers sensed a potential shift that could undermine the accountants’ long-standing defence that a firm’s affiliate partnerships around the world cannot be sued for the alleged wrongdoings of another of its member firms.
A federal judge in New York refused a motion to dismiss a class action lawsuit against Deloitte Touche Tohmatsu and Grant Thornton International, the international umbrella organisations of the accounting firms, brought by shareholders and bondholders of Parmalat, the Italian dairy company hit by alleged accounting fraud.
The lawsuit alleges that the audit firms – which brand themselves as global advisers – helped the company mask billions of dollars of debt and signed off on false financial statements.
The lawyers were quick last week to seize on the importance of the failure of the international firms to extricate themselves last week. Stuart Grant, a co-lead counsel for the class,the class action, said the significance was that the international umbrella organisations were now stuck fast in the case, which keptkeeping open the prospect of a substantial damages settlement. “That’s the mother ship,” he said. “That’s the one able to pay a judgment.”
He also believes the judgment could have wider implications for other claims where the accounting firms service multinational clients as a unified global adviser.
The class action is still in its early stages, and indeed the accounting firms cautioned against reading too much into a preliminary judgment, but the ruling does raise questions over the ability of the accounting firms to maintain their stancetheir dual stance as both unified businesses and federations of independent partnerships.
If the firms find courts are prepared to hold their international networks responsible for alleged audit failures, or face the prospect of being forced to settle claims on that basis, a majorlarge incentive for retaining their existing structures could disappear.
DTT and GTI insisted that as umbrella organisations they did not audit Parmalat and were not involved in any of the alleged fraud committed by the company’s auditors, Deloitte Italy and GT-Italy. Since they were legally separate from their Italian affiliates, they could not be liable for their alleged fraud, they argued.
However, the shareholders and bondholders bringing the class action insisted that separateness was a “fiction”, as the links between the international associations and their Italian arms was far closer than outlined.
Judge Lewis Kaplan – who is also presiding over another suit being brought by Enrico Bondi, the administrator at Parmalat – dismissed several of the related claims against the audit firms’ US entities. But he found that the plaintiffs had adequately stated fraud claims against DTT and GTI by virtue of their “agency” relationships with Parmalat’s Italian auditors. In his judgment,He said allowing the firms “to avoid liability for the misdeeds and omissions of their constituent parts arguably could diminish the organisations’ incentives to police their constituent entities”.
The two accountancy firms say they are not worried by the decision and both firmsexpressed confidence that the claims would be defeated, although they are disappointed that the case must now progress to the discovery stage.
DTT says: “It is important to note that, in rendering its decision, the court was required by law to assume the truth of all the plaintiffs’ allegations for the purposes of this preliminary motion. Therefore, the decision does not mean that plaintiffs’ claims have any merit, or that any of the substantive issues have been decided.”
Both are sticking to the line that their membership organisations had no relationship with any Parmalat entity. Grant Thornton says that wherever these issues have been raised before, courts have given the arguments for wider liability short shrift. OPT CUT ????“In every instance that this has been tried in the past, it has been dismissed because the structures are set out that way. They are clearly communicated to clients so they understand what their contractual relationship is.”
But Mr Grant, managing partner at Grant & Eisenhofer, is adamant that this argument no longer holds in an age of globalised business: “If you pitch to a client on the basis that you are a worldwide unified organisation, the client is serviced that way, and the billing is done as one firm, then if there is a problem you cannot say ‘that was just one small firm, you can’t come after the rest of us’.”
Grant Thornton lawyers had cited securities litigation stemming from the WorldCom scandal to argue that even though promotional materials referred to the firm as “global” and although the firms used a common name, that was not sufficient to justify the finding that the Italian arm was an “agent” of Grant Thornton InternationalGTI.
In the WorldCom case, a US court had dismissed a plaintiffs’ securities claim against Andersen Worldwide, finding the fact that it was the umbrella organisation for the former Arthur Andersen firms insufficient for liability.
However, Judge Kaplan said, however, that the plaintiff’s arguments differed from those in the WorldCom case, not only referring not only to promotional materialor press releases but also contending that GTI exercised control of GT-Italy “in a manner typical of a principal-agent relationship”. The plaintiffs pointed out to the factthat GTI investigated and disciplined the Italian member firm and ultimately expelled it from the network.
OPT CUT ?????The judge said: “GTI’s ability to discipline individual partners of GT-Italy suggests that it had the power to direct the policies and practices of that firm, a defining characteristic of agency.”
The firms’ diversedisparate structures are in fact more of an historical accident of history than a calculated defence mechanism. In order to preserve auditors’ independence, many countries have forbidden audits by non-national organisations. As GTI points out: “You cannot actually be one organisation worldwide.”
There are signs, though, that the profession is preparing for change. Mike Rake, international chairman at KPMG, another of the big accountants, has forecast that his firm could be transformed into a single global partnership within a decade.
Such a shift would depend on international regulatory changes, and specificallyin particular new protections for auditors that would cap their liability to potentially catastrophic claims. Mr Rake has predictedpredicts that some countries wouldwill harmonise their oversight of the accounting profession in the coming years, which could bringbringing the single global partnership closer to reality.
That could be attractive to the firms’ global leaders as it would give them the power to exert more control over their practitioners around the world. More importantly, though, it could give them the legal protection they need as the shield of their historical structure comes under greater pressure than ever.
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