Bloomberg News

Treasury Panel Weighs Liability Reforms for Auditors

May 30, 2008

A U.S. Treasury Department committee may propose that some lawsuits against auditors be argued in federal rather than state court, a step that might help the accounting industry win relief from legal damages.

The 21-member committee, which includes former Federal Reserve Chairman Paul Volcker and former Securities and Exchange Commission Chairman Arthur Levitt, is considering whether to make the recommendation to Congress, Treasury said on its Web site today. The panel, formed in October, avoided suggestions on legal liability in a 153-page draft report published May 5.

Treasury Secretary Henry Paulson set up the committee to examine an industry dominated by four firms: Deloitte & Touche LLP, Ernst & Young LLP, PricewaterhouseCoopers LLP and KPMG LLP. The industry will consider it a setback if the panel rejects its call to rein in lawsuits, accounting experts said.

Accountants ``clearly would like to have litigation reform,'' said Andrew Bailey, a retired accounting professor at the University of Illinois in Urbana-Champaign who now works part time at audit firm Grant Thornton LLP. ``If they get no action on these matters then they will be disappointed.''

Levitt, co-chairman of the Treasury panel with former SEC Chief Accountant Donald Nicolaisen, said ``all issues are under consideration and no final decisions have been made.''

Pending Lawsuits

The six biggest audit firms, which include Grant Thornton and BDO Seidman LLP, faced 27 lawsuits at the end of March with potential damages in each exceeding $1 billion, said the Center for Audit Quality, a Washington-based group that represents accountants. A loss by any firm might force it out of business.

``I'm pleased that this committee, which is charged with looking at the sustainability of the profession, recognizes that catastrophic liability is an issue that firms of all sizes face,'' said Cynthia Fornelli, the center's executive director.

Moving the lawsuits to federal court would benefit accounting firms, because a defendant's legal damages are limited to their share of the fraud, said Adam Pritchard, a professor at the University of Michigan Law School. Plaintiffs also have an easier time bringing cases in state court, he said.

``There is a much higher standard for the plaintiffs to reach to be able to sue the accountants at all'' in federal courts, Pritchard said in a telephone interview.

Lawsuits against auditors peaked at 63 in 2002 when Arthur Andersen LLP was accused of obstructing the federal investigation into accounting practices at energy trader Enron Corp. Andersen, then the nation's fifth-largest accounting firm, shut down as a result of the indictment.

Settlements

Ernst & Young, based in New York, agreed in December to pay $298.5 million to settle lawsuits tied to its audit work for Cendant Corp. New York-based PricewaterhouseCoopers in July agreed to pay $225 million to resolve claims that it failed to uncover a fraud at Tyco International Ltd.

KPMG, based in New York, avoided criminal charges in 2005 by agreeing to pay a $456 million penalty over allegations that it sold abusive tax shelters. KPMG's agreement required the firm to be overseen by an independent monitor for three years.

KPMG is being sued by New Century Financial Corp. shareholders, who say the firm failed to detect improper accounting and underwriting practices in audits of the bankrupt subprime-mortgage lender. KPMG has denied wrongdoing.

The committee said it will seek public comment on whether federal courts should have exclusive jurisdiction over some suits and the types of claims that should fall under such a provision. The panel said it will seek input on what kind of ``uniform standard of care'' should apply to litigation against auditors.

Draft Proposal

``It would be most inappropriate to call this addendum to the draft report a proposal of the Treasury committee or the subcommittee working on it, as neither has approved or concluded it,'' said Lynn Turner, a former SEC chief accountant and committee member.

A panel recommendation would boost the accounting industry in seeking liability protections from Congress, Pritchard said.

``The accountants whine whenever they get sued and it doesn't carry a lot of weight,'' he said. ``If Levitt and Volcker, who are not seen as being overly business friendly, are signing on that indicates that there is a real problem that needs to be fixed.''

Levitt is a senior adviser to the Carlyle Group and a board member of Bloomberg LP, parent company of Bloomberg News.

To contact the reporter on this story: Jesse Westbrook in Washington at jwestbrook1@bloomberg.net.

To contact the editor responsible for this story: Otis Bilodeau at obilodeau@bloomberg.net.


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