New Liability Twist Has Lawyers, Accountants Scurrying : Professions: Lawyers and accountants are facing more lawsuits resulting from failures of companies. The suits raise questions of their obligation to their clients and the public.
At one prestigious Los Angeles law firm, partners have become so sensitive to issues of liability that a mere suggestion that malpractice insurers might not cover some of its attorneys triggered action.
A few lawyers at Paul, Hastings, Janofsky & Walker were serving on boards of directors for companies that were also legal clients. When the insurers raised questions about conflict of interest, the attorneys decided to leave the boards.
“If they can’t get coverage, they have to make a choice--either get off the board or go without coverage,” said Ronald M. Oster, the partner responsible for professional liability issues at the prestigious law firm.
These days, even the appearance of a conflict of interest is a risk few big law or accounting firms are willing to take. Fewer still are willing to go without malpractice insurance--for fear of being targeted in major liability lawsuits.
Increasingly, lawyers and accountants are being blamed for the failures and frauds of their clients. Especially in the massive savings and loan scandal, government regulators, angry investors, creditors and shareholders have gone looking for redress from deep-pocketed professional advisers.
So law and accounting firms have gone on the defensive, looking for ways to reduce their joint and individual exposure to high-stakes liability lawsuits. They are dropping--or not accepting--high-risk clients, being more cautious in the advice they give and lobbying for protective legislation.
But they are not, critics contend, looking for ways to resolve the most crucial dilemma raised by the latest string of high-profile cases: What is the lawyer’s or accountant’s responsibility to the public?
Accounting firms seem to be “surrounding themselves with wagons, hoping against hope to ward off further damages,” said Abraham J. Briloff, professor emeritus of accounting at Bernard Baruch College at New York’s City University.
It doesn’t appear, Briloff said, that the accounting profession is “devoting energies and resources to say, ‘What we’ve been doing over the years is not consistent with what the public requires’ and (then) to affect critical and meaningful changes in their organizations to fulfill the covenant accountants are presumed to have with society.”
The question has been especially troubling in the cases of failed savings and loans, where taxpayers face a more than $400-billion bailout over the next four decades. Outraged investors and creditors have joined with federal regulators in wondering why the auditors didn’t cry foul on mounds of faulty loans, or how such tangled webs could have been woven without the aid of lawyers.
“These kinds of securities fraud or bank fraud can’t happen without the assistance of the professionals,” attorney William Lerach said. Lerach and his firm, Milberg, Weiss, Bershad, Specthrie & Lerach, have represented investors in class-action fraud suits against management and their professional advisers, including the ZZZZ Best and Bank of Credit & Commerce International scandals.
Two recent cases involving the failure of Lincoln Savings & Loan raised the specter of the professional advisers’ obligations to the public--and further unnerved lawyers and accountants. Earlier this month, the New York law firm of Kaye, Scholer, Fierman, Hays & Handler agreed with federal regulators to pay $41 million. Within a week, accountants Arthur Andersen & Co. agreed to a $30-million settlement.
Both firms had been accused of helping Lincoln to the detriment of the public’s interest: The government said Kaye, Scholer lawyers knew troubling information about Charles Keating’s S&L; and should have blown the whistle; regulators and investors also said that Arthur Anderson’s accountants “stuffed” files to add subsequent documentation on questionable loans.
In the settlements, neither firm admitted wrongdoing. And for the most part, lawyers and auditors accused in professional liability lawsuits insist that they were doing their jobs. They and their colleagues say the public simply doesn’t understand their role. They call it an “expectations gap.”
And, they warn, the public could face even greater harm if steps aren’t taken to limit the liability exposure of accountants and lawyers--especially if the professional advisers are forced to assume greater responsibilities to blow the whistle on their clients.
Auditors say their role is to check the company’s financial statements against accounting principles and standards--not to certify that the company itself is financially sound. Lawyers say their responsibility is to represent the client, except when to do so would be aiding or abetting an illegal act.
“If lawyers have to act as whistle blowers, the ability to represent clients, to be fully informed--the ability to be helpful--is going to be damaged,” said Oster of Paul, Hastings.
But critics contend that both lawyers and auditors have obligations to the public: lawyers as officers of the court and accountants in their role of “public watchdog.”
“The real purpose of certified public accounting laws . . . is the audit function,” said Stephen E. Loeb, chairman of the accounting department of the University of Maryland at College Park. “The true reason for the audit function is to protect society, to protect third parties--labor, stockholders, creditors, everybody who relies on financial statements.”
William W. May, an ethicist who teaches at USC’s School of Religion, said: “Accountants are very unique--they work for a client who pays them to report to the public. . . . The question is, what should they tell?
“The Lincoln thing and BCCI blew open, and people were asking, ‘Where were the accountants in protecting the public interest?’ The accountants argued they had done exactly what they were supposed to . . . and (said) they can’t go beyond what they were doing,” said May, who is helping the American Accounting Assn. develop an ethics-based curriculum for accounting students.
Many accounting firms are now refusing to take on new clients in areas they deem high-risk, such as financial institutions, insurance companies and even high-technology firms. Recent surveys have shown a growing reluctance on the part of small certified public accounting firms to do auditing work for any small, publicly held company because of the liability risk.
That’s because in many liability claims, the accountants have had to pay settlements or awards that were many times the amount the firm earned for the audit, said Mark H. Gitenstein, a Washington-based attorney who is a lobbyist for the Big Six accounting firms and the American Institute of Certified Public Accountants, the auditors’ professional organization.
Gitenstein is advocating legislation that would extend to accountants and other professional advisers the concept of proportional liability--that is, to hold accountants and others liable for only the amount of damages directly attributable to their actions. Now, they can be sued for the total amount of damages, regardless of how large or small their role was.
Many accountant groups are also seeking changes in the rules of the state professional associations, to allow accountants to practice as corporations so that if a firm is sued, the accountants’ personal assets would not be at stake.
But critics say that today’s political climate is not particularly conducive to attempts to shelter professionals from liability actions. In fact, the high-profile cases may instead give a boost to longstanding efforts to clarify and expand professional advisers’ responsibilities.
John C. Burton, former Securities and Exchange Commission official and now an accounting professor at Columbia Business School, said: “It’s unfortunate that we have been moving in the direction of having auditors find ways in which they say, ‘We didn’t do anything, and while we didn’t do anything, we didn’t find anything.’ . . . It’s very important that auditors see their public responsibilities and move forward to take them.”
But Gitenstein said: “If we don’t begin to channel the liability problem so it becomes more rational, we can’t make these people audit these companies. The real danger to the public is that they will stop auditing” companies.
In the past, there have always been others willing to pick up the slack when one accounting firm shies away from an industry sector. That may be changing now.
Most of the major accounting firms, now whittled by mergers to six from eight, have agreed to multimillion-dollar settlements or still face litigation in failed-thrift cases. Last November, inundated by malpractice suits, the seventh-largest firm of Laventhol & Horwath declared bankruptcy.
But it is perhaps the predicament of Ernst & Young--the successor company to Arthur Young--that accounting firms find most unsettling.
In the mid-1980s, Arthur Andersen & Co. began pulling out of the savings and loan business. “It cleaned up its act . . . but then Arthur Young came trotting along behind and picked up those clients, including Lincoln,” said Arthur Bowman, editor of Bowman’s Accounting Report.
Ernst & Young, formed when Arthur Young merged with Ernst & Whinney, now faces massive liability litigation, including the ongoing $1.2-billion civil suit alleging fraud in the collapse of Lincoln S&L.; A major judgment against Ernst & Young could have significant impact on the firm and industry.
The possibility that no firms will be willing to take on clients in risky industries “is more real at this time than at any time in history,” said M. Sabry Heakal, coordinator of auditing and accounting at McGladrey & Pullen, the Minneapolis, Minn.-based CPA firm that is the country’s ninth largest. “Those who did jump in, like Ernst & Young, got burned.”
McGladrey & Pullen has long shied away from thrifts, said Heakal, and in the past couple of years has instituted additional policies designed to reduce its liability exposure. These include a more stringent client acceptance process, especially in industry segments the firm has identified as high risk, such as financial services, insurance companies and securities brokers and dealers.
“Also, we didn’t use to, but now we evaluate our relationship with each client annually,” Heakal said. “There are more and more cases nowadays in which we have walked away because of indications that management might not be showing all their cards. And we are quicker in (ending) the relationship because of a perceived risk than we used to be.”
Law firms too have begun to institute additional layers of review in the client-acceptance process.
Among them is Los Angeles-based Kindell & Anderson, where partner Alan Grossman supervises the firm’s professional liability cases and its malpractice insurance needs. “When we open a new file, there are about eight steps” in the review process, he said.
“There are a lot of things that we’re concerned about. I think we are more careful” than before in handling clients’ matters, he said, “not unlike doctors that order extra tests. . . . There’s more defensive lawyering going on.”
Much of the defensiveness comes in direct response to professional firms’ insurers. Premiums have been rising. In Southern California, annual premiums can range from $5,000 to $12,000 per attorney. Accounting firms say their rates are in the same range, and the large firms may carry upward of $150 million in coverage.
Also, insurers have been placing greater restrictions on coverage, or even refusing to cover practices involving high-risk business.
Grossman said that this past year, when Kindell & Anderson was asking for bids on malpractice coverage, “I certainly found a great sensitivity to how much business we were doing with financial services or insurance companies. One (potential insurer) wanted to know everything we have done for a financial company in the past eight years.”
Yet the professional firms still must keep looking back over their shoulder at work done in the past. Bowman said, “We won’t know for years what the potential liability in the BCCI case means to Price Waterhouse,” the accounting firm that gave the bank a clean bill of health in 1987, 1988 and 1989.
And LeRoy E. Martin, national managing partner of McGladrey & Pullen, said that because auditing is “an art and not a science . . . there may be a settlement or lawsuit out there that could kill any of us.”
