ORANGE COUNTY IN BANKRUPTCY : Anticipated Suit Makes an Already Skittish Accounting Industry Shudder

Malpractice has become the bane of the accounting industry, the reason why two of the top 10 accounting firms in the nation have had to close shop within the past decade.

In 1993, the Big Six accounting firms spent about $800 million to pay lawyers’ bills and to settle malpractice claims, industry analysts say.

Accounting firms have become so skittish about liability lawsuits that they are almost daily shedding risky clients from their portfolios, they say.

Now, Orange County’s anticipated lawsuit against its auditor, KPMG Peat Marwick, is sending new shudders through the accounting business at a time when its leaders are lobbying Congress to restrict liability claims against them.

Lawyers, accountants and law professors say accounting firms are usually sued by disgruntled investors because they have “deep pockets” and because they owe a professional obligation--a higher legal standard--to their clients.

Stephen E. Loeb, an accounting professor at the University of Maryland, said certified public accounting firms are entrusted to protect society and third parties who rely on financial statements.

This professional obligation makes them vulnerable, especially when financial statements do not adequately warn the public about financial disasters that later surface in a company, said Marin Scordato, a law professor at Southwestern University School of Law in Los Angeles.

Mike Ueltzen, a vice president with the California Society of CPAs in Sacramento, said Peat Marwick’s performance in reviewing Orange County’s investments will be compared to “what another CPA would do in the same situation.”

Ueltzen, who said the accounting community was closely monitoring Orange County’s threat to sue, defended Peat Marwick.

“An accountant is not hired to speculate on the nature of the investments,” Ueltzen said. “As long as the investment is approved by law, and there is disclosure, it is not necessary to investigate the propriety of that investment.”

David Todd, managing partner of Price Waterhouse in Newport Beach, agreed. “The auditor does not have a professional responsibility to make judgments on the performance of speculative investments,” he said. “It’s just not an area of expertise he possesses or professes to possess.”

A Peat Marwick official on Friday denied that his firm was hired to form an opinion on the riskiness of the investments bought by former County Treasurer-Tax Collector Robert L. Citron, who ultimately lost $1.7 billion in the county’s investment pool.

“Our responsibility was to make sure the [securities] were presented fairly in the financial statement,” said Kevin Kelly, a spokesman for the accounting firm. “We stand by [that] opinion.”

Ronald Rus, an Irvine lawyer who has successfully sued major accounting firms, said auditors are liable for financial disasters because they are “usually the badges of legitimacy” for corporate fraud. It was the same argument Rus made when he got three of the Big Six firms--Ernst & Young, Arthur Andersen, and Touce Ross--to pay $95 million in 1992 to settle a lawsuit alleging that they “aided and abetted” former Lincoln Savings and Loan Chairman Charles H. Keating Jr. in stealing $250 million from bondholders.

But Rus said the Orange County case was “different because we’re dealing with market-sensitive securities.”

“It is a lot more difficult to say that these auditors would have known what was going to happen,” Rus said. “You don’t have the situation where you needed the badges of legitimacy. This is a case where some elected official would have been in a position to know that something was amiss.”

The accounting business has been rocked by malpractice lawsuits during the past decade. In 1991, Pannell Kerr, then the nation’s ninth-largest accounting firm, ceased operations, citing malpractice lawsuits as a major reason for the firm’s financial failure.

A year before, executives with Laventhol & Horvath in Philadelphia, then the nation’s seventh-largest accounting firm, fired its 3,400 employees and dissolved the firm, citing pending lawsuits as the major reason for the firm’s financial problems.

And malpractice claims are climbing.

James S. Sagner, who runs a treasury and cash management consulting firm in West Orange, N.J., said accountants were confronted in 1993 with 5,000 liability suits for a total of $30 billion in damages, or about 13% of all income from audit fees.

The soaring liability lawsuits is one reason why the Big Six and the Institute of CPAs are asking Congress to limit damage awards against auditors, said Mark Gitenstein, whose Washington law firm represents the accounting industry.

Gitenstein said Orange County’s threatened lawsuit would “go after the deep pockets, not the primary wrongdoers like the folks who invested the money unwisely.”

“This is a frivolous lawsuit,” he said. “It’s going to make accounting firms very nervous about representing city governments, because every time someone does something like what Citron did, they’re going to run to court to sue the accounting firm.”