Advertisement

Audit Firms Face Increasing Number of Lawsuits : Finances: Industry analysts and leading accountants say O.C. claim is just another reach into deep pockets.

Share
TIMES STAFF WRITER

Despite its enormity, the $3-billion suit Orange County filed against its former outside auditor Wednesday did not appear to send a chill down the spines of other large auditing firms.

Their vertebrae, it seems, were already on ice.

Industry experts and officials at Big 6 accounting firms said the county’s suit against KPMG Peat Marwick is just the latest example of a growing trend in which clients try to make their accountants foot the bill for massive financial bailouts.

“Unfortunately, we accountants in large firms have become used to attorneys with a lot of zeros in their word processors coming after us,” said Hal Schultz, managing partner of the Newport Beach office of Coopers & Lybrand. “This is another case of a client looking for a deep pocket.”

Advertisement

In the 78-page lawsuit, the county accuses KPMG of failing to see red flags that might have enabled local officials to avert what became the largest municipal bankruptcy in U.S. history. KPMG had been hired from 1992 to 1994 to verify the accuracy of the county’s books.

Schultz and others did say they were surprised that the county is seeking more from its auditor than in its $2-billion suit against Merrill Lynch & Co., the investment firm that sold the county billions of dollars in risky securities.

“Merrill Lynch was making the sales,” said John C. Burton, a professor at Columbia University’s Graduate School of Business, and formerly chief accountant to the federal Securities and Exchange Commission. “The responsibilities of Merrill Lynch are much more clear-cut than the responsibilities of the auditors,” he said.

He noted that generally, it’s the accountant’s job to ask “not are we making a good investment, but do we have a system of checks and balances that makes sense.”

Big 6 accounting firms paid a total of nearly $1.1 billion in judgments, settlements and legal defense costs in 1993. In response to those losses and others in recent years, the firms have been dropping risky clients at an unprecedented pace in an attempt to reduce exposure to such suits. The major firms got rid of 60 clients during the first six months of this year, more than double the number over the comparable period a year earlier, according to an industry report.

Firms are especially wary of clients that might be headed for bankruptcy because “the profession’s experience has been that litigation losses arise from business losses of our clients rather than from doing bad audits,” Schultz said.

Advertisement

The litigation epidemic has prompted legal attempts to protect auditors from frivolous suits. One such legislative measure was vetoed by President Clinton on Tuesday evening, and revived the next day when the House of Representatives voted to override the veto. The measure now awaits action by the Senate.

Further, most of the big firms have undergone extensive restructuring within the last 18 months to protect their partners from exposure to suits by clients, said Jim Bowling, managing partner at the Irvine office of Ernst & Young, the firm now serving as Orange County’s outside auditor.

“Risk management has taken a heightened awareness in all of our firms,” said Bowling, who declined to say whether Wednesday’s suit against a rival makes him nervous about his own firm’s relationship with the county.

Industry experts said they fear that auditors are increasingly being held responsible for matters beyond their control or oversight.

“I don’t think auditors have the responsibility of evaluating investment portfolios,” said Burton.

If the rash of suits are “making auditors more careful, that’s all right,” he said. “But the accounting profession serves a very important function and we don’t want our legal system to set it up so firms can’t serve that function.”

Advertisement
Advertisement