Auditing the Auditors?



Are you a shareholder in a public company? Even if you aren’t, you can be sure that your pension fund is.   Investors in a public company need to know whether the company’s financial position is sound and profitable. If they invest in a company that looks healthy but then goes belly-up, they stand to lose their investment.


“True and fair”

How do shareholders in a public company gauge the health of that company? Simple: They take a look at the company’s audited accounts, which all public companies, including banks, have to have. Under English and EU law auditors (i.e. accountants qualified as auditors) have to determine whether the accounts of the company that they are auditing are “true and fair”.


“Catastrophically wrong”

If auditors sign off a set of company accounts as “true and fair” (which itself is a less than precise standard!), how reliable is this? Investors have long been concerned about this, and their concern has now been heightened by a new standard on accounting for banks, known as International Financial Reporting Standard 9 (IFRS 9), which is due to come into force in 2018. The Local Authority Pension Fund Forum (LAPFF) , which represents the retirement funds of hundreds of thousands of local government employees, commissioned a senior barrister, George Bompas QC, to look into the matter. His opinion, dated 14 August 2015, has only confirmed the investors’ fears that the new standard would not give a really “true and fair” view of a bank’s financial position.  Even the current standard (IAS 1 and IAS 39) does not require accounts to be “true and fair” but only “useful”, which resulted in the publication of accounts which                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              “in some cases were catastrophically wrong”. LAPFF is now calling for IFRS 9 to be scrapped, but the Institute of Chartered Accountants in England and Wales (ICAEW), together with the Financial Reporting Council (FRC), the institution that is supposed to regulate the accountancy profession, seems quite happy with IFRS 9.


Tip of the iceberg

But the problem with IFRS 9 is just the tip of the iceberg.   What can shareholders do if they lose their investment in a failed bank or other public company by trusting accounts which have turned out to be wrong? They can surely sue the auditors who produced those wrong accounts? No, they can’t. Not in Britain anyway, although there is no problem about doing so, for example, in the United States. In fact, in 2012, shareholders in the giant Hewlett-Packard (HP) computer company sued not only HP’s directors – but also HP’s auditors, the big accounting firms KPMG and Deloittes.



So, why can’t UK investors do the same? Answer: Because the whole major area of the law concerned, the Tort of Negligence, is in total disarray. The leading case on this is the 1990 House of Lords decision in Caparo v. Dickman.  Caparo Industries plc was a shareholder in a company called Fidelity plc, which Caparo was interested in taking over.   When Caparo did gain control of Fidelity it found that Fidelity’s financial health was worse than appeared to be the case according to Fidelity’s audited accounts. Caparo therefore sued Touche Ross, the accountants who had prepared Fidelity’s audited accounts. Caparo lost at first instance in the High Court, then won by a 2:1 majority in the Court of Appeal and finally lost before a unanimous House of Lords. This yo-yo pattern is all too common in English court cases, which does not bode well for the development of a stable and principled legal system.


Duty of care

The logic of the House of Lords decision in Caparo v. Dickman is less than impressive. The conclusion was that auditors owe a duty of care only to shareholders as a body, i.e. the company itself, but not to individual shareholders.   This makes little sense in a situation where the auditors are in cahoots with fraudulent directors who control the company.


Limited liability

In what circumstances does a duty of care arise? The Caparo test for the existence of a duty of care throughout the whole of the Tort of Negligence is threefold: (i) proximity, (ii) foreseeability and (iii) whether it is “fair, just and reasonable” to impose a duty of care – hardly an objective test! And, as if accountants were not already sufficiently protected, since 2008 auditors have been able to limit their liability (by means of Limited Liability Agreements) even against the companies whose accounts they audit.

Copyright © Dr Michael Arnheim 2015

Congratulations, Jeremy!

Some 40 economists have come out in favour of Jeremy Corbyn in a letter to The Observer on 23 August 2015.  The letter is surprisingly short — and gives no justification for its bald assertions.

Here are a few extracts:

  • Corbyn’s “opposition to austerity is actually mainstream economics”.  Really?  So, are deficits irrelevant then?
  • Corbyn “aims to boost growth and prosperity”.   How?  
  • Corbyn “voted against the shameful £12bn in cuts in the welfare bill”.   How can the huge welfare bill be afforded?  By more taxation?  More borrowing? Or both?
  • “Cutting government investment in the name of prudence is wrong because it prevents growth, innovation and productivity increases, which are all much needed by our economy, and so over time increases the debt due to lower tax receipts.”  What should the government invest in?   How would it be paid for?  And how would it increase growth and productivity?

Not  a single example is given to back up these bald assertions.

And then, after all this, we read at the very end of the letter: “We the undersigned are not all supporters of Jeremy Corbyn.”                                                 



  • Migrants:      The migrants in Calais are obviously        interested in only one thing — getting to Britain.  Why?  Because the benefits available here are far better than anywhere else.  They are supposed to seek asylum in the first European country they reach, which would generally be Italy, Greece or Spain.  But those countries have no hand-outs to offer them.  And even France is unattractive by comparison with Britain. Solution?   Cut benefits for asylum seekers.
  • Philip Hammond is right. I never thought I’d have occasion to say that!  But I agree with the UK Foreign Secretary that “Europe can’t protect itself and preserve its standard of living and social structure, if it has to absorb millions of migrants from Africa”  (The Telegraph, 10 August 2015).  But Hammond’s suggested solution is short-sighted.  He’s only talking about returning those not “entitled to claim asylum back to their countries of origin”.  How? He does not say. The UK authorities don’t deport would-be migrants who have no ID – ostensibly because the authorities don’t know to which country to deport them. Would-be migrants know about this and throw their ID documents away.  What a lame excuse this is on the part of the authorities!  Don’t they have any interpreters who can figure out what language a particular person speaks, and where they are from?
  • Really? The Refugee Council says on its website: “Asylum seekers do not come to the UK to claim benefits.  In fact, most know nothing about welfare benefits before they arrive and had no expectation that they would receive financial support.”  Really?  So why are so many prepared to risk life and limb to get to the UK after traversing several other European countries?

  • Overpopulation:  The root cause of the migrant crisis is overpopulation in the third world, leading to competition for scarce resources, leading in turn to internecine conflict, resulting in their spilling over into Europe.Solution?  Don’t give aid to any country that is not taking positive steps to control population growth. Alternatively, give aid only in the form of condoms and check to make sure that they are being distributed and used!
  • Condoms: There is a resistance to condoms in certain quarters together with ignorance of their use. The Roman Catholic Church’s opposition to condoms is irrational.  The Church instead preaches sexual abstinence before marriage and faithfulness within marriage as the way to combat HIV/AIDS. This is fine as an adjunct to condoms, but not as a substitute for them. And of course, besides combating  sexually transmitted diseases, condoms are an effective form of population control.  But their use has to be actively promoted.  Until  a government can prove that it is engaged in an effective programme of population control, aid to that country should be suspended.