by Roger Russell
New York - The Sarbanes-Oxley Act and other post-Enron regulations have changed the complexion of professional liability insurance for accountants.
“We’ve had a lot of calls on [Sarbanes-Oxley] and other legislation,” said John Raspante, a regional loss prevention specialist with Camico, the Redwood City, Calif.-based provider of professional liability insurance for accountants. He said that new liability risks will likely emerge from the Enron-inspired SAS 99, a new standard that gives auditors increased responsibility for detecting fraud in companies’ financial statements. SAS 99 takes effect on December 15.
Sarbanes-Oxley’s overall impact on accountants’ risk of being sued for malpractice came to a head during a recent symposium of the Professional Liability Underwriting Society, the trade association of professional liability insurers that cover all industries and professions.
Considering accountants’ risk management in the post-Enron era, Claudia Taft, general counsel at KPMG, emphasized that accountants must work to restore investor confidence when it comes to the reporting process. “Accounting firms around the country have changed their focus in light of Enron,” said Taft.
Prospective legal battles loom on the horizon for auditors, said Kelly M. Hnatt, a partner at New York law firm Willkie Farr & Gallagher. “As a result, a lot of firms and companies are taking steps to improve oversight of financial reporting, ultimately benefiting clients from a litigation perspective. In the courts, we have to expect more cases as defendants. We are easier targets than we were before.”
Hnatt said that auditors must be particularly alert to the Securities and Exchange Commission’s increased focus on the profession. “The SEC is more intensive, scrutinizing issuers themselves. As a result of a restatement, there is a greater chance of an auditor being brought into the litigation,” she explained.
“One way to reduce exposure has been through auditing committees,” said Mark C. Terrell, a partner at the KPMG Audit Committee Institute in Montvale, N.J. “As the Enron factor played out, audit committees increased dramatically. Enron has created an incredible interest in financial reporting at the corporate grievance level. For the auditing profession, it’s a plus to see the commitment level by the committees.”
According to Terrell, accountability will ultimately be manifested in future audit committees. “The auditor’s fate rests with the audit committee, who are taking their job more seriously.”
F. Kyle Nieman, a vice president of CNA Insurance Cos., in Chicago, said at a recent PLUS conference that Sarbanes-Oxley legislation is changing the practice of accounting, and affecting insurance underwriting of professional liability coverage for accounting firms.
Sarbanes-Oxley requires that auditors be hired by, and report to, the audit committee, not management, and increases their responsibility to report on internal controls and procedures, while limiting the scope of services that firms can provide. Nieman expressed concern that “there is a potential for further restrictions on services to non-public audit clients [that are designed] to preserve their independence.”
CNA is the underwriter of the professional liability insurance program that is sponsored by the American Institute of CPAs, and administered by Aon Risk Services of Chicago and Hatboro, Pa.
Nieman reported that audit fees are increasing in order to cover the rising cost of compliance and the perceived increase in risk. At the same time, increased compliance requirements are likely to reduce the number of CPA firms that are performing this service, and more consolidation is likely to occur.
Changes for whistleblowers.
McGuireWoods, of Richmond, Va., an international law firm with a prominent accountants’ liability practice, reports that the corporate legal community has been “rocked” by Sarbanes-Oxley’s provision 307, which sets requirements regarding how corporate employees can report internal financial fraud.
“Remarkably, some critics claim that requiring such intra-corporate disclosure of possible wrongdoing would somehow chill the attorney-client relationship that inside and outside counsel enjoy with corporate officers and employees,” law firm McGuireWoods reported on its Web site, online at www.mcguirewoods.com. “They worry that any reporting requirement will deter corporate employees from sharing secrets with company lawyers.”
However, the law firm notes, “This criticism ignores a basic tenet of all ethics rules. Lawyers who represent corporations owe their duties to the institution, not to any individual within it.”
The law firm explained, “The critics of Sarbanes-Oxley’s ‘up the ladder’ reporting requirements must be advocating a system in which a company lawyer may keep secret from management any material information that the lawyer learns from company employees. This is not only contrary to well-settled ethics and agency principles, it is both inconceivable to a lawyer owing a duty of loyalty to the institution, and unworkable on a day-to-day basis.”
A call for skepticism.
However, SAS 99, which replaces SAS 82, has the greatest potential to directly affect accounting professionals. The AICPA, which fostered the standard, noted that, “We feel strongly that the standard will substantially change auditor performance, thereby improving the likelihood that auditors will detect material misstatements due to fraud.”
“Under the previous SAS 82, if there was an error in bank reconciliation, it resulted in a minor auditing task - you make the required adjustment and go forward,” said Camico’s Raspante. “Now, they want the auditor to have a heightened degree of professional skepticism.”
“Before, you might call a day in advance and tell the client you’re coming over to do some inventory calculations,” he explained, “but now they want you to appear unannounced.”
“If you have a client in a certain industry that’s doing poorly, but your client is doing better than the competition, you must question why it’s doing better at a time when the industry is suffering,” Raspante continued. “You’re supposed to have brainstorming sessions with the client - to ask, ‘If you were going to embezzle, what are the vulnerable areas in the company?’”
Unlike Sarbanes-Oxley, SAS 99 would affect small and sole practitioners, as well as large offices, according to Raspante. “This would affect any audit, including a mom-and-pop stationery store or a pizzeria,” he said. “The accountant is supposed to have an increased understanding of the entity and its environment. It’s not unusual for an accountant to do an audit of a business when he’s not 100 percent familiar with the entity or the environment in which it operates. Under SAS 99, this could create a problem.”
Meanwhile, Bruce R. Swicker, head of professional-liability.com. an Internet-based broker of professional liability insurance for multiple professions, noted, “Certified public accountants today are faced with tremendous competitive and regulatory pressures in a rapidly changing business environment. While most of the headlines have centered on the large national firms, the fact remains that the vast majority of businesses and individuals in the United States rely upon the services of small to midsized firms.”
“With these changes come an increasing number of legal and ethical questions and potential pitfalls,” he said. “Many firms are expanding their practices to include various forms of consultancies, including management, computer/technology, even legal. In fact, the multi-disciplinary practice, or MDP, issue has come to the forefront in the accounting profession’s efforts to stay up to date.”
“Even a small or midsized firm, which might handle only compilation, review or non-audit services, or tax or business management issues,” he maintains, “is faced with a significantly increased risk of a professional liability claim.”
Whither rates?
After an increase in rates last year, it’s unclear where rates are headed now. However, Ric Rosario, Camico’s risk management vice president, noted that several carriers have ceased or scaled back writing professional liability coverage for accountants in the past year. Although he did not say so, less product usually translates into higher prices for the remaining products.
Sarbanes-Oxley is not the only federal law causing malpractice anxiety for accountants and their insurers.
Raspante urged the profession to be aware of the Health Insurance Portability Act. He explained that, under the law, “if information leaks out about a patient having diabetic or psychiatric problems, the patient will sue everyone. Many states have proportionate liability, which could bring the accountant into the mix.”
