CAs For Change - The Legal Environment

“Ontario CAs are right to call for legal liability reform. The province must keep up with liability changes amongst your major trading partners to ensure that business transactions can continue to happen here in a secure environment, on a level playing field for finance and accounting professionals. Indeed, Ontario’s competitiveness depends on it.”

UK auditor insurance expert Richard Hardingham, BSc, FCII, Brit Syndicates Ltd. at Lloyd’s of London

Legal liability reform

Ontario’s current system of joint and several liability exposes financial advisors to an unreasonable degree of legal liability in the event of a financial loss. Under this system, a party to such a loss may be held to account for fully 100 per cent of a claim, even though he or she may be found by the courts to be just one per cent responsible for the loss.

The consequences are three-fold: First, exposure to this degree of liability is deterring some qualified and competent advisors from entering the field, or assuming senior positions within professional services firms, making it more difficult to attract and retain the new and younger talent needed in today’s increasingly competitive business environment. Second, insurers to these service providers are exiting the market, requiring firms to self-insure and become the de facto insurers of our capital markets in a way that is unsustainable over the long term. Third, the increasing risk associated with these advisory services is prompting many professionals to consider abandoning the market for these services altogether. Over time, this threatens to deprive enterprises of every size of the financial advisory services they need to access capital, innovate, compete and create jobs.

Various forms of proportionate liability have now been enacted by all of Ontario’s competing Great Lakes states as well as 30 other states, and is either being implemented or is under consideration by the U.K., the E.U., Australia and many other of Ontario’s leading major trading partners. Failure to keep pace on liability reform puts Ontario at a distinct and growing competitive disadvantage.

Globe and Mail / Ontario CA Publication on Legal Liability Reform

Page 1: Legal Liability Reform, an Introduction- pdf
Page 2: From Major Investments to Human Resources, Liability Issues Hit Ontario's Economy - pdf
Page 3: Ontario Needs a Legal Liability Framework that Contributes to Prosperity - pdf
Page 4: U.S. Auditors, their Clients and Lawyers Grapple with Disproportionate Liability - pdf
Page 5: Bringing Rationality Back to the Legal Liability System - pdf
Page 6: Ad Campaign - pdf

FREQUENTLY ASKED QUESTIONS

Why do we need legal liability reform?
What is joint and several liability?
Why is joint and several liability a problem?
Does joint and several liability have a special impact on auditors?
What are alternatives to the current liability system?
What is proportionate liability?
What are the advantages of proportionate liability as it applies to the financial services industry?
What is happening in other jurisdictions?
How much is legal liability costing?
How much are lawsuits costing the audit industry in Canada?
Can’t financial services providers just get insurance?
How does this issue impact smaller firms?

Why do we need legal liability reform?

Legal liability reform would change Ontario and Canada’s current system from joint and several liability to a system that better balances the interests of plaintiffs and defendants in lawsuits. This would make our business environment more efficient and help keep our country internationally competitive.

What is joint and several liability?

Under joint and several liability, each person who contributed to a financial loss – no matter how minimally – may be fully liable for that loss. This motivates plaintiffs to go after “the deepest pockets.”

Why is joint and several liability a problem?

Under joint and several liability, plaintiffs are incented to name mulitiple parties to a lawsuit, regardless of the extent of their responsibility. If any one of them is found to be even partially responsible, that party may end up having to pay full damages if other parties are unable to pay. Parties judged one per cent responsible could pay the full 100 per cent.

This makes court cases more complex, as more parties are involved, and puts an often-onerous burden on parties that may have been peripheral to the main issues raised.

Does joint and several liability have a special impact on auditors?

All financial service providers can be affected, but the large and often unquantifiable risks associated with joint and several liability are causing a growing crisis for auditors over insurance availability, a risk of catastrophic firm failure and a lack of access to audit services for Ontario enterprises of every size.

What are alternatives to the current liability system?

There are a number of ways the system could be reformed, but the most commonly proposed change would be a system of proportionate liability.

What is proportionate liability?

Under proportionate liability, responsibility for a financial loss is apportioned by the courts according to the extent of responsibility. The goal of such reforms is not to remove all liability from defendants, but rather to remove the risk of catastrophic and disproportionate loss that can come under joint and several liability.

Proportionate liability would only apply in cases where there was no fraud or wrongdoing; in cases involving fraud, joint and several liability would still apply.

What are the advantages of proportionate liability as it applies to the financial services industry?

There are eight major reasons why adopting proportionate liability is in the public interest.

Supply of talent: Because of the high risk caused by the current system, it’s becoming more and more difficult to attract and retain new and especially younger financial professionals, including auditors and firm partners, which is affecting the availability of these needed services.
Reduces the cost of services: Financial services firms have to pass along excessive settlement, litigation and insurance expenses to clients, which raises costs for businesses that in turn must be passed along to consumers.
Ensures access to services: If the current trends continue, many high-risk and smaller public companies won’t be able to find financial advisors, like auditors, or receive the level of services they need, excluding them from access to much needed capital and affecting their ability to create jobs and, ultimately, harming the competitiveness of our economy.
Remaining competitive with our international peers: Canada is becoming a less attractive place to do business compared with a growing number of competing jurisdictions that either intend to scrap joint and several liability or heavily amend it.
Appropriate outcomes: Financial professionals should be responsible for their share of any damages awarded in court, not for the share of others, as is the case in the current joint and several liability regime. In some cases, a firm’s responsibility could be set at only one per cent but, because of unlimited liability and the fact they are perceived to have deep pockets, they’re made to pay for 100 per cent.
Timely information to capital markets: New studies show that auditors are increasingly concerned by the perception that companies are too quick to report positive results and too slow to report negative ones, giving rise to the threat of lawsuits. This drives them toward “over-conservatism” in assessing positive developments, which delays feeding this essential information into the capital markets, thereby distorting the quality of market information overall with negative consequences for investors.
Broader audit firm market: Escalating risks may mean few new accounting firms enter the market for auditing public companies, thus limiting competition and access to audit services. In fact, since 2001, the number of firms offering public company audit services in Ontario has shrunk from approximately 400 to just over 200 firms.
Reduces the risk of firm failure: The size of imposed settlements caused by the current liability regime raises significantly the risk of failure for some accounting firms, a situation that would be highly disruptive to the capital markets and our economy.

Proportionate liability is in the public interest. Canadian businesses need continued access to high-quality financial services. Adopting proportionate liability will enhance choice and quality.

What is happening in other jurisdictions?

Ontario's major trading partners in the U.S., Europe and elsewhere are moving toward new legal liability models, such as proportionate liability. In safeguarding against disproportionate exposure to liability for financial services firms, these reforms will help ensure that enterprises of all sizes have continued access to essential, high-quality financial services that will enable them to compete, innovate and create jobs.

In the U.S., legal liability reforms have been made at the federal level and in 37 states, including all of the Great Lakes states competing with Ontario. And momentum for more change continues to build.

Reforms in the U.K. are allowing auditors to negotiate liability caps with their clients that limit the amount of damages they’re required to pay in a lawsuit. The E.U. as a whole has announced it intends to move forward on proportionate liability in 2008.

How much is legal liability costing?

The dollar values of claims incurred or settled are huge and rising exponentially. Liability issues are of worldwide concern.

For example, the U.S. Chamber of Commerce and the SEC both agree that the U.S. needs to look at legal liability reform for auditors for the very reason that settlements being sought are so big as to risk the collapse of a major audit firm. In some cases, firms which received fees measured in thousands are being held responsible for hundreds of millions in damages.

In Europe, data from 2006 showed there were 16 cases in the E.U. where damages sought from the larger accounting firms were in excess of $200 million U.S. Five of these were in excess of $1 billion.

How much are lawsuits costing the audit industry in Canada?

While we don't have a figure for the total amount of damages claimed in all actions that include auditors, based on current research, we can say that more than 12 suits claiming damages over $100 million have been filed in the past 10 years in Canada, with three of those seeking damages of over $1 billion. While some of those suits may have been or may yet be settled for less, any one of them has the potential to do serious damage to the accounting industry or cause the failure of a firm.

Because of these large claims and the accumulated totals of smaller ones, the dollar value of incurred claims against five of the biggest six accounting firms went from $191 million, in the period 1991 to 1995, to $673 million between 1991 and 2005. Incurred claims are not the total of damages sought but instead reflect the amounts firms must set aside in anticipation of prospective case settlements.

The trend line for the dollar value of amounts actually paid by those audit firms was even more ominous. The amounts paid out during that period leapt from almost $13 million during the period covering 1991 to 1995 to $299 million from 1991 to 2005.

Can’t financial services providers just get insurance?

Because insurance firms today cannot quantify the risks of some assignments – such as global audit engagements – under joint and several liability, many are retreating from the insurance market entirely. Bringing this problem under control through proportionate liability will see insurance companies re-enter the market, which would enable them to “price” that risk and create a source of recovery for shareholders.

How does this issue impact smaller firms?

Insurance premiums, when professional indemnity insurance is available at all, are skyrocketing. Big firms mostly have to self-insure. In a 2005 survey of small firms and sole practitioners in Ontario, 83 per cent of respondents told us that legal liability is an important issue for their firms or practices, and 73 per cent said they had faced moderate to significant premium increases during the previous five years.

Higher insurance premiums make all firms more risk averse and less likely to take on the financial services work that Ontario needs done to keep its economy growing.

The Institute of Chartered Accountants of Ontario Legal Liability Brochure
News Release: Institute of Chartered Accountants of Ontario Submission to the Federal Competition Policy Review Panel

By Section: Institute of Chartered Accountants of Ontario Submission to the Federal Competition Policy Review Panel

Introduction by Institute President and CEO Brian Hunt, FCA
Canada in a Global Context
Becoming a Destination for Capital, Talent and Innovation
An Issue for Bay Street and Main Street
Real Businesses, Real Impacts
Keeping Up With the Neighbours
How Big is the Problem?
U.S. Chamber of Commerce: Auditing – A Profession at Risk
E.U. Commissioner for Internal Markets, Charlie McCreevy's Speech on Statutory Audit Package
E.U. Commissioner for Internal Markets, Charlie McCreevy's Report on Auditor Liability and other Issues for the Profession

KEY POINTS

Ontario CAs have a proud history of advising the provincial government on legislative reforms that can boost our province's competitiveness.
One area of urgently needed reform is Ontario’s current system of joint and several legal liability for finance and accounting professionals, to help protect businesses and our capital markets.
Under the current system, a party that is just one per cent responsible for a financial loss can be held to account for fully 100 per cent of a claim.
Ontario’s audit profession – not just the large firms but also smaller practices in smaller communities – are usually the targets of these huge and growing claims even though they may have had little responsibility for a financial loss.
Ontario CAs report that the current liability scheme is:
- driving them out of the marketplace for their services because of skyrocketing insurance costs and exposure to disproportionate liability
- shutting off access to vital audit services for enterprises of every size, and as a result
- squeezing those companies of the investment capital they need to compete, grow and create jobs

Canada’s major trading partners in the U.S. (including our neighbouring Great Lakes states), the U.K., the E.U., Australia and elsewhere have the same problem, and are addressing it through reforms such as a move to “proportionate liability”.
Under proportionate liability, responsibility for a financial loss is apportioned according to the extent of an individual party’s responsibility for that loss.
For Ontario to maintain its competitive edge in a globalized economy, we need to catch up to our major trading partners in liability reform.