Risk management and quality control are the most important functions in an audit firm. If these tasks are not properly performed, the resulting litigation can cause the firm to sustain enormous losses. Even if insurance covers the first few losses, firms that repeatedly have to defend against legal actions soon find they are unable to buy insurance.

 

In December 2017, after years of litigation at great expense, the Supreme Court of Canada ruled that Deloitte was negligent in its work for Livent and awarded $40.4 million in damages. The damages are related specifically to work Deloitte performed on Livent’s 1997 financial statement audit. In The Globe and Mail article “Supreme Court says Livent auditors liable but sets conditions” Janet McFarland describes the Deloitte audit of now defunct Livent and the resulting litigation at various stages of the legal activity.

 

Audit firms are usually multi-disciplined businesses that require the same variety of professional and management expertise as any other business. Certainly the ability to attract new business is a very important function and ‘rain makers’ have historically received the most recognition and compensation. In recent years there has been much more appreciation for the expertise of technical people and their value in keeping audit firms from litigation.

 

Legal precedents over many years have established the extent of auditor liability, in terms of who can sue an auditor. People or entities that relied on an audited financial statement that later proved to be incorrect have been able to take legal action against auditors. It has been very difficult for a company to sue the auditor because the theory was that the company prepares the statements. If they are incorrect, the company has made the error. The Hercules case was the basis for this argument. The Livent case opens the door to the possibility for companies to take action against their auditors.

 

Audit firms should understand that there is no risk worth taking if the result might be an audit failure. The cost of litigation, even if the firm wins, far exceeds the fees from the audit.