Exposure of auditors and accountants in South Arica is in general observed on 2 levels. Firstly, potential exposure in respect of legal liability arising from audit related work. Secondly, exposure in regulatory investigations initiated by the Independent Regulatory Board of Auditors (“IRBA”).
On legal liability level the exposure of auditors is from time to time the subject matter of investigation by our courts. In Hlumisa Investment Holdings (RF) Ltd and Another v Kurkunus and Others  JOL 47567 (SCA)the Supreme Court of Appeal recently considered the liability of auditors. The Plaintiffs were shareholders in African Bank Investment Ltd and instituted action against inter alia Deloitte & Touche for recovery of damages sustained as shareholders for denomination in share value. Deloitte & Touche were the auditors of both African Bank Investment Limited and African Bank as its subsidiary. African Bank Investment Limited was the holding company. The question to be addressed on the issue of wrongfulness was whether public and legal policy considerations dictated that the auditors of African Bank be held liable to the shareholders of African Bank Investment Limited for the reflective losses they sustained as a result of the underlying losses suffered by African Bank.
The findings in the Hlumisa case are not novel but to a large extent constitute application of existing principles on the issue of a legal duty in respect of pure economic loss and on liability of auditors in general. The court held that if auditors performed their work negligently, it is the company, and not its members that is the proper Plaintiff to sue for any loss as auditors are accountable to shareholders collectively as a body, i.e. as the company. When auditors make negligent misstatements concerning the companies’ financial statements, individual shareholders do not have a claim as the primary purpose of auditing records is to report on the stewardship of the directors to the shareholders as a body. The purpose of the audit report is neither to protect the interest of investors, nor individual shareholders. Such liability would expose auditors to liability in an indeterminate amount for an indeterminate time to an indeterminate class, which is unreasonable. In general, auditors therefore have no duty to third parties with whom there is no relationship unless specific factors may justify the existence of a legal duty.
The good news from a breach of legal duty liability point of view is that a third party must in principle cross various hurdles in order to hold an auditor liable. It is however easier for a client to hold an auditor liable in respect of breach of contract and breach of professional duties in the context of a contractual arrangement.
The final report of the Zondo Commission on State Capture was released in June 2022. The role of the private sector in enabling state capture may lead to claims by the state to recover losses suffered by the state against third parties that participated in fraudulent conduct or that benefitted. Auditors will also and are already under scrutiny for the failure to detect state capture transactions. The failure to detect state capture may also expose auditors in respect of legal liability as well as in regulatory investigations by IRBA.
The failure of auditors to detect corporate fraud is also a potential driver of legal liability as well as of regulatory investigations by IRBA. As already mentioned, a third party Plaintiff will have more hurdles to cross to establish a legal duty owed by the auditor and to hold an auditor liable for breach of such legal duty, but liability arising from breach of professional duties in the context of breach of contract, is in our view a realistic exposure.
On Regulatory level, the search and seizure powers were granted to IRBA when the Auditing Profession Act amendments were signed into law last year and the powers will probably boost the pace of statutory investigations. We predict a further rise in statutory investigations. IRBA is also under political pressure to investigate auditors and their role in the failure to detect corporate fraud as well as the failure to detect state capture, which will lead to a further rise in investigations.
In terms of Section 48 of the Auditing Professions Act, an investigating committee must investigate any complaints of potential improper conduct. The investigating committee as part of this process liaises with the auditor and the auditor is then given an opportunity to respond and to make submissions. The investigating committee must after its investigation recommend to the IRBA whether sufficient grounds exist for a charge of improper conduct. IRBA must in turn in terms of Section 49 charge an auditor with improper conduct if sufficient grounds exist. A formal charge sheet is then issued and the matter will then proceed in terms of Section 50 to a formal disciplinary hearing.
We advise auditors to during the investigation phase, co-operate and to make submissions should such submissions not prejudice auditors in a disciplinary hearing. IRBA will normally after an investigation should the investigating committee believe that there are sufficient grounds for improper conduct, give an auditor an opportunity to plead guilty and to pay an agreed fine in order to avoid a formal disciplinary hearing. We advise auditors to obtain legal advice for guidance through any investigations process.
We advise auditors to, if there is scope and it can be justified, enter into plea bargaining negotiations and use the opportunity to resolve the matter without a protracted formal disciplinary hearing process. In this regard inquiry defence costs as policy benefit can be utilised to obtain sound and independent legal advice (and sometimes with the input of an independent auditor as well as expert) to guide auditors through the process and to resolve a matter. We advise auditors to avoid disciplinary hearings if possible as such hearings can takes years and weeks of actual disciplinary hearing time to complete with involvement of attorneys, advocates and independent auditors as expert witnesses. If it is not possible to avoid a disciplinary hearing process, auditors should ensure that they have sufficient inquiry defence costs cover.
In terms of Section 51(4) of the Auditing Professions Act, a disciplinary committee may order an auditor who admitted guilt or who was fined guilty of improper conduct, to pay such reasonable costs as have been incurred by the investigating committee and the disciplinary committee. This provision in our view does not place the auditor and IRBA on equal footing in a disciplinary hearing context as the disciplinary committee can order a cost order against an auditor but there is no provision in the Auditing Professions Act that an auditor can in fact obtain a cost order against IRBA. A cost order can be substantial. Auditors must ensure that they are as part of their professional indemnity arrangements covered for possible cost orders as well. In the recent African Bank IRBA disciplinary hearing, the auditors were for example ordered after they had reached an agreement with IRBA, to pay R28 million as cost contribution to IRBA’s costs. The actual costs to represent an auditor can obviously also be substantial and auditors must ensure that they have sufficient cover for their own costs.
In a further recent development the Minister of Finance gazetted in June 2023 maximum monetary fines for improper conduct of auditors. Fine exposure is now massive. The previous maximum fine was R200 000 per charge of improper conduct. The maximum fine for an individual who concluded an admission of guilt process is now set at R5 million and in the case of an audit firm the maximum fine is set at R15 million. When a matter is referred for a disciplinary hearing, the maximum fine the disciplinary committee can apply following a disciplinary hearing process is R10 million for an individual and R25 million for an audit firm when on conclusion of the hearing process, the auditor or the audit firm is found guilty. Fines are not indemnifiable under professional indemnity policies and do create the risk of enormous personal exposure for auditors and audit firm. It is therefore crucial that auditors have sufficient inquiry defence costs cover.
We advise auditors to ensure that they are sufficiently covered in respect of legal liability as well as inquiry defence costs for purposes of assistance on Regulatory investigations and disciplinary hearings as well as for any cost orders which may be granted against such auditors.