Chapter 5
What has happened

The impact of financial crises

5.27The last decade has seen several serious, unexpected financial shocks. These include:
  • Major corporate collapses in the United States after accounting “irregularities” – including Enron in 2001 and WorldCom in 2002;
  • The collapse of Arthur Andersen, previously one of the World “Big Five” accounting and audit firms, as a direct result;
  • Collapses of New Zealand finance companies, beginning in 2006 and continuing through and beyond 2010. A recent count shows 66 failures with deposits at risk of over $8.7 billion; not including non-finance company collapses such as Bluechip. Estimated losses are over $3 billion.81
  • A global financial crisis, beginning in the United States in 2007 when various financial products began to fail with disastrous consequences. This has led to the collapse of some major investment banks and governments resorting to bail outs for banks and insurance companies. In New Zealand, the Government has guaranteed retail deposits including those held by finance companies.82 More recently risks of sovereign debt defaults by several Eurozone countries have emerged, potentially putting the future of the Euro in question.

5.28A universal feature of these events is large numbers of depositors and investors being unable to reclaim their investment or deposit from the finance entity with which they contracted. Unless they can benefit from a government rescue, guarantee or other intervention, investors who have suffered loss become potential plaintiffs looking for a solvent defendant.

5.29The auditors of failed entities and, for finance companies, the corporate trustees are potential defendants and sometimes the only defendants with funds available to meet a claim. The question is whether these crises have increased the potential liability of auditors and others to such an extent that some sort of limitation on their liability is justified, whether by proportionate liability, caps on liability or some other method.

5.30Investors and shareholders in New Zealand have sometimes successfully pursued accountants or auditors in some cases, and failed in other such attempts.83 The existing requirements to show that a duty of care is owed to a plaintiff third party and that the auditor has breached the relevant standard of care are likely to continue to restrict cases where auditors may be held liable to a wide class of plaintiffs. On this basis, it may be that the existing law is sufficient to protect auditors against arguably disproportionate or catastrophic losses, because auditors can protect themselves by taking reasonable care. The absence so far of clearly disproportionate awards provides some confirmation for this inference.

5.31Concern nevertheless persists in the industry. Practitioners continue to suggest that even the prospect of such liability discourages individual auditors or firms from entering or staying in the field. It is argued that mid-level firms may be deterred from taking on larger audits, professional indemnity insurance becomes too expensive or unobtainable; and auditors may refuse to undertake the riskiest assignments.

5.32As we discuss in Chapter 6, developments elsewhere are relevant. Auditors and some other professional advisers in Australian states now enjoy statutorily sanctioned schemes that cap their liability. Auditors covered by such a scheme have their liability capped at $1,000,000 for smaller assignment, or at ten times the fees earned for large assignments, with a maximum cap of $75 million. As part of the scheme, each participant must have professional indemnity insurance up to the level of the cap, or have sufficient proven assets to meet claims. We invite submissions as to whether New Zealand should allow similar arrangements; and if so, whether the Australian limitations are reasonable.

5.33The scope of any cap would also need to be determined. Even if limitations on liability are considered necessary to mitigate the most severe effects of liability for financial collapse, some exceptions to these caps may be appropriate. For reasons of principle and efficiency we consider that that any cap on liability should not be available in cases of deliberate misfeasance such as fraud. There is however a secondary issue as to whether or how often professional advisers are likely to be liable for losses in the “catastrophic” range, in the absence of deliberate misfeasance.

81Interest.co.nz “Deep Freeze List” (August 2012)<www.interest.co.nz>.
82Crown Retail Deposit Guarantee Scheme Act 2009.  
83Scott Group Ltd v McFarlane [1978] 1 NZLR 553; Allison v KPMG Peat Marwick - [2000] 1 NZLR 560; but see Boyd Knight v Purdue [1999] 2 NZLR 278 (CA). It is realistic to expect but difficult to substantiate that other proceedings or potential proceedings have been settled.