Auditors and Legal Liability: Case Analysis and Mitigation Strategies

This report provides a comprehensive analysis of auditors' legal liability, focusing on the case of Royal Bank of Scotland (RBS) vs. Bannerman Johnstone MacLay. The report examines the key events, factual issues, and the responsibilities of the involved parties, including the auditing firm Bannerman. It delves into the relevant accounting and auditing issues raised by the case, exploring the root causes of the problems and the mistakes made by the defendants. Furthermore, the report offers recommendations for improving auditing strategies, programs, and other effective measures to minimize the risk of litigation and ensure professional integrity. The analysis highlights the importance of auditor's duty of care to third parties and the implications of disclaimers in audit reports. The report concludes with an overview of the legal and professional responsibilities of auditors and the significance of maintaining a high standard of conduct to protect both the profession and the public interest.

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AUDIT ASSURANCE AND COMPLIANCE
by [Name]
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Professor( Tutor)
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Date

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Exective summary
The paper focuses on providing an analysis of the role of auditors and their legal liability. Over
the years, the audit profession has been facing an increase in litigations and liabilities; this is
highly costing the occupation, over billions of pounds. There have been several cases in court
were auditor firms, had been penalized for their negligence, fraud, misrepresentation of
information, especially those involving third parties. This has reduced competition among the
auditing firms because small firms will be shunning large listed companies because of the
potential risks and costs involved in auditing them. Within the auditing profession, auditors can
make all the endeavors to reduce the litigation and penalty rate since that for so long has affected
the industry. The high litigation and penalty rate for years have been a preventative measure to
competition among the acting firms, and one way or the other has affected and damaged the
capital market of the industry.

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Table of Contents
Introduction......................................................................................................................................3
Body.................................................................................................................................................3
Description of Key events and factual issues which were behind the Royal Bank of Scotland
(RBS) Vs. Bannerman Johnston MacLay and others......................................................................4
The parties which were responsible and reasons why.....................................................................5
The relevant issues raised in Accounting and Auditing by case.....................................................5
The root cause of the problems........................................................................................................6
Mistakes and misrepresentations which were carried out by defendants during the session of the
court, thus contributing to awarding of the damages.......................................................................7
Recommendations to the Auditing Strategy and Auditing program as well as other effective
measures..........................................................................................................................................7
Conclusion.......................................................................................................................................8
Bibliography....................................................................................................................................9

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Introduction
The critical responsibility performed by the auditor is to offer reasonable assurance to financial
statement users that information presented on that statement is free form errors and right.
Therefore, something which causes a barrier to this purpose as performed by auditors becomes a
professional liability to them. The case under study is from the United Kingdom. Auditors
within society are responsible for providing assurance services. Therefore, investors within the
public view them as the guarantor of investment corporations (Marianne 2009). Auditors should
always be alert in ways they are offering their services (Samsonova-Taddei & Siddiqui 2016.).
This is because auditors are still prosecutable in the criminal court for matters concerning them
being reckless or knowingly issue an inappropriate audit opinion (Humphrey 2013). This means
that shareholders look for relief from auditors in case they fail to obey the terms and conditions
on engagement letter.
Auditing and litatiation
Auditing companies face different types of liabilities; some of these liabilities are civil and
criminal offenses. Criminal liability occurs to auditors when they have potentially breached the
imposed law by the government, and this means that criminal acts offer a relationship between
the state and the auditing entities (Richardson & Eberlein 2011). The civil laws in auditing deal
with differences or misunderstandings between organizations and individuals (Marianne 2019).

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Auditor, like any other individuals, is limited by laws and rules within the countries they are
operating in. Under criminal law liability, auditors could be prosecuted with acts related to
insider trading and fraud; one example of such a law is in the UK Companies Act of recklessly or
knowingly formulating a report(under section 495) to provide any matter that is false, misleading
or deceptive in any way possible or material. Concerning the civil offenses, there is a provision
of two pieces of the civil law for a particular significance to the auditing profession. These pieces
are the law of tort and contract law (Citron, 2013). These establish auditor liability principles to
third parties and clients. Through using the contract law, parties seek rectifications for breaching
of contractual obligations. Through the act of tort, auditors are sued for their negligence in case
they breach a care duty towards the third party who is suffering from any loss form.
While analyzing the litigation which is faced by the Auditing teams, the chosen case is of Royal
Bank of Scotland (RBS) Vs. Bannerman Johnston MacLay (Bannerman) which was very
useful in the year of 2002(Scottish Courts and Tribunals 2018)
Description of Key events and factual issues which were behind the Royal Bank of Scotland
(RBS) Vs. Bannerman Johnston MacLay and others.
The case involved two parties where one was the defendant, and the other was the plaintiff, there
was the third-party who was the center of discussion of the case. The plaintiff in the law case
refers to an individual or party which is accusing the other of breaking the law hence affecting
him; the plaintiff relates to an individual who drags the other to court. The defendant refers to an
individual who is taken to court for either breaking a civil law or criminal law. The plaintiff
always accuses the defendant from doing wrong. Within this case, the defendant was Bannerman
Johnstone Maclay and others(Cunningham 2011). The defendant was an auditing company
which carried out all the auditing services for the plaintiff in the earlier years before an issue was
taken to court. The plaintiff of the case was the Royal Bank of Scotland. The defendant of the
case was dragged to court because in the years before took audits concerning the plaintiff
causing issues in the year of 1998, in that year the company lost money while the third-party
company received an amount of money of around 13 million pounds. Royal Bank of Scotland
claimed a refund of 13 million pounds from the auditor's company, there complain is that the

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accounts or audits which were made in the previous years were misstating the right financial
standings of the company and the same time the auditing company was negligent in detecting it
(Gillis et al. 2014). The plaintiff used the accounts, which resulted in a considerable loss. The
Royal Bank of Scotland was the primary lender or banker of the company; because of the
reports, it exercised options to subscribe to company's majority shares as well as carrying out
loan services. The specification for the lending agreement was sent to the bank audited and
monthly management accounts immediately they are practicable. Bannerman Johnstone Maclay,
the defendant, was charged for damages which occurred to the bank because of their negligence.
The Royal Bank of Scotland, which was the plaintiff claimed that they vividly relied on the
accounts to carry out their services (Cunningham 2014). The defendants in their defense basing
on Galoo case stated that there was no need for correctly carry out the auditing for a specific
action within the bank. For the bank to issue the case to court, it was after sustaining severe
damages because of fraud and negligence done by Michael McMahon during auditing, which
was an employee in the auditing company.
The parties which were responsible and reasons why
There are two parties involved within the case, and the other is a third-party, APC limited which
the third party during the auditing went into receivership while at the same time Royal Bank of
Scotland was losing its money. The Royal Bank of Scotland decided to recover its losses through
suing defendants who were the auditing company to the court making claims that the company
was too negligent of its services as well as breached the duty of care it was owing to the Bank.
Bannerman, the defendant in court, argued that it was not right if the stated allegation is said to
be accurate, in no manner did they owe the Royal Bank of Scotland a duty of care. Therefore, in
this case, the pursuers sued the defendants two instances, one of the cases was a fraud, and the
other case was breaching the duty of care. The pursuers were pleading for payments of four
separate sums of money to cover their losses. These sums of money were 12,016,000 pounds as
the first sum, the second sum was 7,116,000 pounds, the third sum was 1,947,000 pounds, and
the fourth sum was 12,016,000 pounds. Both parties were heard in the court, and the court held
in favor of the plaintiff or the Royal Bank of Scotland. The case was in support of the bank
because the court stated that the auditors had prior knowledge of how the bank would use the

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auditing information to third parties and it depended so much on the auditing information to
carry out its services.
Nevertheless the point for fraud was dismissed, the court on the other side also rejected the
arguments which were passed on by the defendant that, for the existence of a duty of care, there
should and must be express assumptions for the responsibility of the third party to an auditing
company. Lord Macfayden commented that since the auditors were aware of the required details
for the lending agreement, they would have possibly disclaimed the responsibilities to the bank
(Humphrey et al. 2009). There was further appealing of the case to the Scottish Court by
Bannerman, but the appeal was dismissed in 2005 during the court session. The Scottish Court
agreed and believed in the pronouncements made by the judge at the first instance. It also made a
confirmation that the duty of care could also be made even in the unawareness of the auditor's
intention provided that they have deemed or actual knowledge that the auditing information
would probably be used for third parties.
The defendant was proved guilty for negligence, and this did not seem right, in other words, they
did not deserve the penalty of thirteen million pounds which was the loss suffered by the
plaintiff, they did not deserve this because they never neglected there work.
The relevant issues raised in Accounting and Auditing by the case
The question which was built after the occurrence of the case was regarding the auditor's duty of
care to the third parties. Handling the auditor's third-party duty of care specifically looked at the
different scenarios of how disclaimers would be considered appropriate (Chandler 2017). The
case raised a lot of question to the accounting fraternity whether accountants or auditors might
protect themselves from the possible liabilities and litigations through using disclaimers, which
are standard in their audit reports made as a company. There was a change in the Companies Act
laws to carter for the third party when auditing is done for the company to protect the auditors or
accountants. Section 235 for the Companies Act 1985 suggested for periods of accounting which
started on and after 6 April 2008 and also the section 495 of the Companies Act 2006,
accountants or auditors of a given auditing company require for response from the company

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members whether the provided financial statements they have provided after auditing are
following the Act of verification and whether the check was done on a fair and right view
(Humphrey & Loft 2011). The council and technical committee of ACCA monitored
developments basing on the ruling of the Bannerman case. Basing on the matter, ACCA council
suggested that the only way accountants can restrict themselves from any form of liability is
through carrying out their professional auditing works regarding the auditing standards (Öhman
& Wallerstedt 2012). They farther suggested that when there is proper conduction of auditing,
there is no need for attaching the work to disclaimers to protect themselves. The ACCA issued a
technical fact sheet on CCAB behalf explaining lenders who are third parties and auditors (Carter
& Spence 2014). One of the parts in the fact sheet was that auditors or accountants who are
aware and in receipt of the request to give acknowledgment of the responsibilities and roles to
client lenders must not go unanswered.
The case also raised concerns about litigations to audit companies, some of the advantages of
litigation to auditing companies are; auditors will be alert when carrying out their
responsibilities. Before operating or carrying out work for the client, they will ensure the
performance of specific duties needed as well as presenting essential matters excluded during the
audit. Liability is critical to the way that auditors will need an engagement letter before work
(Humphrey & Loft 2008). In the same manner, when auditors are requested to perform additional
action or duties on later dates, they would need clients to define this in writing. Professional
liability avoid negligence in the provision of advice to clients by auditors; because of fear of
commitment, when auditors are presenting incomplete information to their clients, they possibly
make it clear to their clients that the advice they are providing is subjected to limitations and
there is need for further in-depth study or revision of the information.
The root cause of the issues
The Royal Bank of Scotland claimed that there was a fraud which was created by one of the
defender's employees seconded to act as the financial controller for the APC a third party, this
allegation was dismissed in court. The pursuer also alleged the defendant as Bannerman auditors
and owed them a duty of care; the pursuers claim that they made a loss as a result of the breach

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of the task. Therefore, in the case of the Royal Bank of Scotland as the plaintiff Vs Bannerman
Johnstone Maclay and others, was not a cause of fraud, market pressure, or organizational
culture but instead was as a cause of misrepresentations of the information provided by the
auditors to the bank thus making the bank to misinterpret causing damages to its standard
running services through making losses. The auditing team failed to adequately represent itself
on how the bank would use the accounting information in its day to day standard serving of its
clients who seem to be third parties to the auditing company.
Mistakes and misrepresentations which were carried out by defendants during the session
of the court thus contributing to awarding of the damages
When the defendants were presenting themselves, few mistakes were made. The pursuers claim
that there were fraud and negligence during the occurrence of the audit. In their defense, the
defenders stated that the pursuers did not inform them about the intentions of the review. They
barely knew about the existence of a duty of care which the defenders owed the pursuers
concerning the audit of APC accounts. Following the defense provided by the defendant, there
were no mistakes conducted. The court responsible for the hearing of the case just ruled in favor
of Royal Bank of Scotland claiming that the defendants who were the Bannerman were aware of
the third-party identity and at the same time was aware of the bank using the audit accounts to
offer its services to the third. The court, at the same time, neglected the defense opinions of the
defendant that the existence of a duty of care should be dependent on the prior assumption of the
responsibility by the auditor to the third party. To show that Bannerman who were the defendants
knew what they were doing, they went forward and appealed the case in the Scottish court,
which was dismissed during the court session in the year of 2005. The court followed the first
decisions which were made in the first hearing, therefore, stating that they are considering them
because pronouncements made by the primary judge since the duty of care be established even
though there are no intentions by the auditor, given that there is deemed or actual knowledge.

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Recommendations to the Auditing Strategy and Auditing program as well as other effective
measures
As a result of judgment which was made during the Bannerman case, Bannerman paragraph or
Bannerman clause was established within the Companies Act of 2006. This is very helpful in
protecting the auditing firms or companies from unnecessary litigations from client companies.
From the above case, auditing companies learned the following: During the time of auditing of
such institutions, the following should be put into consideration.
There should always be critical identification of the third parties before carrying out any
auditing. Management teams should continually fully evaluate and monitor third parties which
are connected to the institution they are auditing (Huepkes 2010). Third-parties are always
associated with high risks, and these risks are still affecting the auditing teams. Therefore, a
better third-party strategy should access all the risks associated with auditing companies related
to third parties.
There is also a need for assessing the third party risk management program; there should be a
determination whether the company's third-party program is associated with diligence processes
(Gomes et al. 2011).
To void liability, auditors have to understand that there are potential areas of professional
auditing where there is no possibility for limiting or excluding a given liability for example when
one fails to make correct auditing when acting under the Companies Act 1985 as an auditor.
Auditors also understand that there are areas within professional work where even if an exclusion
or limitation is included as a liability (International Ethics Standards Board for Accountants
(IESBA) 2014), its effectiveness only depends on the court's view or ruling. He only understands
this understanding of the different terms and possible areas where an auditor may be leveraged to
liability because of the rules governing auditing, therefore professional verification is both
helpful and advantageous to auditors such that they offer quality work and to the clients such that
they are adequately protected from lazy and unfaithful auditors (Clements et al. 2009).

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Basing on the case, Auditing firms should look for the different ways of limiting disputes;
disputes within Auditing always occur for a number of reasons but some of the reasons why they
do occur is third party or clients claiming that the loss suffered within their business is because
of the negligence of the auditing team which they employed, the auditing also may be suggesting
that the business results or losses suffered by the client or third party are not their negligence
instead is due to client's incompetence ( Köhler 2009). Therefore, the introduction of liability
helped to improve on the competency of auditors as members would wish to make proper
management of their risks and cause an extension of potential liability to third parties or clients
during provision of professional services. In auditing, disputes sometimes do not rise because of
inherent defects within the performed professional work, but rather misunderstandings relating to
the work scope agreed between the auditor and the client. Therefore ruling of conditions and
terms relating to why, what, when, and how are accountants subjected to liability after
participating themselves in auditing is very helpful to both the client and auditors. Auditors
mostly suffer burdens when there are claims of professional negligence, damage to company
reputation, breaching of trust, as well as statutory duties (Camfferman & Zeff 2017).
Conclusion
Litigation is very disadvantageous to auditing firms; it is stated that over millions to billions of
liabilities have been passed onto the big four auditing companies in two decades. Following the
identified case within the report, it is noted that litigation is not only disadvantageous but also
advantageous because it will educate firms on how to avoid negligence, fraud, and
misrepresentation of information by these firms since are the leading causes of litigation.
Sometimes litigation occurs when the auditing company does not do falsification of information
but rather the client company fails to agree with the team which carried out auditing. Following
the case identified above, rules concerning the handling of third-parties should always be put into
practice by firms carrying out verification.

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Bibliography
Camfferman, K, Zeff, SA. 2017. Financial Reporting and Global Capital Markets: A History of
the International Accounting Standards Committee, 1973–2000. Oxford: Oxford University
Press.
Carter, C, Spence, C .2014. Being a successful professional: An exploration of who makes
partner in the Big 4. Contemporary Accounting Research 31(4): 949–981.
Chandler, R. A., 2017. Questions of ethics and etiquette in the society of accountants in
Edinburgh, 1853–1951. Accounting History 22(2): 179–192.