Auditing and Legal Liability: PWC vs. Tyco International Shareholders

This report examines the legal case involving PricewaterhouseCoopers (PWC) and the shareholders of Tyco International LTD, where PWC was accused of failing to uncover a $5.8 billion fraud. The report delves into the background of the case, highlighting the accounting overstatements, misappropriated compensations, and interest-free loans that contributed to the fraud. It explores the thresholds for litigation against auditors, including duty of care, negligence, loss, and connection. The analysis investigates PWC's alleged failure to detect the fraud, the potential negligence and corruption of the auditors, and the root causes of the problem. The report also outlines the events' outcomes, including investigations by the Securities and Exchange Commission and the court proceedings initiated by shareholders. Finally, the report provides recommendations for audit firms to minimize litigation risk, such as invoking disclaimers of liability and entering into Liability Limitation Agreements. The conclusion emphasizes the importance of auditing services in benefiting stakeholders and the increasing risks and costs associated with auditor litigation.

Auditing Theory (PricewaterhouseCoopers versus Tyco International
LTD Shareholders)
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Background
•PricewaterhouseCoopers (PWC) was involved in a case with the shareholders of Tyco
International LTD which saw PWC pay $229 million .
•Being the auditor, PWC was accused of not uncovering $5.8 billion fraud where Tyco
LTD made accounting overstatements.
•As the fraud span from 1995, PWC was expected to have noticed the millions of
unreported dollars, misrepresented and misappropriated compensations.
•Tyco gave interest-free loans to high ranking company employees and reported stock
sales in a belated manner
•Dennis Kozlowski and the then chief financial officer were handed 25 years in jail after
conviction in 2005, while PWC bore the brunt by agreeing to pay the damages to Tyco’s
shareholders in 2007.
•The payments were shared among those who acquired shares in Tyco between 1999
and 2002. PWC raises serious concerns over the misuse of auditor autonomy in the
United Kingdom (UK).

The Threshold For Litigation Against Auditors
• it is essential for the plaintiff to show that the auditor owed a duty to them.
• Another threshold that the case against an auditor must meet is that the
plaintiff must prove that the auditor either deliberately or inadvertently
neglected or breached that duty to care.
• Thirdly, the case must meet the threshold that the plaintiff suffered a loss.
• Lastly, there must be a clear demonstration of the connection between the
plaintiff’s loss and the auditor’s negligence.

PricewaterhouseCoopers did not uncover a $5.8 billion fraud
• In 2002, Tyco came into the limelight as a company whose ethical standards had
gone askew. Kozlowski cunningly perpetrated conflicts of interests and fraud crimes
by stealing close to $170 million from Tyco.
• Although the auditor can never be considered as an insurer of the financial
statements in any company, they are expected to provide the management with
reasonable assurances about the financial statements. Unfortunately, these
devastating effects are not confined to the client who asked for the auditing services.
• In the case of PWC and Tyco shareholders, inflated and misleading statements were
posted for several years. The investors depended on these audited reports to make
assessments and evaluations of their company.
• The action to settle the $229 million was adept since this would probably cost them
more in litigation and settlement when found guilty.

PricewaterhouseCoopers ignorantly or deliberately
abated crime
• Since all financial records are available to auditors, it is reasonable and
logical to assume that PWC’s auditors accessed such data.
• Since there were several high ranking officials in Tyco LTD who got interest-
free loans, it was not easy for this information to be missed by the
professional auditors.
• Additionally, any auditor will easily detect escalations in financial statements
and get suspicious. This raises concerns as to why PWC’s auditors were
not able to get this.
• It is possible that the auditor was corrupted and hence became a
perpetrator of the fraud that he was hired to unravel or prevent.

Root Causes of the Problem
• The real reason behind the case was negligence.
• There is the aspect of fraud in the case as well.
• There was the aspect of conflict of interest.

Events’ Outcome
•After the Tyco restated its financials in 1999, the Securities and Exchange Commission
commenced investigations due to suspicion.
•Kozlowski was found culpable of huge tax evasions resulting to further investigations
that unveiled more illegal activities in Tyco .
•It became imminent to establish the role of the auditor. The auditor was found to have
an underhand in the dealings.
•The shareholders instigated the court proceedings against PWC.

The Appropriateness of the Imposed Penalties and Damages
• Tyco’s shareholders lost large amounts of money.
• It is justifiable that they paid $229 million in damages.
• The illegal acts perpetrated by PWC required a strong predicament and the
amount paid in damages was sufficient.

Recommendations
a. It is important for audit firms to invoke the disclaimers of liability (based on
the 'Bannerman Paragraph') since failure to do this will attract litigation form
third parties they haven’t disclaimed liability.
b. The auditors can also enter into Liability Limitation Agreements. This is a
strategy that significantly reduces the threat of litigation.
c. The relevant bodies should come up with a way of reducing litigation against
auditors without encouraging them to get involved in deliberate acts of
crime.

Conclusion
• Auditing services are meant to benefit the auditee and any interested third
party. When auditing services fail to meet this need, they become an
unnecessary cost to the client. This may result in litigation. As a
consequence, auditors are required to operate within the confines of the law
and ensure satisfaction of the client. Due to the increasing cases of litigation
against auditors, there are increased risks and costs of auditing services.
Although there are ways in which auditors can minimize litigation, the audit
industry is losing billions in law suits emanating from clients and third
parties. It is becoming exceedingly challenging for auditors in the job market
as the clients desire quality, even as some have demands that are not
within the law.