In the last five years, Arthur Andersen & Co. has paid out more than $137 million in court settlements, according to the Securities and Exchange Commission.
Andersen is not alone. The nation's accounting industry is faced with an unprecedented wave of lawsuits -- a legal attack industry officials claim threatens the size and financial health of the profession.
Peat, Marwick, Mitchell has paid out more then $19 million, Ernst & Whinney more than $6 million and Deloitte Haskins & Sells nearly $5 million, according to figures assembled by the SEC. And though figures for other "Big Eight" firms are at this point considerably smaller, all face huge claims for audit negligence than run into the tens and even hundreds of millions of dollars.
Lawsuits are nothing new for accountants, but lawyers for big firms say the current upsurge is unusual in the number and size of the claims outstanding. Attorneys for several Big Eight companies said their firms face up to a dozen new cases each year. They link this increase to court decisions expanding the definition of an accountant's liability plus the fallout from the business recession of the early 1980s.
Industry critics, however, link the increase to long-standing deficiencies in the accounting practices followed by major firms. They argue that wholesale reforms are needed to restore public trust in independent audits.
The courts have in general expanded the classes of people to which accountants may be found liable. According to lawyers familiar with the profession, recent court decisions have made accountants liable not just to their clients, but to investors, creditors and other third parties who may have been harmed by an audit failure.
At least 75 percent of the lawsuits against the nation's largest firms are brought by third parties, according to Mark Berens, a Chicago lawyer who has studied liability cases.
The courts have also expanded the class of actions for which accountants may be held negligent and hence liable to a civil suit.
Accounting industry officials argue these legal trends both expose firms to an indeterminate and unfair amount of claims and reflect a misunderstanding of the way they do business.
Jerry Kolb, a partner in Deloitte, Haskins & Sells, said the public does not understand the function of an audit and often "ascribes to an audit a much higher degree of certainty and accuracy than is contemplated."
As a result, Kolb and other industry officials said, courts and juries have had difficulty distinguishing between a business failure and an audit failure and are increasingly blaming accounting firms for bad business decisions.
This tendency has proved devastating at a time of failing health for many banks and financial companies, some of which went out of business or had financial troubles shortly after being given a clean bill of health by auditors.
Auditors, for example, had given clean bills of health to Penn Square National Bank, Continental Illinois National Bank, Drysdale Government Securities and United American Bank just before their financial troubles were made public.
Whether or not an audit failure is to blame for such business failures, the accounting firm often makes the most tempting target for disgruntled investors or creditors looking to recoup their losses, according to industry officials.
"If something goes wrong, it's an accepted fact that someone must be liable," said Harris Amhowitz, general counsel for Coopers and Lybrand. "People look for someone to pay them back for their investments and accountants are often the only ones left."
Victor Earle, Amhowitz's counterpart at Peat, Marwick, Mitchell added, "You have firms of professionals being asked to be an insurer of last resort."
It is no surprise, according to accounting industry officials, that surges of litigation against accountants have coincided with times of great financial uncertainty. The last great wave of lawsuits, for instance, was in the early 1970s, when a number of companies went belly-up in the wake of the oil crisis.
As critics of the industry tell it, however, the current spate of litigation is at least partly an outgrowth of long-standing problems with the way accounting firms audit major corporations.
"You've got a system where the people being audited hire, fire and pay the auditor," said John Chesson, an aide to Rep. John D. Dingell (D-Mich.), chairman of the House subcommittee on oversight and investigations.
Dingell is currently holding a series of hearings to investigate the conflict-of-interest and other alleged deficiencies in the accounting industry. The hearings are scheduled to resume Monday.
Witnesses already heard by the committee have criticized as ineffective the peer review system set up by accounting firms to regulate themselves and have said the SEC is too lax in its legal role of overseeing the profession.
These shortcomings have contributed to the current explosion of litigation, critics said. Because accountants are beholden to their clients for their salaries and business, they are often reluctant to report objectively the financial condition of the company they are auditing, which is their mandate under the law, said Melvyn I. Weiss, a New York attorney who has sued accounting firms on behalf of investors.
"What the accounting profession is supposed to do is protect the investor from those risks he does not want to take," Weiss added. "The only reason the accountants are being charged for big dollar settlements is that they are messing up."
Increasingly the courts agree, and the costs are high for the accounting firms. In 1981, for example, a federal jury in New York ordered Arthur Andersen to pay $80.7 million for defrauding the shareholders of the Fund of Funds mutual fund, though a judge reduced this amount to an undisclosed figure believed to be in the $50 million range.
These numbers are on the low side compared to the new financial threat facing accounting firms around the world. An Australian judge recently awarded damages of $95 million against Fell & Starkey -- the biggest judgment against any firm ever -- for its audit of the Cambridge Credit Corporation, which went out of business in 1974. Meanwhile the British government has launched a $240 million lawsuit against Andersen, the auditors of the failed DeLorean Motor Co.
Adding to accountants' worries is the shrinking availability of liability insurance, even at sharply increased costs. Last year Big Eight firms, which are insured through underwriting syndicates at Lloyd's of London, were believed to carry about $200 million worth of coverage each, said Donald J. Schneeman, an official with the American Institute of Certified Public Accountants.
Schneeman said that figure has probably dropped by a quarter, while premiums have risen on the order of 125 percent. Premiums throughout the profession have risen from 200 percent to 500 percent, and some firms have stopped offering insurance to accountants, industry officials say.
The decreased protection has raised fears throughout the profession that a single bad judgment could wipe out a major firm. Because accounting firms are organized in partnerships, not corporations, accountants face unlimited liability and, in a successful suit, the prospect of losing their own money and homes, officials said.
The sheer size of the claims, as well as the attendant legal costs, has provided a clear incentive for firms to settle complaints out of court, a tactic Andersen in particular has followed. But this policy, lawyers with other firms said, often just invites more litigation.
Earle, the attorney for Peate, Marwick, Mitchell, likens the fight against plaintiffs to the fight against terrorism and said the largesse shown by Andersen makes it difficult for him to take a tough line on lawsuits.
Earle's firm is currently in the hot seat for its 1981 audit of the Penn Square Bank in Oklahoma City. Shortly after the accounting firm issued an unqualified audit opinion of Penn Square's 1981 financial statements, the $500 million bank collapsed, the victim of excessive overdrafts among other unsafe practices.
Since that time, the FDIC has referred more than 400 instances of criminal activity to the Justice Department and has sued the firm for $130 million for not conducting a proper audit. The Justice Department recently filed its own suit on the matter.
Meanwhile, claims may accumulate on the order of more than $1 billion against Alexander Grant, the nation's 11th largest accounting firm, for allegedly failing to blow the whistle on the insolvent E.S.M. Government Securities, according to the International Accounting Bulletin.
Such cases have created doubt for some critics as to the credibility of the current system in which the Big Eight serve as independent auditors to the vast majority of large corporations in the United States.
"Accountants say the system is working, but if the system is working and all this stuff is happening, then it isn't working," said Dingell aide Chesson.