In recent years, Jersey’s traditional reliance on tourism as a money spinner has been  supplemented by  the emergence of  a well recognised off-shore financial services centre. By arguing that it is a clean and respectable place to trade in, Jersey has attracted real business rather than just the brass plates so common in many offshore locations. This success also brings responsibilities and expectations that business activity would be matched by openness, accountability and concern for the welfare of consumers, without which long-term confidence in Jersey’s reputation would be hard to retain.

How well is Jersey responding to such challenges? Not very well, if the evidence relating to the recent attempts to introduce the Limited Liability Partnership (LLP) law is anything to go by.  The LLP Bill was published in May 1996 and  seeks to give major accountancy (law and actuarial) firms, the right to form limited liability partnerships without any  formal arrangements for public accountability e.g. through publication of information about their affairs, or though annual audits. The LLP legislation is based upon the flimsiest of arguments and offers little (or no) economic benefit to Jersey. It shows little concern for openness and the welfare of audit consumers and has the potential to damage Jersey’s  long-term standing.

LACK OF EVIDENCE

In most liberal democracies, people speculate about the extent to which the legislative processes are ‘captured’ by organised business interests. However, in Jersey this appears to be relatively clear-cut. The LLP Bill was drafted by UK accountancy firms Ernst & Young and Price Waterhouse after secretive discussions with the Jersey Finance and Economics Committee since October 1995. There has been little public consultation in drafting the Bill. To appease its sponsors, the Bill has been ‘fast tracked’ to get it through Parliament with the minimum of debate.

Speeches in Jersey Parliament by Senator Pierre Horsfall and others argue that the law is necessary to protect accountancy firms and their partners from crippling lawsuits. One might respond to this by saying that no one has ever forced any auditor to accept dubious financial figures or be a party to misleading financial statements. No auditing firm ever declined to accept clients like Maxwell, BCCI, Dunsdale, Barlow Clowse, or Levitt. Jersey’s concern for auditor welfare is touching, but in drafting the Bill and considering its implications for audit consumers, the  Finance and Economics Committee appears to have paid little attention to the causes of  lawsuits against auditors. During the Parliamentary speeches Deputies and Senators sympathetic to the Bill painted a picture of hordes of unethical stakeholders who unfairly pick on auditors. Even a rudimentary glance at auditing literature would have shown that audit failures and lawsuits often arise because auditor’s follow ‘passive’ auditing approaches which minimise audit work , compromise their independence by pursuing consultancy income  and pursue work practices  which encourage audit teams to deliberately falsify  audit work.

It is claimed that audit firms have been made liable for one hundred per cent of the losses (e.g. when fraud is alleged and  a company collapses) even though their guilt only amounts to one percent. Despite extensive research, I am not aware of any such case and no example has been provided to Jersey Parliament.

It has been claimed that major auditing firms spend some 8% of their auditing income  to meet lawsuit claims.  But we all know that actual settlements tend to be a fraction of the claims. In the Jersey debates, no evidence has been produced to show the actual legal settlements, whether paid by the firm, its partners or insurers.

The evidence cited by the firms is also misleading on a number of other counts. Some of the lawsuits data published by the industry does not relate entirely to audits. For example, the lawsuits against Ernst & Young over the collapse of Sound Diffusion relate to the firm’s report on a rights issue document. The UK accountancy firms insist that the provision of auditing and non-auditing services are related and that they should not be barred from selling non-auditing services to audit clients even though the Department of Trade and Industry (DTI) Inspectors have related some audit failures to the loss of independence caused by the provision of non-auditing services. Therefore, it is more appropriate to relate the lawsuits costs to their entire income. On this basis the lawsuits (not actual settlements) come to 2.67% of the total income . Is this too onerous compared to say the advertising and PR costs of the firms?

Most of the major lawsuits are by one accountancy firm against another. The  insolvency arm of one firm is suing the auditing arm of another as this helps to increase the fees collected by the firm in its capacity as a  receivers. For example, Deloitte & Touche are suing Price Waterhouse for £7.5 billion over the collapse of BCCI. Price Waterhouse  have issued a £1.5 billion lawsuit against Deloitte & Touche over the collapse of Atlantic Computers. Price Waterhouse is suing Coopers & Lybrand and Deloitte & Touche for £460 million over the collapse of Barings. Such lawsuits yield large fees to accountancy firms because in their capacity as receivers because prolonged litigation increases the duration of a receivership, yielding more fees.  Shareholders, unsecured creditors and employees rarely receive anything substantial from lawsuits against auditors. Ordinary stakeholders are rarely able to sue auditors. The legal processes are expensive and only the wealthy are in a position to pursue auditors.

In the Jersey debate, no attempt has been made to estimate the losses which have been caused to stakeholders by audit failures. Episodes like BCCI, Maxwell, Barings, London United Investments and Polly Peck show that audit failures have resulted in loss of jobs, bank deposits, pensions, savings, investments and taxation revenues. Such aspects should have been raised by the Institute of Chartered Accountants in England & Wales (ICAEW) which is expected to act as a regulator and protector of the interests of audit consumers. It approved the clauses in the Jersey LLP Bill. But the ICAEW’s recent 122 page document on the subject matter has little to say about the  rights of audit consumers.
 

JERSEY OFFERS

The claim that accountancy firms are unjust victims of lawsuits has neither been substantiated nor supported by any evidence. Undeterred, Jersey has offered limited liability status to accountancy firms. But following the Companies Act 1989, UK accountancy firms already have a right to form limited liability companies and enjoy the same rights and obligations conferred upon manufacturers of food, drink, medicine, biotechnology and other businesses. This right was specifically sought by major firms who argued that partnership structure is unsuitable for firms, some of whom have as many as 600 partners in the UK. In addition, they argued that incorporation would give them easy access to capital markets. Of the major firms only KPMG have incorporated the auditing side of its business and has agreed to publish information about its affairs. Other firms whilst making millions out of a statutory monopoly of external audits are not so keen to open their books and secretive  affairs to the public. They now want to keep the partnership structure and secrecy, but want limited liability.

Article 9(2) of the Jersey Bill states, “Subject to the partnership agreement, it shall not be necessary for a limited liability partnership to appoint an auditor or have its accounts audited”. At the same time, to meet potential claims, Jersey LLPs would be required to have a bond of £5 million to pay debts should the partnership fail. This is in addition to the assets of  the LLP.  But in the absence of publicly available audited information how will anyone know what the financial position of LLPs is? The £5 figure has been plucked out of thin air. Coopers & Lybrand are estimated to have an annual income of £570 million and no one knows what kind of capital is employed or the extent of assets/liabilities used to generate this income. The £5 million bond amounts to less than 1% of its turnover. When the hour of need arises, would this be adequate to satisfy injured stakeholders?

The concern with secrecy runs throughout the Bill. For example, the fact that a firm has sought registration in Jersey as a LLP does not need to be advertised in any newspaper. The public has no right to object. Accountancy firms based in Jersey will enter into numerous transactions and issue audit reports, but the LLP Bill does not require them to state on every audit report, invoice, headed paper and other public documents the fact that they are located in Jersey.

The Jersey legislation is being enacted at a time when following the House of Lords judgement in cases such as Caparo,  company auditors do not owe a ‘duty of care’ to any current/potential individual investor or creditor who might have used audited financial statements to make a decisions. To some in an age when buying  packet of sweets confer consumer rights, but buying an audit confers nothing suggests that the auditing industry is already enjoying too many privileges. Jersey LLP Bill makes no attempt to redress the situation.

Some Jersey legislators claim to be concerned with promoting fair play and even promoting consumer rights. But the Jersey LLP law does not give any rights to audit consumers. For example, unlike the USA position, UK investors cannot bring ‘class actions’  against negligent auditors and solicitors cannot be persuaded to operate on a ‘no win  no fee’ basis. If Jersey was concerned with consumer rights, it would give the clients of Jersey based firms, legally enforceable ‘class action’ and other rights, but the  LLP law gives no rights to any stakeholder. It only seeks to give further advantages to ‘producers’ of audit reports.

LACK OF SUPPORT

During Parliamentary speeches, Senator Horsfall and his supporters argued that the LLP Bill has the support of the industry. Well, some accountancy firms have supported it. But there is little support for the concept of secrecy with limited liability from other quarters

Whilst many commentators would support the concept of LLP, as long as it was accompanied by some notion of openness and  public accountability, together with a concern for stakeholder rights, few have supported the Jersey version. The Confederation of British Industry, the Institute of Directors and the Law Society have not joined the accountants’ in supporting the Jersey LLP Bill. A survey of Britain’s 1,000 major businesses  has shown that  around 45% (i.e. less than half)  believe that accountancy firms should be able to limit their liability through incorporation. Only 5% supported the creation of off shore partnerships to achieve the same result.

On 2nd July, during the Parliamentary passage of the LLP Bill, Senator Horsfall said, “I also know from an extremely reliable source that the Labour Party, as a Party, will not be obstructive to this [i.e. Jersey LLP] law”. This implies that he has the support of the Labour Party. When asked, Labour Party spokesperson on accountancy and law matters replied , “I have never heard of Pierre Horsfall let alone spoken with him ....”

A RECIPE FOR DISCONTENT

There are some curious aspects of the LLP Bill. It does not offer any large sums to Jersey economy as the firms  registering in Jersey will only pay a registration fee of £10,000 . New jobs in accounting industry are likely to be few, if any. Senator Horsfall argues that once registered in Jersey, the firms will pass business to other Jersey based companies. This is unlikely as Jersey does not have the capacity to handle large scale consultancy and capital market reference work. Besides, if accountancy firms are so benevolent, they can contribute to the Jersey economy regardless of the LLP law.

Even when the LLP Bill is enacted, there will be many problems. For example, to locate outside the UK, the firms may have to (re)negotiate numerous contracts, transactions and agreements. No accountancy firm will be physically relocating its offices in Jersey. The registration will be in name only and the audit business will continue in the UK as normal. In view of this, the UK courts are unlikely to give any legal recognition to the new circumstances the firms seek to weave. Any liability disputes with UK clients, unless already agreed in advance, are likely to be heard in the UK courts and according to the UK laws. Should the firms seek refuge in Jersey laws and have the cases heard in Jersey courts, a severe public backlash is sure to follow. The UK court decisions will depend on common law developments relating to consumer rights and public policy considerations applicable in the UK rather than Jersey. Any firm announcing the move to Jersey will face a flood of lawsuits as all prospective litigants would want to register their claims before the effects of LLP come into operation. So the benefits of shifting to Jersey may not be that great.

As audit firms are frequently implicated in major corporate collapses, the issue of who has the responsibility to investigate such scandals is important. But the Jersey legislation gives no attention to such issues. By locating in a foreign jurisdiction, accountancy firms could easily argue that they are beyond the reach of the UK investigators. When in the aftermath of  the BCCI collapse, US Senate investigated alleged audit failures, it requested sight of Price Waterhouse (UK) files. The firm refused to co-operate by saying that each arm of Price Waterhouse was independent (i.e. UK and USA were independent) and that the US investigator’s authority did not apply to the UK firm . More recently, similar arguments have been raised by the US offshoot of  KPMG over the fraud and alleged audit failures at Ferranti. Jersey is enacting its legislation with the full awareness of the issues, yet there are no provisions for investigation, or for requiring firms to open their files to national investigators. Will Jersey investigate the affairs of firms implicated in scandals? The absence of such laws means that Jersey would be ripe for accusations of  cover-up and obstructing investigations. In addition, there would also be arguments about which jurisdiction investors and/or regulators may be able to bring their lawsuits, resulting in considerable delay, costs and public criticism. Either way, Jersey’s reputation would suffer.

During the Parliamentary debates it has been argued that Delaware and many other US states have LLP laws. This is true, but this needs to be seen in the context of federal laws which give auditors a statutory duty to report fraud to the regulators within one business day, even without the knowledge of company directors. No such laws apply to auditors operating from Jersey.  Jersey has no overall regulators such as the Securities and Exchange Commission (SEC).

As indicated earlier, accountancy firms already have the right to form limited liability companies in the UK. But the firms want secrecy and limited liability. The Jersey LLP law is accompanied by a number of uncertainties and hardly offers any economic gain to Jersey. So why are the firms keen for Jersey to enact the LLP laws? The answer is that the Jersey law enables the firms and their supporters to hold the British government and parliament to ransom. ‘Give us what we want, or we go to Jersey’, they say. Deputy Prime Minister Michael Heseltine and the DTI have been looking at ways of reforming the Partnership Act 1907 to create LLPs but with requirements for openness and accountability. The UK government can’t easily do this as various stakeholders also have an interest in auditor liability. So a wide consultation has to take place.  Enacting LLP laws in Britain may also enable many other companies to (re)register as LLPs and avoid the present modest public accountability requirements. Such a move is bound to be criticised by banks, creditors and consumer rights organisations, because published financial information plays a significant role in the market place. So various compromises, checks and balances will need to negotiated. Regardless of who wins the next general election, LLP laws won’t be introduced in Britain until possibly 1998/99, and even then they will not support the secrecy provided by Jersey. Early signs are that some pension funds and institutional investors will question auditors at company AGMs and  will oppose the appointment of auditors based outside the UK. Along the way Jersey way of doing things is bound to be criticised. A potential for long-term damage to Jersey exists.

CONCLUDING COMMENTS

The LLP legislation hardly offers any economic benefits to Jersey. It only succeeds in showing that Jersey legislature is available for hire to major businesses who are busy playing their global regulatory games. By persuading small states to offer minimal regulation, they hope to exert pressure on other states and reconfigure the international regulatory board and achieve minimal regulation with maximum benefits. Those choosing to  become pawns in this game may find that in the event of  crisis, their minimalist strategies will not be able to satisfy injured stakeholders. Public backlash will follow. Irreparable damage will be done to Jersey.