Negligence in General
There is no case against auditors and this made it hard to be accurate as to where the auditor’s legal liability falls. We require therefore referring to decided cased. Though even in countries there are in fact very few decided cases against the auditors. The vast majority of actions against auditors are completed out of court. This saves what could or else be very costly court costs. It is also important to note that this saves dragging the professional firm's name via the courts and most probable via the newspapers. Firms are of course concerned to avoid such awful publicity.
It is though usually known that the auditor's liability falls beneath three specific headings:
(a) To his clients underneath contract law;
(b) To third parties beneath the law of tort;
(c) Civil and criminal liability beneath statute law
To his clients:
The auditor is under responsibility to report to the members in common meetings on all accounts observed by him and lay before them. His contract is thus with the company as an entire and not with separate shareholders. The auditor can thus be accused of carelessness if:
(a) He fails to notice scam or error that he must reasonably have noticed;
(b) When he fails to obey with generally admitted auditing standards and practices.
Though, it is also usually held that for an auditor to suffer real financial loss, the following situation should be met.
- He must be confirmed to have been neglectful;
- The complainant should have suffered a loss;
- The loss should be as a direct result of his reliance on the auditor's report and the auditor’s carelessness.
Hence when the auditor fails to detect a scam that is immaterial to the accounts and unless there are suspicious situations which he had observed or must reasonably have observed, it is unlikely that he will be held neglectful.
Even when the fraud was material to the accounts, he might still escape liability if detection could not reasonably have been attained by using normal audit process. It should be admitted though this is a very dubious region of law.
The auditor has no responsibility to separate shareholders. A shareholder who makes an investment decision by relying on the auditor's report and suffers loss cannot claim under the law of contract. Only when the company as an entire has suffered, can the entire body of shareholders claim from the auditor.