AUDITOR LIABILITY TO THIRD PARTIES IN SPAIN AND THE UNITED STATES: A COMPARATIVE STUDY SULAIMAN ABDUSSAMAD DOCTOR OF LAWS NOVEMBER 2015 SUPERVISED BY: DR. FRANCISCO OLIVA BLÁZQUEZ 1 AUDITOR LIABILITY TO THIRD PARTIES IN SPAIN AND THE UNITED STATES: A COMPARATIVE STUDY BY SULAIMAN ABDUSSAMAD A THESIS SUBMITTED TO THE FACULTY OF LAW, PABLO OLAVIDE UNIVERSITY IN PARTIAL FULFILMENT OF THE REQUIREMENTS FOR THE DEGREE OF DOCTOR OF LAWS NOVEMBER 2015 2 DEDICATION To the memory of my parents, Aisha Isaku Injin and Mallam Abdussamad Habibullah, this work is lovingly dedicated. 3 ACKNOWLEDGEMENTS First, I thank Allah for giving me the strength and endurance to finish this project. My profound gratitude also goes to my supervisor, Dr. Francisco Oliva Blázquez for his guidance and the wealth of experience I have drawn from. I am also grateful to late Dr. Rosario Valpuesta for her kind words and encouragement. May she rest in peace! Finally, to my wife, Aisha Vasquez Vega and the members of my extended family I owe them all a debt of gratitude for their love and support. 4 ABSTRACT In the aftermath of the litany of corporate scandals, few subjects have aroused so much passion in the world of accountancy as that of auditor’s liability. Now the study and understanding auditors’ liability to third parties cross nationally is not only fashionable but also a business imperative given the globalization of capital, corporations, and audit practice. This study explores the doctrinal differences in third party liability claims by comparing the status of auditors’ liability to third parties under the common laws of the United States and the civil law of Spain. It will examine how the common and civil law courts faced with auditor liability claims, had to strike a balance between two potentially conflicting interests: the public’s interest in having an independent and competent review of financial statements and the interest the auditing profession has in carrying out its duties without the fear of a potentially overwhelming liability. Specifically, it looks at the efforts of both courts to fashion out an appropriate doctrine of liability in their respective systems. Moreover, in response these scandals, the US had quickly promulgated the Sarbanes-Oxley Act to impose some restrictions on the auditor. The EU, on the other hand, in a clear response to the financial crisis has just published Directive 2014/56/EU of the European Parliament and of the Council of 16 April 2014 amending Directive 2006/43/EC on statutory audits of annual accounts and consolidated accounts and Regulation (EU) No 537/2014 of the European Parliament and of the Council of 16 April 2014 on specific requirements regarding statutory audit of public interest entities and repealing Commission Decision 2005/909/EC, to reinforce auditor independence and improve the public supervision of audit. If anything, these scandals have taught us that even in free markets controls are necessary. Spain had from the onset embraced public supervision of auditors exercised by the Instituto de Contabilidad y Auditoria de Cuentas (ICAC), albeit, in collaboration with auditing professional organizations. In playing its supervision role, the ICAC was widely criticized by the members of the audit profession who then preferred the Anglo-Saxon model of self-regulation. Now the Spanish model has been vindicated and independent public oversight function is generally being embraced as the most reliable system for enhancing audit quality and market security. 5 RESUMEN Después de los numerosos escándalos corporativos que hemos visto pocos temas han suscitado tanto pasión en el mundo de contabilidad como la responsabilidad civil del auditor. Hoy en día, el estudio y conocimiento transfronterizo de la responsabilidad civil de los auditores de cuentas frente al tercero no es cuestión de gustos sino una exigencia para los negocios dado la globalización de capital, corporaciones y la práctica de la auditoría. Este estudio explora las diferencias doctrinales que existen en casos de responsabilidad civil extra-contractual haciendo una comparación del estatus de la responsabilidad civil de los auditores de cuentas frente a terceros entre EE.UU y España, y hará una indagación de cómo los tribunales de “civil law” y los de “common law” que hacen frente a las reclamaciones de la responsabilidad civil extra-contractual contra los auditores, tienen que luchar entre dos intereses opuestos: el interés del público a la revisión independiente y competente de informaciones financieras y el interés de la profesión de la auditoría en realizar su función sin tener que preocuparse de la carga de una responsabilidad potencialmente aplastante. Examinará, por ello, los esfuerzos de los tribunales para crear una apropiada doctrina de la responsabilidad civil extra-contractual en ambos sistemas. 6 CONTENTS Dedication 3 Acknowledgements 4 Abstract 5 Resumen 6 Contents 7 Abbreviations 12 Background to the Study 13 CHAPTER I Auditing in the Corporate Laws of the United States and Spain 1. Introduction 17 2. The Birth of Audit in the United States 18 3. Modernization of Spanish Corporate Laws 19 4. The Position of Director in Corporate Government 21 4.1 The Standard of Director’s Conduct in the United States 22 4.1.1 Director’s Duty of Care 23 4.1.2 Director’s Duty of Loyalty 25 4.1.3 Director’s Duty of Good Faith 25 4.2 Standard of “Los Administradores” in Spain 26 4.2.1 Duty of Diligence of “El Administrador” 27 4.2.2 Duty of Loyalty of “El Administrador” 28 4.2.3 Prohibition of Conflict of Interest of “El Administrador” 28 5. The Auditing Context 30 5.1 The Financial Statements 30 5.2 Publicity of Financial Statements 31 6. Auditing in the United States’ Legal System 34 6.1 Company Law and Interstate Commerce 34 7. The Spanish Legal Environment 35 7.1 The European Single Market Experiment 35 8. The Position of Auditors 37 8.1 The Function of Auditors 40 8.2 The Importance of Audit 44 8.3 Auditor’s Right of Access to Information 46 8.4 Auditor Professional Standards 48 9. The Conduct of Audit in the United States 52 9.1 The Humble Beginning 52 9.2 The Audit Report 55 10. The Certifícate of “Los Auditores de Cuentas” 57 7 11. Conclusion 59 CHAPTER II The Audit Expectation Gap Question 1. Introduction 60 2. Expectation Gap and Auditor Liability 61 3. Evolution of Audit in Spain 64 4. Genesis of the Audit Expectation Gap Concept 67 4.1 Introduction 67 4.2 Definitions 70 4.3 Nature and Structure of the Expectation Gap 72 5. Modernization of Audit Practice in Spain 74 5.1 The 1988 Audit Law 74 5.1 Enter the Expectation Gap in Spain 77 6. Factors Responsible for Audit Expectation Gap 80 6.1 Introduction 80 6.2 Ignorance of Audit Function 80 6.3 Conflicting Role of Auditors 82 6.4 Retrospective Evaluation of Auditors’ Performance 82 6.5 Time Lag in Responding to Changing Expectations 83 6. 6 Self-Regulation Process of the Auditing Profession 84 6.7 The Unreasonable Expectations 85 6.8 Conclusion: Bridging the Gap by Statutory Means 86 7. The Effect of Auditing Standards on Expectation Gap 86 7.1 The Conflicting Views 86 7.2 Performance Rate Study in the United States 88 7.3 The Spanish Context 91 7.3.1 Auditing Standards in Spain 91 7.3.2 Audit Quality and Going Concern Opinion 93 7.3.3 Study of Going Concern Opinion in Spain 94 7.3.4 The Research Result 97 A. Descriptive Statistics Table 98 B. Univariate Analysis Table 98 C. Logistic Regression Result 100 7.4 The Impact of Auditing Standards on Expectation Gap 102 8. Reducing the Expectation Gap 104 8.1 Expanded Audit Report 104 8.2 Educating the Public 105 8.3 Structured Audit Methodologies 106 8.4 Expanding Auditor’s Responsibility 107 9. Audi Alteram Partem-Spain 108 8 CHAPTER III PART 1 Auditor Liability as Pure Economic Loss 1. Introduction 110 2. The Concept of Pure Economic Loss 111 2.1 Introduction 111 2.2 Tort of Negligence and Economic Loss 112 2.2.1 Tort Defined 112 2. 2.2 Definition of Pure Economic Loss 115 2.2.3 The Difference between Consequential and Pure Loss 116 3. Tort of Negligence and its Limited Remedy 117 3.1 Introduction 117 3.2 The Legal Requirements in a Negligence Action 119 3.3 The Concept of Duty of Care 119 3.3.1 Foreseeability of Harm 125 3.3.2 Proximity of Relationship 127 3.3.3 Fairness Justice and Reasonableness 129 4. American View and the Advent of Bright Line Rule 131 5. Pure Economic Loss under Spanish Law 134 5.1 An “Extranjero” Concept 134 5.2 Unlawfulness (Antijuricidad) 135 5.3 Fault (Culpa) 138 5.4 Certainty and Directness 141 6. Taxonomy of Standard Economic Loss Cases 143 6.1 Contract-Like Relations 143 6.2 Product Defects as Economic Loss 145 6.3 Wrongful Death 150 6.4 Impediments to Business Operation 152 6.5 Flawed Services 153 7. Justification for Restriction of Pure Economic Loss 154 8. Conclusion 157 PART 2 Auditor’s Liability in the United States and Spain 1. Liability under Contract 158 1.1 Introduction 158 1.2 The Overlap of Contract and Tort: The Doctrine of Privity 159 1.3 Liability to Third Parties in the United States 166 1.3.1 An Historical Perspective: The Shift Away from Privity 166 1.3.2 The Return of Privity 170 2. The Constant Quest for Adequate Standard of Care 173 2.1 The Different Approaches 173 9 2.2 The Privity Standard 173 2.3 The Reasonable Foreseeability Standard 177 2.4 The Restatement Standard 181 3.