Academic journal article Stanford Journal of Law, Business & Finance

Note: An Alternative Approach to Vicarious Liability for International Accounting Firm Networks

Academic journal article Stanford Journal of Law, Business & Finance

Note: An Alternative Approach to Vicarious Liability for International Accounting Firm Networks

Article excerpt


The major accounting firm networks of the world are worried, and with good reason. In January of 2009, Judge Kaplan of the United States District Court for the Southern District of New York opened the door for international accounting firm networks to be subject to vicarious liability for liabilities incurred by their individual constituent member firms during audits.1

Many people are familiar with the major accounting firms of the world; Ernst & Young, PricewaterhouseCoopers, Deloitte Touche Tohmatsu, and KPMG are all more or less household names. However, it is less well-known that these seemingly behemoth firms are in fact disaggregated firm networks - groups of accounting firms, one per country, that share information and intellectual property, but little else. In order to make this business model work, these networks vest their intellectual property and some coordinating functions in separately incorporated coordinating entities.2

In 2009, the In re Parmalat Securities Litigation court, solidifying a trend that had begun in 2008 in a Florida appellate decision, held that Deloitte Touche International, an international accounting firm network's coordinating entity, could have exercised sufficient control over its individual member firms to become their principal under a standard application of agency law.3 Under such an approach, if a jury finds, after applying a simple three-part test, that a network's coordinating entity was indeed its firms' principal, black-letter agency law imputes to it vicarious liability for its agents' actions.4

The effect that the proliferation of this approach would have on major accounting firm networks is difficult to overstate. Even though the Parmalat approach only allows for the possibility of vicarious liability and places the final determination of agency in the hands of a jury, the possibility alone imposes significant costs on international accounting firm networks. Because the Parmalat approach requires a broad and fact-intensive inquiry, any plaintiff that alleges that an accounting network's international coordinating entity was a member firm's principal under an agency theory can subject the international coordinating entity to onerous litigation and protracted discovery, often in a jurisdiction that is not the international coordinating entity's place of business or incorporation and often not even in the same country as the international coordinating entity's offices. Even international coordinating entities that are confident that they can prevail at trial will bear a significant financial burden as a result of this approach. Moreover, already crowded court dockets and overworked judges will be forced to sort out which of these agency allegations are meritorious.

These downsides might nonetheless be acceptable if we were confident that the Parmalat regime provided the proper incentives to international accounting firm networks and diminished the likelihood of negligent or otherwise legally actionable audits by accounting firms. However, the Parmalat decision aptly illustrates how traditional agency law analysis fails meaningfully to incentivize better conduct, while subjecting an international accounting firm network to years of costly litigation.

One virtue of the Parmalat approach is that it increases the probability that aggrieved parties will achieve redress for their injuries, by increasing the likelihood that an entity with ample financial resources will be made to pay the judgment. Compensating aggrieved parties is of course an important countervailing interest that any alternative to the Parmalat approach must consider carefully. Luckily, the Parmalat approach is not the only way to ensure that these victims are compensated. This Note argues that courts should instead adopt a bright-line rule that allows international coordinating entities whose member firm agreements fulfill certain key criteria, such as requiring member firms to maintain liability insurance, to escape vicarious liability as a matter of law. …

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