I. INTRODUCTORY REMARKS
Evaluation and response to risks by lawyers, accountants, and auditors turns out to be a crucial issue not only for the three professions but for the functioning of capital markets as well. Whether and how lawyers, accountants, and auditors evaluate and respond to risk is a matter of how they are professionally trained to do so. It is also a matter of ethical standards of these professions, and last but not least it is a matter of regulation of these professions. The regulation may be, and regularly is, different for the three professions. Whereas auditors have a monitoring function and thus should be obliged to evaluate and respond to risk, lawyers consult on legal matters and thus enjoy a position vis-a-vis their clients characterized by mutual trust, which might be endangered if they have the obligation to evaluate and respond to risk. Traditional wisdom thus tells us that when it comes to risk evaluation and response to risk there should be a division of labor between lawyers, accountants and auditors. But, on the other hand, lawyers might consult with their clients in a way that certain risks can be disguised or are difficult to discover. This is true, for instance, when it comes to "creative" methods of accounting. Then it has to be determined whether regulation of lawyers should cover evaluation and response to risk. This might be one factor for the effective functioning of capital markets. It is this relationship between lawyers' ability and obligation to evaluate and respond to risk and the effective functioning of capital markets which will be discussed in this Article.
As far as the term 'risk' is concerned, this Article is not dealing with all sorts of risks but with one certain type of risk: the risk of investors making wrong decisions about investing in a company, due to false information from the company's financial statement. Such false information might be the result of manipulating the books of the company, manipulating financial statements, or of just making use of the wide discretion given to management by accounting rules and standards.
In the principal-agent relationship between investors (shareholders) and management, modern corporate and capital market law has built in several devices for the protection of the principals' interests, i.e. that of shareholders. One of those devices is the auditing of financial statements by independent auditors. Auditors are acting as agents for shareholders in order to monitor transactions of management. Management is responsible for accounting and financial reporting under the supervision of auditors. However, this control mechanism does not function when auditors are not fully independent and especially if it comes to collusion between management and auditors. Regulation of auditors has thus become one of the major topics in the wake of such cases as Enron and WorldCom, where investors have lost billions of dollars due to false information provided by financial statements.
Other professions may play a role in such cases as well, especially lawyers consulting management on legal devices which are utilized to enable manipulation of financial statements. This has been the case when lawyers design special purpose entities used to reduce the amount of liabilities in consolidated financial statements, placing them into the financial statements of such special purpose entities which have not been consolidated. The question then arises whether new control mechanisms-besides those of regulating auditors-should be put into action covering not only auditors but lawyers as well.
Today regulation of auditors and lawyers in many countries differs considerably. But both professions may be engaged in transactions which might directly or indirectly turn out to be harmful for investors. This Article shall not discuss proposals of regulating lawyers for the purpose of improving the functioning of capital markets. Rather, it shall deal with the question of how lawyers can be enabled to detect, evaluate, and respond to risk. …