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GAZETTE
DECEMBER 1988
Legal audit
Are t he cus t oma ry aud it procedures, as car r i ed out by
aud i t o rs and ce r t i f i ed by t hem, su f f i c i ent f or t he
p r o t ec t i on of shareho l ders and o t hers dea l i ng w i t h
l imi t ed l i ab i l i ty compan i es? Mr . Neil Frish Thompson,
in a paper prepared f or t he C.C.B.E. (Counc il of t he Bars
and Law Soc i e t i es of t he European Commun i t y)
proposes t hat an ex t ra t ier of i nves t i ga t i on be i nc l uded
in annual aud it procedures i nvo l v i ng t he legal as we l l
as t he ac coun t ancy pro f ess i on.
P r eamb le
The approach of the accounting
profession to audit is one that is
directed primarily to verifying the
accounting records of the company
and to expressing a view as to the
annual Balance Sheet and Profit
and Loss Account.
Insofar as the subject matter of
the business for wh i ch accounts
are being prepared falls readily into
an annual cycle this presents no
problem; the farmer and the retailer
by and large operate over definable
(although not definitive) seasons.
However, in relation to industry
where, for example, the life of a
product f r om its inception in
research and development through
its launch, to the establishment of
market share and then decline
through obsolescence, the audit
system runs into difficulty. The
problems are compounded by
auditors, in practice, being selected
and dismissed at the volition of the
d i r e c t o rs
and
not
of
t he
s ha r eho l de rs for w h om t he
auditors are supposed to be watch-
dogs. At the present time the
situation has become even more
confused because only about half
t he r emune r a t i on of aud i t o rs
derives from audit. The rest comes
f r om being entrusted by the Board
or senior management w i th further
wo rk on behalf of the company. In
order to avoid conflicts of interest
within accountancy firms, some
firms even erect "Chinese Wa l l s"
round their audit departments in
order to ensure that audit partners
are not aware of what their
collleagues may be advising the
company. Another problem to be
considered is the introduction of
accounting standards, including
current cost accounting, wh i ch
itself depends on going concern
assumptions which may or may
not be valid in terms of the
c omp a n y 's
c o n t r a c ts
and
ownership.
Increasingly auditors are asking
that the solicitors to the company
confirm the whereabouts of the
company's title deeds, even, in
some cases, asking wha t, if any,
transactions have taken or are
taking place in relation to them.
Auditors now enquire (in varying
by Neil Frish Thomp s on
depth) as to the disputes and
litigation in wh i ch a company is or
may be engaged. These tasks are
not made any easier because it
may be extremely difficult to
identify wh i ch firms of solicitors
may be involved.
Legal A u d i t
This article proposes that, in the
light of p r o b l ems, of w h i ch
company fraud is perhaps only the
tip of the iceberg, the audit process
should not be left to accountants
alone. In the first instance, the
company's solicitors should be
registered; that is to say, the
company should keep a record of
the solicitors it instructs. Once so
appointed, a company solicitor
wo u l d be answe r ab le to t he
auditors and under a duty at the
time of audit to give a report, from
the date of the last audit report, of
each job undertaken on behalf of
the company and t he result,
indicating wha t, if any, financial
reserves it wou ld be prudent to
make. Solicitors w i th such a duty,
as officers of the Court, could be
relied upon not to cover up
activities. Similarly, in relation to
company assets, the solicitor
emp l o y ed
on
t he
o r i g i nal
acquisition or last dealing would at
audit time be required to report as
to whether the asset was still held
and the state of it. Local land
charge searches and the usual
enquiries wou ld be made to check
if there had been developments or
changes wh i ch added or sub-
tracted to the information on which
its value was based.
As to company contracts, it
would be the duty of the company
solicitor to peruse these (or at least
those important to the business of
the company) whether formal or
made informally by letter, to see if
these wou ld justify assumptions
about the state of the company's
business and its expectations. In
t he cou r se of such perusal,
solicitors wou ld be expected to
report whether renewals were due
or required and whether supporting
agreements for supplies or services
we r e in place, as we ll as
app r op r i a te
c o n t r a c ts
w i t h
c omp e t e nt
e x e c u t i v es
and
employees.
Much of this work is done in
practice when a company is to be
the subject of quotation on the
Stock Exchange, or some similar
major transaction but, and this
goes to the root of the problem,
there is no systematic legal annual
review and this, in turn, leaves
broad areas for misunderstandings
or o u t r i g ht d e c e p t i o n. Mo re
important still is that the necessity
for such a review would make
boards and senior management
conscious of problem areas wh i ch
they would not otherwise have to
cons i de r, as we ll as mak i ng
commerce and industry as a whole
much more scrupulous in arranging
and documenting their affairs.
If legal audit became obligatory,
then systems to limit its costs
could be developed.
As a preliminary paper on the
subject, detailed consideration of
the various heads for audit have
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