The Gazette 1988

DECEMBER 1988

GAZETTE

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

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

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 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 by Neil Frish Thomp s on

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