Research On The Identification Mechanism Of CPA's Liability

In recent years, a series of financial fraud scandals in public companies have been exposed. The auditors always act in collusion with those companies. The dishonesty of auditors has caused a big problem in security market. The lack of civil liability and low non-compliance cost for auditors brings about auditors'frequent violations of the law and discipline. Compared with relying on the conscience and professional ethics of auditors only, a sound legal supervision mechanism could be more effective in preventing auditors from seeking for profit unscrupulously. In order to restrict the auditing collusion, the litigation risk and civil liability of auditors should be strengthened and disciplinary systems also need to be built up to increase auditors' awareness of litigation risk and auditing quality. On January 9,2003, the Supreme People's Court in China promulgated a judicial interpretation of'Several Provisions on Trial of Civil Compensation Cases Arising from False Representation in the Securities Market'. On June 11,2007, another judicial interpretation is issued as'Several Provisions on the Trial of Cases Involving Civil Tort Compensation in Connection with Audit Activities by Accounting Firms'. Those provisions provide practical guideline in the identification of civil liability of accounting firms to ensure the sound development of market economy and safeguard the public interest and the lawful rights and interests of investors, which is also beneficial to the development of China's CPA industry. Although there are quite a few accounting firms convicted of the civil liability for false representation until now, it is predictable that litigation risk for auditors is going to increase along with the continuous improvement of relative regulations and the establishment of civil compensation mechanism in security market. Considering the high professional of audit service and the complexity of evidence in such cases, if the evidences is cross-examined and confirmed just according to general rules, the judgment might be insufficient and defective from professional angle and the punishment on accounting firms might be too heavy or too light due to different applications of general rules. The best way to remedy the defects is to build up a set of identification mechanism of CPAs'liability. Therefore, the establishment of liability identification mechanism reflecting CPA characteristics has become an objective demand to improve legal system in the socialist market economy. Expert opinions will become authoritative and important basis for determining whether auditors should assume the civil compensation liability. It provides expert support for the justice trial of cases arising from auditors'false representation, which is beneficial to protect investors' and auditors'lawful rights and interests.This paper is based on relevant researches in the field of auditing, economics and law. Normative analysis and case study approach are adopted in the research involving how to construct a set of identification mechanism of CPAs'liability in China. The paper began with an analysis of the basic theories about the identification mechanism of CPAs'liability from different perspectives. Next, it tried to establish a basic framework of the identification mechanism, which integrates subject system of identification, identification standards, identification procedure, admissibility system of expert opinion, and rights and obligations of appraisers. The main contents are as following:(1) Basic theories about identification mechanism of CPAs' liability. The identification of CPAs'liability is a sort of legal service. The expert witnesses serve the society based on their professional knowledge. They serve litigant parties in the adversary system and serve judges in the inquisitory system. The identification activity is characterized by profession, neutrality and the combination of subjectivity and objectivity. It helps judges to investigate the truth, make right decisions and check the reliability of other evidences. From the perspective of auditing, the definition of audit liability represents a dynamite balance process, which coordinates the public expectation and the profession expectation. Introducing the identification mechanism into the lawsuits and focusing CPAs' characteristics and social responsibility, it is beneficial to settle different views among public, legal profession and audit profession. It makes a balance between public interest and CPAs'interests, which helps the CPA industry to avoid from unrealistic responsibilities and develop soundly. From the view of economics, although the identification mechanism will cost a lot for its construction and operation, it will improve the efficiency and effectiveness of trials which could lower the costs of litigation further. Therefore, in the long-term, the benefits will overwhelm the costs. From the perspective of Law, a special function of the authentication is to produce the effectiveness of evidence when the court finds the facts of the case. And from the view of evidence law, as a professional identification, one of its special functions is to confirm the accounting and auditing evidences provided by accounting firms and make them admissible at last in the court.(2) Analysis about the basic framework of the identification mechanism of CPAs' liability.'Justice and efficiency'should be a uniform value objective pursued in every institutional design. The final aim of identification mechanism is to protect litigants' legal rights, to be in favor of applying laws properly, and to promote judicial fairness and judicial efficiency. The value objective of justice has reflected in ensuring that the identification subject is neutral, the identification procedure is fair and the identification standards are scientific and unified. The value objective of efficiency is embodied in an appropriate mechanism which makes each neutral expert witness act according to the reasonable identification procedure and scientific and unified standards, then issue objective, neutral and authoritative opinions in time and avoid abnormal repeated or multiple identifications. The identification mechanism of CPAs' liability is considered as a group of relevant institutions, regulations, rules and their interactions. It can be divided into three parts in generally as identification subject system, standards of identification and identification procedures. Each part consists of different systems and institutions.(3) Design of the subject system of identification. A scientific and reasonable identification subject system is the core of the whole identification mechanism, which influences on whether the mechanism works efficiently and plays a positive role in lawsuits. In China only people who have got qualification can work as an appraiser in accordance with the power of expertise. The appraiser can only take the job by joining in an appraisal institution. In traditional identification mode, investigating, appealing, judging and identifying may integrate in a sole subject. So the justice is suspicious. As a sort of intermediary agency, the identification committee separate from procuratorate organs, courts, judicial and other administrative departments, which is more independent and can be a suitable subject in CPAs' liability identification. At present, there are still some improvements should be made, such as innovation of the committee's management, dual subject institution and register system of appraisers. The committee should be authorized and supervised by the Ministry of Finance and the Justice Department together. It is under the direct supervision of Chinese Institute of Certified Public Accountants (CICPA) and takes qualification examination each year according to regulations of judicial identification issued by the Justice Department. Meanwhile, local identification committee in each province should be set up, which is supervised by provincial institute of certified public accountants and provincial judicial department. Dual subject system means that the responsibility entity of identification is composed of by the identification committee and appraisers both. Such kind of dual subject system will amend the defects caused by sole subject system. In a sole subject system, judges and litigants always cannot inquiry expert opinions because of appraisers'absence, which could affect the fairness and authority of expert opinions. With the help of the Institute of Certified Public Accountants, judicial department can make a personnel roster of qualified and capable appraisers after the process of investigating, publishing and approving openly. The roster records some relevant personal information for each appraiser such as resume, educational background, academic level, identification experience and published works etc. It can be displayed on the professional websites and provided in courts, law firms or other relevant places for judges'or litigants' selection.(4) Research on the standards of identification. Considering the nature of identification evidence, it is necessary to establish a set of consolidated identification standards. On one hand, it ensures the quality of identification and defenses the judicial fairness. On the other hand, it also defenses the appraisers'reputation. In a broad sense, identification standards can be divided into two groups as quoted standards and specialized standards. Quoted standards refers to those existing rules which can be cited directly, such as laws, statutes, regulations, principles and institutions related to auditors'litigation arising from false statements. Specialized standards represent regulations set up especially based on laws and rules and combined with specific professional knowledge focusing on specific issues in identification process, which consist of judging standards and reporting standards. Judging standards regulate the process of gathering evidences and forming expert opinions. Reporting standards are rules appraisers have to follow when reporting the opinions. The realistic base for judging the reality of auditing reports is legal truth. CPA practice guidelines provide a direct measurement to reveal legal truth. As to CPAs, judging the severity of their faults is based on how worse they fail to maintain due professional prudence. In practice, the violation of CPA practice guidelines is regarded as a substitute indicator. To determine whether the auditor committed intentionally or negligently should take into account the nature and importance of auditing failure, and whether the auditor has followed CPA practice guidelines and so on.(5) Study on identification procedure and admissibility system of expert opinion. CPAs'liability identification involves a serial of specific procedures and systems, which are mutually interrelate and independent. The identification procedure can be divided into three parts, which are start-up process, implementation process and admissibility system of expert opinions. There are two ways to start an identification procedure. One is that the court responds to the application of litigants to start it. The other is the court starts it according to the needs of trial. The judge has the right to finally decide whether or not identification is needed. The litigant's right to apply has no effect on the discretion of judge. In order to protect litigants'interest, some specific regulations should be set up. It is to say, in certain cases or under certain circumstances, identification procedures must be started up according to the law. The implementation process is made up of the consignation and acceptance of identification, operating identification, and issuing an expert opinion report, etc. Whether the expert opinion is admitted as direct evidence is decided by the judge. The majority of judges are not experts of accounting or auditing. For this reason, to make sure the judge get a reasonable evaluation and then guide lawyers and litigants, an admissibility system of expert opinion should be set up, which consists of cross-examination process, admissibility rules and admissibility announcement. The expert opinion should be cross-examined and the appraiser has to testify at the trial. The process of cross-examination may not only help litigants get better understanding about expert opinion so as to avoid unnecessary repeated identification, but also help judges avoid credulity and form a correct conviction. Possible errors might be exposed during the process as well. In addition, once appraisers required to testify at the trial become into a common scene, it will also stimulate appraisers to be conscientious in their work. The admissibility of expert opinion is based on the testimony subject, the normality of its preparation process and the testimony admissibility process. The judge should give the reasons whether the expert opinion is admissible or not in adjudicative document.(6) Analysis of rights, obligations and responsibilities of appraisers. To insure appraisers operating smoothly and making objective and fair opinion, it is necessary to grant appraisers suitable rights, obligations and legal responsibilities. Rights and obligations connect to each other. Obligations also cannot be separated from responsibilities. In addition to rights and obligations endowed by existing laws and regulations, supplements should be made. On the side of right, juridical protection is necessary, and appraisers have the right to know whether the expert opinion is admissible. On the obligation side, appraisers should make a pledge and be supervised by judges and related parties. If appraisers against the obligations, they should be claimed with criminal, civil and administrative liability. Compared with other nations, administrative penalty is relatively weak in China, which cannot meet the needs to regulating identification activities. In addition to usual administrative penalties like warning and deregistration, authorities (Ministry of Finance and Judicial Department) could refer to the section No.8 of the'Administrative Punishment Law' to introduce fines and forfeiture of payment when appraisers against their obligations. At last, professional bodies like CICPA could also carry out industry self-discipline punishments and penalties.