Regulation, Auditor Litigation and Settlements

33 Pages Posted: 20 Jul 2016 Last revised: 29 Mar 2017

See all articles by Lakshmana Krishna Moorthy

Lakshmana Krishna Moorthy

Tulane University - A.B. Freeman School of Business

Bharat Sarath

Rutgers, The State University of New Jersey - Accounting

Date Written: November 30, 2015

Abstract

This paper aims to understand the determinants of lawsuits against auditors in securities class action litigation and the settlement pattern by auditors when the suit is not dismissed. The issues we consider are: (i) when are auditors named as defendants (ii) when do auditors choose to settle and (iii) what proportion of the settlement do auditors pay in relation to the settlement by all the other parties; and (iv) differences in settlement strategies among the big-n firms. We also want to understand how these suit and settlement patterns have changed following the enactment of major regulation such as the Private Securities Litigation Reform Act (PSLRA), Sarbanes Oxley Act (SOX). Following prior literature, we first establish that auditors are more likely both to be named and to settle in cases involving restatement of earnings, accusations of violation of GAAP or accounting improprieties. We then show that the likelihood of suit and settlement increase in a measure that we construct measuring the complexity of litigation. We then examine differences in settlement patterns across periods preceding and after the passage of PSLRA and SOX. We find that auditors are named less often in the post PSLRA period (relative to the pre-PSLRA period), settle with the same frequency in both periods but pay less proportional damages. The same set of comparisons show that auditors are just as likely to be sued post-SOX as pre-SOX, but settle with lower frequency and pay the same proportion of damages. Overall this study documents the beneficial role of both PSLRA and SOX on reducing the litigation burden on auditors. With regard to settlement strategies, we document the varying strategies employed by the Big-n firms that settle at different rates, vary in their aggressiveness and time to settle signaling the willingness to fight or cooperate in the settlement.

Suggested Citation

Krishna Moorthy, Lakshmana and Sarath, Bharat Sarrukai, Regulation, Auditor Litigation and Settlements (November 30, 2015). Available at SSRN: https://ssrn.com/abstract=2811460 or http://dx.doi.org/10.2139/ssrn.2811460

Lakshmana Krishna Moorthy (Contact Author)

Tulane University - A.B. Freeman School of Business ( email )

7 McAlister Drive
New Orleans, LA 70118
United States

Bharat Sarrukai Sarath

Rutgers, The State University of New Jersey - Accounting ( email )

94 Rockafeller Road
Piscataway, NJ 08854
United States

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