Negligence in Auditing
The Act on External Audit of Stock Companies is causing a controversy between accounting firms and financial companies in the wake of the recently exposed fraudulent accounting of Daewoo Shipbuilding & Marine Engineering.
According to the act, an accounting firm itself has to prove its lack of negligence in auditing in order to be free from the duty of compensation in the event of a damage suit attributable to poor accounting. When the plaintiff in the suit is a financial company or a company that appointed the accounting firm, however, that company has to prove the defendant accounting firm’s negligence. In other words, a financial company itself has to prove the firm’s negligence when the firm failed to detect an accounting fraud of a certain corporation and the financial company has to bear losses as a result of the failure.
Those in the financial sector are calling this into question. “According to the act, accounting firms have access to corporate accounting data and property data but financial companies, which do not have the same access, have to look into enterprises with financial statements alone, which means it is very difficult for financial companies to prove the responsibility of accounting firms,” one of them explained, adding, “Although accounting firms claim that the same responsibility lies in financial companies in the United States as well, situations are different between South Korea and the U.S. in that plaintiffs and defendants share their litigation documents in the event of lawsuits in the latter.”
A potential problem is that this legal structure might result in accounting firms’ passiveness in accounting fraud detection. “Under the current condition, accounting firms are not exposed to risks associated with suits for damages, and as such, they are likely to focus on auditing fees and overlook accounting frauds,” he went on to say.