Fallout From Accounting Class Actions Could Extend Beyond Issuers

Although we have ample evidence to the contrary, the idea of an accounting scandal seems strange because it is hard to imagine accountants engaging in scandalous behavior. We picture accountants as meticulous bean counters – hardly the types to find themselves as defendants in class-action lawsuits. However, they’re dealing with increased risk as scrutiny of their clients’ accounting practices ratchets up.

First, the news from the legal world, where a new report from legal and economic consulting firm Cornerstone Research shows signs of a more litigious environment for issuers. Securities class action filings involving accounting allegations ticked up 11% in 2022 from 2021. The number of filings that referenced financial restatements or insufficient internal controls also rebounded to levels seen prior to 2021, when such filings went through a significant one-year decline.

Meanwhile, the median market capitalization of the defendants in accounting case filings in 2022, $1.1 billion, represented a low point since 2017. That suggests litigants have started taking a broader swath of publicly traded companies to court.

Equally important, the total settlement value from accounting-related class actions grew from $817 million in 2021 to nearly $1.4 billion, a year-over-year increase of roughly 70%. The median settlement value almost doubled from $8.1 million to $15.5 million in 2022. In other words, not only were more lawsuits filed against issuers in 2022, but they were also more costly for companies to resolve. (Perhaps the latter had something to do with the former?)

To be fair, despite the increase in 2022, Cornerstone Research pointed out that the volume of accounting-related case filings in 2022 remained “well below the historical average.” Likewise, even though the total value of accounting case settlements grew last year, it failed to reach the annual average in total settlement amounts from 2013 to 2021. Considering the Covid-19 pandemic’s impact on daily life, increased class-action activity a year ago may signify a step on the path back to normalcy.

Nevertheless, accounting-related securities class actions are rising, and that’s trouble for the accounting firms that sign off on issuers’ financial disclosures. More accounting lawsuits against their clients equals more scrutiny of the firms’ work in reviewing financial statements. That means more risk exposure for the firms themselves.

Look no further than the implosions of Silicon Valley Bank and Signature Bank in March for an example of a major accounting firm getting caught up in the maelstrom around its clients. KPMG LLP signed off on both banks’ audits less than two weeks before they collapsed. At best, the Big Four accounting firm now must explain to government regulators and the public why it wasn’t asleep at the switch when it gave its opinion of the banks’ financial statements.

If an investigation turns up signs of negligence on the firm’s part, however, the consequences for KPMG could be dire. Some enterprising attorneys out there probably have a lawsuit already drawn up.

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