In June 2020, the Wirecard-scandal hit the financial markets. The German financial service provider Wirecard AG (“Wirecard”), a DAX 30 company, filed for insolvency after revelations that an amount of EUR 1.9 billion was missing from its books and the auditors had refused to certify Wirecard’s balance sheet. The company’s stock fell more than 70 % in only two days. In the future, books and movies will certainly exploit this scandal: a crime thriller including fake banks on the Philippines and a fugitive former Chief Operating Officer wanted by the German police.
The triggering event that led to Wirecard’s insolvency was the auditors’ refusal to certify the company’s balance sheet. The auditors should thus be the heroes in this story, right? Far from it. The auditing firm had acted as Wirecard’s financial auditor for more than a decade since 2009. It had certified Wirecard’s balance sheet in all previous years without reservations. Immediately, the question arose why the auditors had failed to uncover the financial fraud years earlier. Because of this, the auditing firm now sees itself confronted with a tsunami of (threatened) litigations in Germany, for example damages claims from shareholders who lost their investments (cf. FAZ, 14 October 2020, page 16).
Broad limitation of liability for auditors under German law
Under German law, the liability of auditors performing year-end audits is capped at an amount of EUR 1 million per audit or EUR 4 million per audit for publicly noted companies (Section 323 paragraph 2 of the German Commercial Code). In addition, auditors benefit from generous possibilities to contractually limit their exposure to liability risks: Section 54a of the German Public Accountant Act allows a limitation of liability for negligent breaches of contract of EUR 1 million. A limitation of liability is even possible in standard terms, which auditing firms always include in their contracts.
The details here are controversially debated amongst German scholars and courts (cf. Dauner-Lieb, ZIP 2019, 1041 (1044); Stoffels, ZIP 2016, 2389 (2396); BGH NJW 1997, 1008 (1012)). Still, because of this statutory framework, civil liability is often not a real threat for auditors in Germany.
German Government’s actionplan to improve the work of auditors
As a consequence of the Wirecard-scandal, the German Government now takes action to increase the potential liability of auditors. The Federal Ministry of Finance and the Federal Ministry of Justice have prepared a joint action plan for “combating financial reporting fraud and strengthening controls over financial markets“. This action plan was announced on 7 October 2020 (https://www.bundesfinanzministerium.de/Content/EN/Standardartikel/Topics/Financial_markets/Articles/2020-10-09-combating-financial-reporting-fraud-strengthening-controls-financial-markets.html). Amongst others, the goal is to improve the work of auditors. To achieve this goal, the government plans three levers:
- All auditors, not only those of listed banks, will be obliged to move on from a client after ten years at the latest in order not to become blinkered with regards to possible shortcomings (rotation mechanism);
- A far-reaching ban on providing companies with both, auditing and consultancy services will prevent financial and other conflicts of interest (separation of auditing and consulting);
Auditors’ maximum civil liability for breaches of duty will be increased in order to provide an incentive for improving the quality of auditing activities. In cases of gross negligence, auditors will have unlimited liability. The liability for slight negligence will be increased for the current maximum of EUR 4 million to EUR 20 million (increasing liability).
In the future unlimited liability for auditors?
In particular the plan to increase liability is a spike in the eye of German auditors and auditing firms. The Institute of Public Auditors in Germany (IDW) already publicly criticized the government’s action plan and announced its own proposal (FAZ, 20 October 2020, page 22). Such an unlimited liability for gross negligence is not unheard of under German law though. For example, Section 52 of the German Federal Lawyer’s Act – addressing professional services of lawyers to clients – allows a limitation of liability for gross negligence only in individual agreements, not in standard terms. The same is true for any other contract under the general rule on standard terms in Section 309 no. (7)(b) of the German Civil Code. It remains to be seen whether the government will actually statute an unlimited liability in all cases of gross negligence or whether limitations of liability in individual agreements remain possible. The latter is more likely.
So far, only the political action plan has been announced. A draft legislation with the intention of fundamentally reforming the financial reporting enforcement system, including the liability of auditors and auditing firms, is said to be presented shortly. Lobbyists from all sides – the auditors’, the shareholders’/investors’ and the companies’ – now get busy to shift the draft legislation one way or the other. The result has the potential to be a game changer for the entire professional service sector in Germany.