Auditors’ liability and investors’ protection in Canada: The ‘leaky umbrella’

Abstract

In the spring of 1997, the Supreme Court of Canada (“Court”) rendered a decision in Hercules Managements Ltd. v. Ernst & Young [1997] (“Hercules”) that left shareholders out in the cold. Ever since the verdict in Hercules was released, the audit profession has been shielded from being held liable to third parties in cases of negligent misrepresentation. In Hercules, the Court ruled that audited reports are meant to inform management and creditors, but not for shareholders to make personal decisions. The Hercules’ ruling was labelled a “national embarrassment” and exposes investors to even more aggressive accounting techniques. As is evident from the spate of corporate accounting frauds since the verdict in 1997, Canadian corporations and their auditors found it easier to sidestep accounting rules to produce financial statements that make their companies look healthier, when in actual fact they were downright toxic. Accordingly, the study of auditors’ liability to third parties has a growing importance. In this paper, I argue that the Court’s endorsement in Hercules has set a dangerous precedent to limit the liability owed by auditors towards shareholders in preparing financial reports. The paper shows how the discourse from Hercules has been disseminated and consumed by the audit profession and corporate enterprises to the detriment of shareholders. The paper emphasizes the residing significance of the auditors to use the discourse in Hercules to privilege their clients’ interests and background the interests of non-contractual third parties.