Equitable v E&Y
They are not exactly crowing, but they are pretty happy. It is several days on from Equitable Life’s settlement with Ernst & Young (E&Y) on its massive auditor liability case, and the E&Y legal team – Barlow Lyde & Gilbert (BLG) partner Clare Canning, Brick Court’s Mark Hapgood QC and 7 King’s Bench Walk’s (7KBW) Jonathan Gaisman QC – are still expressing theatrical bemusement at why the case was brought at all.
“There was always a problem in trying to build a coherent set of links between alleged audit failure and the demise of Equitable,” declares an indignant Gaisman. “If a claim was going to be made it was always going to be a stretch to build those links. If any of those links failed, as it became increasingly obvious during the trial that probably all of them would, then the claim was doomed.”
Strong words. But the entire case was characterised by robust language from the start. “One of the more colourful factors was the evidence which came out that [Equitable chairman] Vanni Treves had said during this case, that they were suing to get into the deep pockets of E&Y,” remarks Hapgood. “That’s not a very attractive platform on which to make such a massive claim.”
“PR has been a feature of this case,” observes Canning dryly. So much so that press strategy appeared to drive the legal strategy at times. Equitable may break new ground as the first major piece of civil litigation to be fought in the press room as much as in the court room.
Hapgood’s remark at the close of the case was nicely calculated to hit the headlines. He condemned the action as “this very long, costly and utterly pointless piece of litigation, which has culminated in the biggest climbdown in English legal history”.
Several days later, Hapgood is unrepentant. “Someone had the cheek to suggest that it was hyperbole. I’d like to know what was the biggest climbdown [if not Equitable’s],” he states. “It was my immediate reaction when I heard that there was going to be a drop-hands settlement.
“It had come down in four stages when it started, from £3.6bn to £2.3bn; then down to £2bn, then down to £700m, then down to zero – it’s going down a very steep mountain in very large steps.”
Burden of proof
Yet what puzzles many City litigators is how it got to that stage in the first place. There was an awful lot to prove on causation. And for a claim this size, the evidence seemed sketchy, say several City litigation partners. (Equitable and Herbert Smith declined to comment on the Equitable case at all.)
One well-known litigator says: “If your litigation strategy always involves firing aggressive missiles, it doesn’t look good if they turn out to be blank.”
Not that E&Y’s legal team was averse to tough language. Gaisman, who opened for E&Y, began his submission by saying: “This is a case where the claim brought suffers from so many defects that it’s hard to know which of them deserves pride of place.”
He told the court: “Evidence in professional negligence claims that the managers or directors, if only told of certain facts, would have taken or refrained from certain action, is always subjected to close scrutiny, not least on the behavioural principle associated with Mandy Rice-Davies. But here there is no such evidence.
“It must be unique in a claim against an auditor, which depends on establishing factual causation, that a company does not adduce a single piece of evidence from the relevant managers or directors that they would have done what it now says. On the contrary, the claimant has to advance its case directly in the teeth of the cogent and unequivocal evidence of the society’s [Equitable’s] management and board that they would in fact have done no such thing.”
Even allowing for the normal bullishness of any barrister’s opening statement, the ferocity of Gaisman’s rhetoric highlights the difficulties faced by Ian Milligan QC and Herbert Smith in proving its claim.
The running of the case
£25m is a lot of money to spend on a defence. The decision of E&Y general counsel Victoria Cochrane and Canning to go for not one, but two silks was an expensive one; Hapgood and Gaisman are understood to charge around £800 per hour, while Canning’s rate is around £380 per hour. Unsurprisingly, Hapgood argues that the additional cost was “absolutely irrelevant in the overall scheme of things. If it gets your opponent to drop the claim then it’s money well spent.”
The courtroom performance impressed many: one solicitor present describes the two silks as “systematically shredding the case against them”.
E&Y general counsel Victoria Cochrane says: “The figures for the costs look huge and one of the reasons was the immense complexity of the case. That’s one of Barlow Lyde and Gilbert’s [BLG] strengths.
Equitable kept changing the claim and BLG got up to speed on each claim extremely quickly. That’s a rare skill. They were much better prepared than Herbert Smith.”
Canning, dubbed by Hapgood and Gaisman as the general in the case, parcelled the work out neatly between the two silks. Hapgood dealt with the overview of the claim, including: the factual causation point of whether the directors would have done anything different; legal causation; the lost sale claim; and the contributory negligence by Equitable.
Gaisman dealt with the provisioning claim, which revolved around Equitable’s allegations that E&Y should have insisted on higher provisions within the accounts from 1997-1999. He also handled the contingent liability claim, the nature of the audit duty and the scope of duty – whether there was a real link between the alleged breaches and the loss claimed.
“If you have two co-leaders and have a coherent division, there are days in the case when you can genuinely relax,” says Gaisman. The E&Y team’s life was made a lot easier by a series of unforced errors on the part of Herbert Smith. Hapgood was able to pounce early on. In Court 76 at the beginning of May, Hapgood said that minutes of an Equitable board meeting held on 2 July 2001 had not been disclosed, despite a request made to Herbert Smith by BLG in November 2004. Hapgood told Mr Justice Langley that Herbert Smith had then claimed the minutes were not germane to the case. In another instance, further documents were not disclosed until the beginning of May to former Equitable director Christopher Headdon.
Hapgood leapt upon this, too, declaring that it raised concerns about the disclosure exercise carried out by Herbert Smith on Equitable’s documents in 2001 and 2002. “Our concern is that there’s never been a proper review by Herbert Smith of the 2001 and 2002 documents starting from the correct position that everything must be looked at to see what’s relevant,” he says. “And it’s not for the defendant to identify relevant areas and then try and second guess what documents there may be – it is for Herbert Smith to go through those documents and ascertain what’s relevant.
“And, above all, has the society ever, or has Herbert Smith ever, conducted a proper review of the society’s 2001 and 2002 documents, applying the correct test of standard disclosure?”
Throughout the case, Treves maintained that the board of Equitable had no option but to bring the action. He was widely quoted as saying: “We launched this claim having received expert reports and clear legal advice that we had a duty to bring the claim.” (Treves was not available for comment.)
Opinion in the City is divided as to who led whom here. Treves, a solicitor of many years’ standing and former senior partner of Macfarlanes, was hardly new to the law. Did he interpret Herbert Smith’s advice in an aggressive light? Or did Herbert Smith revert to its time-honoured Rottweiler tactics? Either way, City litigators are baffled. “Part of a solicitor’s job is to control their client,” comments one partner.
Obviously enough, the theory doing the rounds in the City is simply that Equitable, Herbert Smith and 20 Essex Street were all betting that E&Y would cave in.
Hapgood trenchantly referred to this at the close of the case, saying in court: “There’s a salutary lesson to be learnt for those thinking of suing auditors, and it is simply this: bringing a hugely inflated claim for blood-curdling amounts of money, in the hope that the sheer scale of the claim will force the defendant into making a substantial cash payment, is misconceived. It hasn’t worked against Ernst & Young in this claim and it will not work against Ernst & Young in the future.”
Accountants have often preferred to settle in the past – Coopers & Lybrand settled in both the Barings and Maxwell cases, for example.
But even after Enron and the collapse of Arthur Andersen (which was not an audit claim), the climate has changed. This time round, Equitable and Herbert Smith picked the wrong moment to intimidate the other side into settlement. Canning, Gaisman and Hapgood all have heavyweight experience of acting for auditors. Canning and Hapgood both acted for PricewaterhouseCoopers in the Elton John case and Gaisman worked on Barings for Deloitte & Touche.
The trio say never once was there a moment where surrender was considered. “If they’d succeeded it would have been a complete carte blanche for auditors’ negligence claims,” says Canning. “It would have been a terrifying prospect.”
If that was the gamble Treves and Herbert Smith were taking, it failed spectacularly. In July Equitable dropped the ‘lost sale’ claim of £1.3bn, which was based on the allegation that the directors would have put the mutual up for sale earlier if E&Y had insisted on different provisions which reflected the true exposure from the guaranteed annuity rate policies.
At that point, says the E&Y team members, they knew things were definitively turning their way. When the former executive and non-executive directors, led by Headdon, queued up to say that, whatever the auditors had done it would never have changed the board’s position, Equitable had to start its humiliating retreat.
“It became obvious that we’d won the case when Mr Headdon had given evidence,” says Gaisman.
The question, then, that needs to be answered is why Equitable’s legal team had not guessed the outcome after reading the directors’ witness statements in the first place. E&Y’s Cochrane says: “The directors’ witness statements and documentation is all consistent with their evidence. It was quite a long shot expecting them to change their position. There was nothing revealed in the trial that Equitable did not know about before it started.” On this, as with all current Equitable issues, Herbert Smith is silent.
Setting the benchmark
E&Y is not quite out of the woods yet. Canning is defending the firm at the Joint Disciplinary Tribunal. But E&Y’s success in fending off Equitable has sent out a signal to other accountancy firms that they, too, can tough it out.
“Obviously the Government is looking at liability reform for auditors at the moment,” says Canning. “This is an object lesson in the type of deep-pockets litigation that auditors have unfairly to face. The thing that E&Y did so well is that they held their nerve.”
- Iain Milligan QC, 20 Essex Street
- Robert Miles QC, 4 Stone Buidings
- Guy Morpuss, 20 Essex Street
- Charles Plant, Herbert Smith
- Julian Copeman, Herbert Smith
- Christa Band, Herbert Smith
For Ernst & Young
- Mark Hapgood QC, Brick Court Chambers
- Jonathan Gaisman QC, 7 King’s Bench Walk
- James Brocklebank, 7 King’s Bench Walk
- Cyril Kinsky, 3 Verulam Buildings
- Clare Canning, Barlow Lyde & Gilbert
- Matthew Lawson, Barlow Lyde & Gilbert
- Simon Willis, Barlow Lyde & GilbertEquitable v E&Y in brief
Mutual assurer Equitable Life, led by new chairman Vanni Treves and advised by Herbert Smith, had sued its former auditor Ernst & Young (E&Y) for negligence and breach of duty over the way E&Y had provisioned for the guaranteed annuity rate (GAR) policies in the 1997, 1998 and 1999 accounts. The claim was filed originally against E&Y in April 2002, nearly two years after a House of Lords test case on GARs went against the society. Equitable sought damages of £2.6bn. It also brought a claim against the former directors for £3.2bn.
The case proceeded in fits and starts before the trial proper began. BLG partner Claire Canning’s team won an early battle when Mr Justice Langley struck out a large part of the claim against E&Y because he did not accept that the damages flowed from E&Y’s actions. However, Equitable appealed and the decision was overturned. E&Y’s costs from this strike-out action were met by Equitable as part of the settlement.
The trial began in front of Langley J on 11 April 2005. At that point, Equitable was claiming £2bn from E&Y and £1.7bn from former Equitable directors.
On 18 July, Equitable dropped its loss of sale action against E&Y, reducing the overall claim to £705m. On 22 September, the drop-hands deal was struck between the two parties. At press time, Equitable’s action against the directors was continuing, albeit amid reports of settlement negotiations.