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      The Changing Landscape of Auditor Litigation and Its Implications for Audit Quality
      13 May 2019Working Paper Summaries

      The Changing Landscape of Auditor Litigation and Its Implications for Audit Quality

      by Colleen Honigsberg, Shivaram Rajgopal, and Suraj Srinivasan
      Data from 1996 to 2016 shows that shareholder litigation against auditors has declined in recent years. Empirical evidence shows that Rule 10b-5, the Securities Act statute used for class action lawsuits, has lost its bite for use against auditors. This decline is driven, at least in part, by the US Supreme Court’s narrowing of liability standards. These findings suggest weakened shareholder protection with profound implications for investors.
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      Author Abstract

      We provide a comprehensive overview of shareholder litigation against auditors since the passage of the Private Securities Litigation Reform Act (PSLRA). The number of lawsuits per year has declined, dismissals have increased, and settlements in recent years have declined. Our study asks why. Because we find that the likelihood an auditor is sued following a severe restatement has significantly declined in recent years, it does not appear that the decline can be attributed solely to increases in audit quality. Instead, we consider whether the recent wave of Supreme Court cases limiting the scope of Rule 10b-5 against private actors may have led to the decline. To study this possibility, we focus on the Supreme Court’s 2007 and 2011 rulings in Tellabs v. Makor and Janus v. First Derivative, respectively. These decisions affected Rule 10b-5 litigation in different ways; Tellabs related to pleading standards, while Janus related to liability rules. Our analysis provides strong evidence that the higher liability standards imposed by Janus significantly reduced auditors’ liability exposure, but we find only limited evidence that the pleading standard imposed by Tellabs had a significant effect.

      Paper Information

      • Full Working Paper Text
      • Working Paper Publication Date: April 2019
      • HBS Working Paper Number: HBS Working Paper #19-113
      • Faculty Unit(s): Accounting and Management
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      Suraj Srinivasan
      Suraj Srinivasan
      Philip J. Stomberg Professor of Business Administration
      Unit Head, Accounting and Management
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