Insurer begins huge claim against auditor

Equitable Life Assurance Society this week began a 3.8 billion ($10 billion) lawsuit claiming its former management and auditor, Ernst & Young, led the London-based insurer to the brink of collapse.

Equitable said the accounting firm and 15 former directors failed to prepare it for a 2000 court judgment that cost the company 1.5 billion, blocking its sale and forcing it to cut payments to 750,000 policyholders.

Ernst & Young and the insurer's directors deny wrongdoing and contest the claims.

"We don't want to put Ernst & Young and their staff and families into bankruptcy, but we will if we have to," said Equitable chairman Vanni Treves.

The lawsuit, the biggest of its kind in British history, has been a factor in a Government proposal to allow shareholders to limit auditors' financial liability and may set new corporate governance standards for company directors.

The two claims - for 2.1 billion against the British unit of Ernst & Young and 1.7 billion against the directors - will be tried simultaneously during a 26-week High Court trial at London. Both stem from Equitable's move to cut payments to holders of "guaranteed annuity rate" (GAR) insurance policies in 1994.

The policies, sold by the insurer for more than three decades, could be exchanged upon retirement for an annuity paying a guaranteed minimum return. Policyholders were also entitled to a so-called bonus payment based on a portion of Equitable's investment profits.

When Britain's interest rate tumbled from 15 per cent in 1989 to just 5.5 per cent by November 1993, Equitable was locked into paying a higher annuity to GAR policyholders than the market rate. The insurer decided to cut the final or "terminal" bonus owed to some policyholders.

In July 2000 the House of Lords ruled the cuts were unlawful, leaving Equitable with a 1.5 billion hole in its accounts.

Equitable, which in 1998 had pension arrangements with more than 300 of Britain's 500 largest companies, claims Ernst & Young should have included an accounting note that disclosed the potential costs of losing the case.

It also claims the firm didn't include the proper technical provisions for the GAR liabilities in its 1997, 1998 and 1999 accounts, creating an "unquantified black hole" that prevented the insurer's sale.

"If they had known, the directors would have tried to sell the company when it was eminently sellable, not after," Treves said.

Ernst & Young says its provision of 200 million for the GAR liabilities was reasonable and has been supported by its external auditor, KPMG International.

The British Government is proposing to allow shareholders to limit auditors' financial liability to their own mistakes, separate from errors by company management or other outside advisers.

The plan, which would not affect Equitable's claim against Ernst & Young, must still be passed by Parliament.

Apart from the claim against the auditor, Equitable is also suing six former executive directors and nine former non-executive directors, claiming they should have taken legal advice about the terminal bonus policy and failed to mitigate the risks of losing the litigation.

A large judgment against them may deter executives from seeking outside directorships and make British companies "more cautious" about recruiting and maintaining qualified board members, said Charles Evans, a partner at London-based law firm Norton Rose.

"It could end up as a warning to people to get off the bandwagon of the old-boy network in appointing directors."