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StoneRidge Investment Partners v. Scientific Atlanta: A Test of Auditor Litigation Risk

Journal of Business Ethics volume 187, pages 517–538 (2023)Cite this article

Abstract

This paper examines the effects of a decrease in auditor litigation risk in a setting that isolates a change in auditor litigation risk from changes in auditor reputation. StoneRidge Investment Partners v. Scientific Atlanta is a 2008 U.S. Supreme Court ruling that restricted secondary actor liability in class action suits, resulting in a decrease in class actions that listed auditors as defendants. We document that the StoneRidge decision is associated with a negative CAR for clients of Big 4 auditors and industry specialist auditors, in particular those associated with high-litigation risk, low cash, and past incidences of modified going concern opinions. These findings are consistent with investor perception of lower potential payoffs from secondary defendants in class action suits, in particular auditors, following the StoneRidge decision. We also document that auditors are more (less) likely to accept (reject) risky clients and charge lower audit fees to risky clients after StoneRidge, consistent with a decrease in auditor litigation risk that increases auditor risk tolerance. Finally, we provide evidence that audit firms issue fewer going concern opinions following StoneRidge, consistent with a decrease in litigation risk leading to lower audit quality. Our results are relevant to policy makers as they consider the disciplinary role of litigation on audit markets.

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Notes

  1. StoneRidge Investment Partners, LLC v. Scientific Atlanta, Inc., 552 U.S. 148, 166–67 (2008).

  2. The six conditions are (i) a material misrepresentation or omission by defendant; (ii) scienter; (iii) a connection between the misrepresentation and the purchase or sale of securities; (iv) reliance upon the misrepresentation; (v) economic loss; and (vi) loss causation.

  3. In Legal Background and Hypothesis Development, we more thoroughly discuss the legal ramifications of StoneRidge and in doing so, validate our setting as a shock to auditor litigation risk.

  4. It is perhaps not surprising that non-Big 4 auditors do not accept (reject) more (fewer) risky clients post-StoneRidge, as client switching is essentially a zero-sum game. That is, clients may switch from a Big 4 auditor to another Big 4, from a non-Big 4 to another non-Big 4, from a non-Big 4 to a Big 4 (an “upgrade”), or from a Big 4 to a non-Big 4 (a “downgrade”). Therefore, for example, for Big 4 auditors to accept more risky clients, non-Big 4 auditors may have to lose risky clients (in the event of an auditor upgrade). In “Client Gain/Losses” section, we discuss this idea further and provide descriptive statistics of the distribution of client switches.

  5. More recent class action settlements which had auditors as co-defendants include a total of $14.6MM in 2019, partially payable by Deloitte and Grant Thornton related to their audit work for client Ashley Services, and a total of $50MM in 2021, partially payable by PwC related to its audit work for client Vocation (Tadros and Wootton, 2022).

  6. Central Bank of Denver, N.A. v. First Interstate Bank of Denver, N.A., 511 U.S. 164 (1994).

  7. Bravin, Jess, and Mark H. Anderson (2008-01-23). "Justices Rebuff Enron Holders". Wall Street Journal.

  8. Including year fixed effects renders the variable Post irrelevant as it only takes on the value of a specific year in the analysis. We therefore do not have any prediction regarding β1.

  9. We exclude from the sample any additional going concern opinions that are issued after the first opinion.

  10. Calculated as the Market-Value ($3,227 million) X 0.00439 (Big4 coefficient).

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Authors and Affiliations

  1. David D. Reh School of Business, Clarkson University, Potsdam, NY, USA

    Anna Bergman Brown

  2. Sawyer Business School, Suffolk University, Boston, MA, USA

    Nicole M. Heron

  3. Zicklin School of Business, Baruch College, City University of New York, New York, NY, USA

    Hagit Levy

  4. R.H. Smith School of Business, University of Maryland, 4333F Van Munching Hall, College Park, MD, 20742, USA

    Emanuel Zur

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  1. Anna Bergman Brown
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  2. Nicole M. Heron
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  4. Emanuel Zur
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Correspondence to Emanuel Zur.

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Brown, A.B., Heron, N.M., Levy, H. et al. StoneRidge Investment Partners v. Scientific Atlanta: A Test of Auditor Litigation Risk. J Bus Ethics 187, 517–538 (2023). https://doi.org/10.1007/s10551-022-05267-y

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