Administrative liability of the members of a listed company’s audit committee for serious errors or inaccuracies in the audited annual accounts

13 November 2020

1. Although Judgment no. 1279/2020 of the Spanish Supreme Court (Administrative Division) of 8 October, affirming the Judgment of the Audiencia Nacional of 31 January 2019 (appeal 3053/2014), states that the liability of the members of a listed company’s Audit Committee, required by the Spanish Securities Market Authority (CNMV) to restate the company’s consolidated annual accounts for 2012 and to publish the appropriate significant event in this regard, is not strict in terms of the mere discharge of duties or membership of the Audit Committee alone, it concludes that such Board Committee members are administratively liable for not having detected a serious inaccuracy in the view given of the company in the audited annual accounts. In the case under consideration, the Audiencia Nacional had not found any reason to believe that the penalised directors had not been at fault.

2. As regards the facts of the case, the judgment of the Audiencia Nacional rejected the application for judicial review made by the listed company and four members of the Board’s Audit Committee against the Order of the Ministry of Economy of 23 May 2014, which imposed the following fines for the commission of a very serious infringement (at that time classed as such in Art. 99(m) of the Securities Market Act and now in Art. 282(2) of the recast version of 2015): EUR 100,000 on the listed company and EUR 10,000 on each of the four directors who were members of the Board's Audit Committee. The penalised conduct is the submission to the CNMV and dissemination of the 2012 consolidated accounts with inaccurate or untruthful data, classed in the aforementioned articles as: "the presentation to the Securities Market Authority of regulated financial information containing data that is incorrect, untrue o misleading, or omissions of material information or data".

The Audiencia Nacional deemed as an established fact the inaccuracy of the 2012 audited annual accounts, which did not reflect losses in excess of EUR 29 million, reflecting only EUR 104.7 million in losses. This difference of around 28% was corrected, at the behest of the CNMV, in the listed company’s subsequent restatement of the accounts.

3. In its judgment of 8 October, the Supreme Court included the second and third points of law of the aforementioned judgment of the Audiencia Nacional, which, among other things, stated that the inaccuracy of the company's annual accounts had been proven and the points of law of the judgment of the Audiencia Nacional of 29 November 2018 (appeal 245/2017), which ratified the penalty for a very serious infringement imposed on the auditors for having reported favourably on the aforementioned consolidated annual accounts before they were restated, had been incorporated by reference. More questionable are the assertions made by the Audiencia Nacional in the third point of law in its judgment of 31 January 2019 regarding the fault “even of the members of the Board of Directors, taking into account [their] status as principals in respect of the significant event underlying the disputed penalty, without having to find any reason to believe that the penalised directors had not been at fault on the basis of the unlawfulness of the conduct according to the correct classification as very serious by the disputed administrative act”. The party required to communicate significant events, in accordance with the rules then in force, is the listed company itself, that is, its Board of Directors, and not the members of a certain committee within the Board (v. Art. 81(2) of the repealed 1988 Securities Market Act and Arts. 226 and 227 of the recast version of 2015).

4. The interest for the formation of case law on breaches of the rules governing the determination of disputes (‘cassational’interest) is contained in the third point of law: the appellants, members of the Audit Committee, contended that they were “not responsible for the accounting errors that could occur when the annual accounts are prepared, especially when the company's auditor has endorsed the accounts without qualifications. Otherwise, they would be equated with the auditor in their functions and responsibility and would be considered to be involved in a case of strict liability" in an interpretation contrary to the principle of liability contained in Art. 130 of Act 30/1992 (current Art. 28(1) of Act 40/2015).

Moreover, the appellants state that "although the members of the Audit Committee have special knowledge in this area, this body has the function of directing and supervising the audit systems implemented in the company, as well as monitoring the independence of the external auditor, but in no way does it fall to them to duplicate the work of the auditor and carry out a second audit".

The Supreme Court rejects these arguments, denying that the judgment under appeal is based on a concept of strict liability contrary to the principle of personal liability under administrative penalty law: “The appellants are right in that the special supervisory duties assumed by the members of the Board of Directors who are themselves members of the Audit Committee do not make them auditors or have them assume or duplicate the tasks of the external auditor. Consequently, under no circumstances may there be a strict transfer of liability from the auditors to the members of the Audit Committee. However, their role of managing and supervising the commercial company's auditing systems, among which the external auditor stands out for its importance, as well as their special training in accounting and their knowledge of the company's accounts, gives them special responsibility in all matters relating to the correct performance of the accounting and auditing tasks carried out by the company” [emphasis added]. Citing the eighteenth additional provision of the Securities Market Act applicable to the case - now Art. 529 quaterdecies of the Companies Act - which specified as a function of the Audit Committee, among others, “3. To supervise the process of preparing and presenting the regulated financial information", the Supreme Court states that: "It is clear that this special responsibility does not mean that any error or inaccuracy in the accounting work and, in particular, in the preparation and presentation of the annual accounts can be attached to them. And it is also clear that it is the external auditor who is fundamentally responsible for verifying the accuracy and veracity of the annual accounts. However, the supervisory duties of the members of the Audit Committee, which the appellants themselves acknowledge, and, therefore, its responsibility in the area of auditing and accounting, do extend to reviewing the correct performance of the auditing tasks and, therefore, to ensuring that a task of great impact on the view of the company, such as the annual accounts, even if they are audited by an external auditor, does not contain serious errors or inaccuracies, as has been the case” [emphasis added].

The Supreme Court accepts the statements of the Audiencia Nacional’s judgment that there was, on the one hand, "inaccuracy or lack of veracity in the annual accounts of undisputed significance and, on the other hand, a complete absence of causes or circumstances of personal exemption from liability of the penalised directors".

This important third point of law concludes by summarising the above as follows: "'Finally, it should be noted that the rejection of the appeal and the ruling that the penalty was consistent with the law does not mean that the party's assertions in the plea-in-law are wrong, as is clear from the legal considerations already put forward. Thus, we have explicitly rejected that the penalty is based on strict liability for the mere discharge of duties or membership of the Audit Committee alone. We also stated that the functions performed in this body are not equivalent to and do not confer the same responsibility as that of the auditor, and that the penalty responds to neglect in the performance of the functions as members of the body responsible for supervising the audit work, which involves consideration of the actions and the absence of specific grounds of exculpation in the conduct of the penalised directors. However, for the reasons set out above, all those considerations do not in this case prevent the rejection of the appeal, but, on the contrary, lead to the affirmation of the contested judgment and, therefore, of the penalty imposed".

5. In short, in this judgment the Supreme Court is applying the principles of administrative penalty law in the securities markets: administrative liability punishable in accordance with the seriousness of the conduct and the principle of fault; principles in this case adjusted by the existence of a legal presumption of liability of directors of listed companies in accordance with Art. 95 of the repealed 1988 Securities Market Act, a presumption that is now contained in Art. 271(3) of the recast version of 2015.

A different matter is that the constitutionality of this presumption may be questioned.