Business judgment v. audit judgment: Why the legal distinction?

Abstract

This paper explores the legal contrast between the well-established “business judgment rule” and a comparable, although nascent, “audit judgment rule”. The business judgment rule often appears in litigation against corporate directors but not in litigation against public auditors. The audit judgment rule has never been voiced or cited explicitly in a case against auditors, but it can be inferred from court opinions. From the contextual background of multi-disciplinary research issues, this study focuses on the question of legal distinction and restricts the inquiry to case law in the United States. Expertise and professionalism are at the center of concern. The first three sections explore the precedential link between burden of proof and standard of care. The first section reviews “burden of proof” as a jurisprudential ground for contrasting the business judgment rule, described in the next section, and the audit judgement rule, inferred in the third section. The different legal “rules” derive from different legal presumptions about the different standards of care (i.e. duties) required of corporate directors and of public auditors. In general, case law has placed a higher burden of proof for plaintiffs against corporate directors upon whom rests a duty of care that is a less detailed and more general standard of behavior. Correlatively, precendent has allowed a lower burden of proof for plaintiffs against auditors upon whom rests a duty of care that is more detailed (i.e. higher) than is the standard behavior required of corporate directors. Therefore, corporate directors have an easier defense in litigation than public auditors have. The different economic roles of directors and auditors are considered thereafter, with some implications of these roles as possible justification for the different legal precedents. The concluding section comments on recent trends and raises a crucial legal question for corporate audit committees.