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Will a cap on auditors' liability encourage complacency?
October, 05th 2006
A press release of great relevance to accounting professionals is on, the site of the European Commission (EC). `Auditors' liability: Commission publishes independent study on economic impact of current rules,' reads the title of the Brussels-datelined communiqu issued `1 hour ago' at the time of writing. Four key conclusions of the study are as follows: Concentration and domination of the international market for statutory audits of large and very large companies by the Big-4 networks. "The likelihood of new entrants into this market is very limited in the coming years. Additionally, under the current circumstances, middle-tier firms are unlikely to become a major alternative if a Big-4 network fails," notes the Commission. Falling liability insurance, especially at higher limits. The study postulates that "the remaining source of funds to face claims may essentially be the income of partners belonging to the same international network," even as large claims threaten to `put at risk an entire network'. Wider economy impact when a network fails. Such as "a significant reduction in large company statutory audit capacity possibly creating serious problems for companies whose financial statements need to be audited." Auditor liability limitation, a possible antidote to the risk of adverse impact. Worth a read is the 381-page study, on `the economic impact of auditors' liability regimes', prepared by `London Economics in association with Professor Ralf Ewert, Goethe University', and presented to EC's Internal Market and Services. It makes sombre observations, as for example, that the profession is already viewed as increasingly less attractive and as risky. "Audit firms have indicated that unlimited liability makes it more difficult to attract talented people into the profession but, much more importantly, to retain professional staff," states the study. "A major claim that threatens the survival of a firm would simply reinforce the negative perceptions about the profession. The general view from the Big-4 networks is that any financial obligation requiring more than a 15 per cent to 20 per cent cut in income for more than 3-4 years would likely result in the collapse of the firm." The report puts the risk `in perspective', thus: "It is estimated that the largest single claim the largest firm in Europe could sustain over a certain period once the resources of the network's captive are exhausted is about {euro}540 million, or less than 0.3 per cent of the market capitalisation of the largest UK company by market size and just under 0.25 per cent of the turnover of the largest UK company by turnover." Alarmingly, many claims are pending. As of September 2005, it seems "there were 20 outstanding claims against auditors in the US where the damages sought or the estimated losses were $1 billion or more if the lawsuits are primarily directed against accounting firms and $10 billion or more if the lawsuits are directed against audit clients and auditors are named as additional defendants." What is the position in Europe? "The firms of the major European networks (Big-4 + two largest middle-tier networks) face currently in a number of EU Member States a series of very substantial claims or potential claims related to statutory audit services which, at the high end of the claims' distribution, vastly exceed the available insurance cover and the firm's own resources," cautions the study. "28 of the 69 claims and potential claims are in excess of $100 million, 16 are in excess of $200 million and 5 are in excess of $1 billion." Liability caps aren't new. "A small number of EU member-states (Austria, Belgium, Germany, Greece and Slovenia) have a statutory limitation on auditors and in the UK a bill currently reviewed by Parliament foresees proportional liability by contract," states London Economics. The consultancy's site has many reports, such as `an assessment of the regulatory framework for electronic communications', and on `Globally Harmonised System of Classification and Labelling of Chemicals'. Speaking about the study is a Financial Times article on "Anxiety about the risk of losing another big accounting firm has been running high since Arthur Andersen disintegrated in 2002 following an indictment related to the Enron scandal," it chronicles. "The collapse of KPMG, Ernst & Young, PwC or Deloitte the four remaining big firms could pose a grave threat to financial stability given the reliance of large banks, insurers and companies on their services." However, there are voices against a limit to liability. Unlimited liability is `an important driver of rigorous auditing', they argue and `warn that a cap could encourage complacency', as the FT article explains. Closer home, we may not be talking about limiting the liability of auditors. Perhaps, because, claims against auditors are almost unheard of. So too is the status of professional liability insurance. D. Murali
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