Auditor liability – international developments
First principles the exposure of the auditor The audit gives en entity’s owners an expert, independent opinion on whether the financial statements comply with accounts preparation rules (the true and fair standard in EU terms) An auditor can be sued by (among others) - The entity’s management Persons who buy shares in the entity Third parties The entity’s new owners The entity’s liquidator Under joint and several liability rules, the auditor can be made to assume full responsibility for loss, even where others are also negligent
Approaches to limiting auditor’s exposure (1) – limited liability structures Audit firms may be allowed to organise themselves in limited liability structures- these may either be commercial limited companies or specially-devised vehicles such as the ‘limited liability parttnership’ Where auditors practise in such formats, the debts and liabilities of the firm belong to the firm and individual partners bear no personal responsibility for them This approach protects the personal assets of partners but does not protect the firm from a huge claim
Approaches to limiting auditor’s exposure (2) – liability caps The law in some countries specifies a maximum amount for which auditors may be sued in the case of their negligence In the EU, such caps exist in Germany, Austria, Greece, Belgium and Slovenia Such caps may not protect the auditor in the case of fraud or intentional damage The law will also address whether the cap applies to actions by third parties as well as the audited entity
Approaches to limiting auditor’s exposure (3) – proportionate liability Legal reforms have taken place in the USA and Australia, with effect that damages for economic loss should be allocated in accordance with courts’ determination of wrongdoers’ relative responsibility for the cause of the loss
Approaches to limiting auditor’s exposure (4) – the UK reform The UK now allows individual companies and their auditors to enter into ‘liability limitation agreements’ whereby the liability of the auditor to the company is limited on some agreed basis No restriction on how liability is to be limited BUT the basis must be ‘fair and reasonable’ bearing in mind - the auditor’s statutory responsibilities - the auditor’s contractual obligations - the auditor’s professional obligations The company’s shareholders must approve any such agreement for it to be valid
The EU initiative on auditor liability The issue has become politicised following Enron et al The revised statutory directive called on EC to carry out study of EU’s audit liability regimes This study has been followed by consultation exercise, offering four possible bases for reform: - One single monetary cap - A variable monetary cap - Limitation by reference to the audit fee -- Proportionate liability
Arguments in favour of reform
The markets need an adequate suppply of qualified and experienced auditors - we cannot risk another big firm collapse We must address the issue of competition – markets where liability is limited show that it is possible for mid-tier firms to compete for listed company business Active threat of litigation drives up insurance costs Audit profession now much more regulated Joint and several liability is a disproportionate sanction
Concluding arguments Exposure to liability for negligent work remains a driver of quality Shareholders need to have rights against a negligent auditor Any reform needs to safeguard audit quality Auditors should not be guarantor of shareholder losses Any reformed basis of auditor liability should strike better balance and reflect real nature of audit function and relationship between auditor and stakeholders
Thank you
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